Powell Industries - 10-Q quarterly report FY

     Indicate by “X” 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.

     Indicate by “X” whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

     Common Stock, par value $.01 per share; 10,847,278 shares outstanding as of September 6, 2005.

SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted, requires that each derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability and measured at its fair value. The statement also requires that changes in the derivative’s fair value be recognized currently in earnings in either income (loss) from continuing operations or accumulated other comprehensive income (loss), depending on whether the derivative qualifies for hedge accounting treatment.

On July 14, 2005, the Company entered into a forward foreign exchange contract with a notional amount of 2.1 million Canadian dollars maturing on December 23, 2005. This foreign currency derivative qualifies for and is classified as a fair value hedge. The purpose of the Company’s foreign currency hedging activities is to protect the Company from the risk that the eventual cash flows resulting from transactions in foreign currencies will be adversely affected by changes in exchange rates. Changes in fair values of outstanding fair value hedge derivatives that are effective are recorded in other comprehensive income, until net income is affected by the variability of cash flows of the hedged transaction. In most cases amounts recorded in other comprehensive income will be released to net income some time after the maturity of the related derivative. Gains and losses on these contracts are deferred and recognized as adjustments to either the basis of those assets or foreign exchange gains/losses, as applicable. At July 31, 2005, the fair value of the forward swap contract resulted in an unrealized gain of approximately $13,000.

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” The amendments made by SFAS No. 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after November 23, 2004. We do not believe the adoption of SFAS No. 151 will have a material impact on our consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), “Share-Based Payment.” SFAS No. 123(R) will require that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123(R) replaces FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123, as originally issued in 1995, established as preferable a fair value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in APB Opinion No. 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair value-based method been used. Public entities will be required to apply SFAS No. 123(R) as of the first annual reporting period that begins after June 15, 2005. The impact of the adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future.

We develop, design, manufacture, and service equipment and systems for the management and control of electrical energy and other critical processes. Headquartered in Houston, Texas, we serve the transportation, environmental, industrial, and utility industries. Our business operations are consolidated into two business segments: Electrical Power Products and Process Control Systems. On July 4, 2005 we acquired selected assets and assumed the operating liabilities and contracts of Switchgear and Instrumentation Limited (“S&I”) in the United Kingdom. The operating results of S&I are included in our Electrical Power Products Segment. Financial information related to these business segments is included in Note F of the Notes to Condensed Consolidated Financial Statements.

Consolidated revenues increased $14.1 million to $66.9 million in the third quarter of fiscal 2005 compared to third quarter 2004 revenues of $52.8 million. Revenues increased primarily due to general market recovery, a concerted sales efforts in 2004 aimed at strengthening our backlog and the acquisition in early July 2005 of S&I. The acquisition of S&I added revenues of $3.0 million, all outside the United States, in the third quarter of fiscal 2005. For the three months ended July 31, 2005 domestic revenues increased by 6% to $46.8 million. International revenues were $20.1 million in the third quarter 2005 compared to $8.5 million in the same quarter of the prior year. Revenues outside the United States accounted for 30% of consolidated revenues in the third quarter of fiscal 2005 compared to 16% in the third quarter of fiscal 2004 due primarily to the acquisition of S&I.

For the nine months ended July 31, 2005, consolidated revenues increased $16.0 million to $173.5 million compared to the nine months ended July 31, 2004 of $157.5 million for the reasons indicated above. Domestic revenues for the first nine months of fiscal 2005 were $138.0 million compared to $132.7 million for the first nine months of fiscal 2004. International revenues were $35.6 million for the first nine months of fiscal 2005 compared to $24.8 million for the same period of last year. For the nine months ended July 31, 2005, revenue outside of the United States accounted for 20% of consolidated revenues compared to 16% for the same period a year ago. The acquisition of S&I added revenues of $3.0 million, all outside of the United States, since its acquisition on July 4, 2005.

Our Electrical Power Products segment recorded revenues of $58.2 million in the third quarter of 2005, which includes revenues of $3.0 million from the acquisition of S&I, compared to $43.3 million for the same time period of the previous year. During the third quarter of fiscal 2005, revenues from utility markets and from industrial customers strengthened compared to the same period of the prior year. In the third quarter of fiscal 2005, revenues from public and private utilities were approximately $27.9 million, an increase of $11.1 million compared to the third quarter of fiscal 2004. Revenues from industrial customers totaled $28.7 million in the third quarter of fiscal 2005 compared to $21.6 million in the same period of the prior year. Municipal and transit projects generated revenues of $1.6 million in the third quarter of fiscal 2005 compared to $4.9 million in the same period a year ago.

For the nine months ended July 31, 2005, the Electrical Power Products Segment recorded revenues of $146.4 million, which includes revenues of $3.0 million from the acquisition of S&I, compared to $133.4 million for the first nine months of fiscal 2004. During the first nine months of 2005, revenues from utility markets strengthened from the same period a year ago. Utility revenues totaled $70.8 million, an increase of approximately 52%. Industrial revenues were $68.2 million, compared to $73.1 million a year ago and revenues from municipal and transit projects totaled $7.4 million, compared to $13.8 million for the same period last year.

The Electrical Power Products segment reported gross profit, as a percentage of revenues, of 15.8% in the third quarter of fiscal 2005, compared to 17.4% in the third quarter of fiscal 2004. Excluding the S&I acquisition, segment gross profit would have been 15.6%. Material costs increased $0.3 million in the third quarter of fiscal 2005 compared to the same period a year ago, primarily due to higher unit prices for copper, aluminum and steel. In addition, gross profit margins continue to be adversely impacted in the third quarter of 2005 due to competitive pricing pressures as a result of depressed market levels when projects were bid in previous periods. Gross profit in the third quarter of 2004 was adversely impacted by one-time expenses of $0.9 million associated with our decision to close our Greenville, Texas and Elyria, Ohio facilities. These expenses included employee severance, training and equipment relocation costs.

For the nine months ended July 31, 2005, gross profit as a percentage of revenues decreased to 13.9% from 17.0% for the first nine months of fiscal 2004. Excluding the acquisition of S&I, segment gross profit would have been 13.8%. As discussed above, higher commodity price levels and competitive pricing due to depressed market levels have contributed to lower gross profit. Direct material costs have increased approximately 1.7%, or $1.3 million, during the first nine months of fiscal 2005 compared to the same period a year ago. In addition, incremental production costs of approximately $0.6 million were incurred during the first three months of fiscal 2005 due to start-up difficulties and inefficiencies with our recently relocated distribution switch product line. In addition, we incurred separation costs and other one-time expenses of $1.2 million in the first nine months of 2004 as a result of our decision to consolidate operations.

Revenues in our Process Control Systems segment decreased to $8.7 million in the third quarter of fiscal 2005 from $9.5 million for the same period of the prior year. Revenues related to our contract to design and build the Intelligent Transportation Systems (ITS) for the Holland and Lincoln tunnels have been reduced as certain portions of the work have been deferred and the balance of the project is nearing completion. Partially offsetting lower revenues from this project were revenues of $1.5 million related to the settlement on the Central Artery Tunnel Project as discussed in Note J of the Notes to Condensed Consolidated Financial Statements. For the nine months ended July 31, 2005, segment revenues increased $3.1 million to $27.2 million compared to $24.1 million for the same period of the prior year.

Segment gross profit, as a percentage of revenues, improved to 38.4% in the third quarter of fiscal 2005 compared to 18.9% in the same quarter of the prior year and for the first nine months of fiscal 2005 increased to 27.8% compared to 19.7% in the same period of fiscal 2004. This increase in gross profit margin can be attributed to improved job performance on a number of projects nearing completion and the recovery of previously recognized costs on the Central Artery Tunnel Project.

For additional information related to our business segments, see Note F of the Notes to Condensed Consolidated Financial Statements.

Selling, general and administrative expenses increased by $1.1 million to $9.9 million in the third quarter of 2005 compared to approximately $8.8 million in the same period of last year. Approximately 50% of this increase is related to the operational activities of S&I. Commission expenses for sales representatives as well as, direct sales expenses increased by approximately $0.6 million in the third quarter of 2005 compared to the third quarter of 2004 due to the concerted effort to increase revenues and backlog discussed above. Accounting and professional fees have increased by $0.4 million primarily due to costs incurred for Sarbanes-Oxley compliance as well as for costs associated with acquisition activities. These increases in selling, general and administrative costs were offset by a decrease of approximately $0.5 million as a result of the closing of our facility in Elyria, Ohio in June 2004. Additionally, research and development expenditures decreased to $0.5 million (excluding S&I) in the third quarter of fiscal 2005 from $0.8 million in last year’s third quarter. Selling, general and administrative expenses have also increased due to the commensurate increase in revenue.

For the nine months ended July 31, 2005, selling, general and administrative expenses were $28.8 million, or 16.6% of revenues, compared to $25.6 million, or 16.2% of revenues, for the first nine months of fiscal 2004. Commission expenses for

manufacturing sales representatives, as well as direct sales expenses increased by approximately $1.5 million in the first nine months of fiscal 2005 compared to the same period of fiscal 2004 as a result of the efforts to increase backlog and revenues discussed above. Accounting and professional fees increased by $1.1 million (excluding S&I) in the first nine months of fiscal 2005 compared to the same period of fiscal 2004 primarily due to costs incurred for Sarbanes-Oxley compliance and costs associated with acquisition activities. For the nine months ended July 31, 2005, research and development expenditures decreased to $1.7 million from $2.6 million in first nine months of fiscal 2004 primarily due to a planned reduction in R&D efforts. Additionally, selling, general and administrative expenses in the first nine months of fiscal 2005 were reduced due to the collection of $0.4 million from a customer which had been previously written off in the prior year as bad debt expense. Increases in selling, general and administrative costs were also offset by approximately $0.5 million related to the closing of our facility in Elyria, Ohio in June 2004. Selling, general and administrative expenses have increased due to the commensurate increase in revenue.

Interest expense was approximately $0.1 million in the third quarter of fiscal 2005, an increase of approximately $0.1 million compared to the same period in fiscal 2004. This increase in interest expense is primarily due to additional debt obtained to partially finance the acquisition of S&I. For the nine months ended July 31, 2005, we incurred $0.3 million in interest expense compared to $0.1 million for the same time period of fiscal 2004. This increase is primarily related to the interest payments to state taxing authorities and incurred interest on debt related to the acquisition of S&I.

We earned approximately $0.3 million of interest income in the third quarter of 2005 compared to approximately $0.2 million in the same period of the previous year and approximately $0.9 million in the first nine months of 2005 compared to $0.6 million in the same period of the prior year. Interest income increased primarily due to higher market interest rates and a higher average balance of marketable securities in the first nine months of fiscal 2005 compared to the same period in fiscal 2004.

Our provision (benefit) for income taxes reflects an effective tax rate on earnings before income taxes of 24.5% in the third quarter of fiscal 2005 compared to (12.0%) in the third quarter of fiscal 2004 and an effective tax rate of (259.5%) in the first nine months of fiscal 2005 compared to 23.5% in the first nine months of fiscal 2004. The tax rate for the third quarter and the nine month period results from a change in estimate on our Extraterritorial Income Exclusion Benefit on the prior year federal tax return and the reversal of state income tax accruals from previous years due to the expiration of the statutory limitations. The overall effective tax rate improved as a result of the favorable tax impact of approximately $0.8 million of pretax deductions resulting from the reconciliation of the income tax provision to the prior year income tax return.

In the third quarter of 2005, we generated net income of $2.1 million, or $0.19 per diluted share, compared to net income of $0.7 million, or $0.07 per diluted share, in the third quarter of fiscal 2004. For the nine months ended July 31, 2005, we generated net income of $0.4 million, or $0.04 per diluted share, compared to net income of $1.8 million, or $0.17 per diluted share, for the first nine months of 2004. Lower gross profits in our Electrical Power Products business segment and higher selling, general and administrative expenses offset by the higher gross profits in our Process Control business segments as well as favorable impact from the provision for income taxes contributed to the decrease in net income in the first nine months of fiscal 2005 compared to the same period of the prior year.

The order backlog on July 31, 2005, was $250.8 million, compared to $134.3 million at fiscal year end 2004 and $121.0 million at the end of the third quarter one year ago. New orders placed during the third quarter totaled $135.4 million compared to $42.1 million in the same period one year ago.

Working capital was $97.4 million at July 31, 2005 compared to $99.3 million at October 31, 2004. As of July 31, 2005, current assets exceeded current liabilities by 2.7 times and our debt to capitalization ratio was 11.0%.

As of July 31, 2005, we had cash, cash equivalents and marketable securities of $25.3 million compared to $63.2 million as of October 31, 2004. Long-term debt and capital lease obligations, net of current maturities, totaled $16.0 million at July 31, 2005 compared to $6.6 million at October 31, 2004. In addition to our long-term debt, we have a $22 million revolving credit agreement in the United States and £4 million (approximately $7.0 million) revolving credit agreement in the United Kingdom expiring June 2008. As of July 31, 2005, there were no borrowings under these revolving credit facilities. We were in compliance with all debt covenants as of July 31, 2005.

For the nine months ended July 31, 2005, cash used in operating activities was $27.5 million compared to cash provided by operations of $17.9 million for the nine months ended July 31, 2004. This reduction in cash was principally used to fund growth in accounts receivable, inventories and costs related to uncompleted contracts which were not billed. This use of cash has resulted from the ramp up of our manufacturing operations resulting in working capital being required to fund the increase in volume.

Cash used for the purchase of property, plant and equipment during the nine months ended July 31, 2005 was $3.2 million compared to $4.9 million for the same period of the prior year. The majority of our 2005 capital expenditures were used to improve our capabilities to manufacture switchgear and electrical power control rooms. A year ago, the majority of our capital expenditures were used to increase our manufacturing capabilities available for the manufacture of electrical power modules. These modules are provided to the oil and gas industry for use on offshore platforms. The Company also used $18.5 million for the acquisition of S&I.

Net proceeds from the sale and purchases of auction rate securities during the nine months ended July 31, 2005 were $38.1 million compared to cash used to purchase short-term auction rate securities of $22.2 million for the nine months ended July 31, 2004. Auction rate securities were sold to finance working capital requirements of the business in the first nine months of fiscal 2005.

Financing activities provided $11.4 million for the nine months ended July 31, 2005 compared to $0.7 million in the same period a year ago. The primary source of cash from financing activities was proceeds from borrowings of $10.6 million under the term loan associated with the acquisition of S&I and proceeds from the exercise of stock options.

We expect our principal markets to remain steady throughout the balance of 2005. Customer inquiries, or requests for proposals, have steadily strengthened during the second half of fiscal 2004 and on into 2005. One of the positive trends we have experienced is an increase in new order activity. New orders in the third, second and first quarters of 2005 totaled $135.4 million, $73.6 million and $60.1 million, respectively, compared to $42.1 million, $45.3 million and $33.1 million in the same periods one year ago. We are cautiously optimistic that we will maintain this strengthened order rate throughout fiscal 2005.

In our Electrical Power Products segment, new orders in the third, second and first quarters of 2005 totaled $128.4 million, $62.1 million and $55.5 million, respectively, compared to $40.7 million, $38.4 million and $30.3 million in the same periods one year ago. In addition, we expect to realize lower overhead expenses and increased efficiencies as a result of our consolidation efforts initiated in 2004 and capital improvements, both of which should improve our competitive position. Although our Process Control Systems segment continues to experience soft market conditions, we anticipate increased funding for municipal projects will be available as general economic conditions strengthen. We believe we are well-positioned to take advantage of improving economic conditions.

We anticipate that we may need to reinvest a portion of our cash in operating working capital for the remainder of fiscal 2005. Working capital needs are anticipated to increase with growing levels of business activity. We believe that working capital, borrowing capabilities, and cash generated from operations will be sufficient to finance the anticipated operational activities, capital improvements, debt repayments and possible future acquisitions for the foreseeable future.

We are exposed to certain market risks arising from transactions we have entered into in the normal course of business. These risks primarily relate to fluctuations in interest rates, foreign exchange rates and commodity prices.

We are subject to market risk resulting from changes in interest rates related to our outstanding debt and investments in marketable debt securities. Regarding our various debt instruments outstanding at July 31, 2005 and October 31, 2004, a 100 basis point increase in interest rates would result in a total annual increase in interest expense of less than $200,000. Our investments in marketable debt securities are carried at fair value on the consolidated balance sheet, with unrealized gains and losses reported in other comprehensive income. Changes in interest rates will affect the fair value of the marketable securities as reported. While we do not currently have any derivative contracts to hedge our exposure to interest rate risk, we have in the past and may in the future enter into such contracts. Overall, we believe that changes in interest rates will not have a material near-term impact on our future earnings or cash flows. During each of the past three years, we have not experienced a significant effect on our business due to changes in interest rates.

On July 14, 2005, the Company entered into a forward foreign exchange contract to mature on December 23, 2005. This foreign currency derivative qualifies for and is classified as a foreign currency fair value hedge. The purpose of the Company’s foreign currency hedging activities is to protect the Company from the risk that the eventual cash flows resulting from transactions in foreign currencies will be adversely affected by changes in exchange rates. Changes in fair values of outstanding fair value hedge derivatives that are highly effective are recorded in other comprehensive income, until net income is affected by the variability of cash flows of the hedged transaction. In most cases amounts recorded in other comprehensive income will be released to net income some time after the maturity of the related derivative. Gains and losses on these contracts are deferred and recognized as adjustments to either the basis of those assets or foreign exchange gains/losses, as applicable. At July 31, 2005, the fair value of the forward swap contract resulted in an unrealized gain of approximately $13,000.

We are subject to market risk from fluctuating market prices of certain raw materials. While such materials are typically available from numerous suppliers, commodity raw materials are subject to price fluctuations. We attempt to pass along such commodity price increases to our customers on a contract-by-contract basis to avoid profit margin erosion. While we may do so in the future, we have not entered into any derivative contracts to hedge our exposure to commodity risk in fiscal years 2005 or 2004. We continue to experience significant price pressures with some of our key raw materials. Competitive market pressures limited our ability to pass these cost increases to our customers, thus eroding our earnings in 2004 and the first nine months of fiscal 2005. Fluctuations in commodity prices may have a material near-term effect on our future earnings and cash flows.

Management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, our CEO and CFO have each concluded that as of the end of such period, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosures.

We also maintain a system of internal accounting controls that are designed to provide reasonable assurance that our books and records accurately reflect our transactions and that our policies and procedures are followed. There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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.

POWELL INDUSTRIES, INC.

Registrant