SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number 001-12488

Powell Industries, Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(713) 944-6900

 

Securities registered pursuant to section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of Act:

 

Common Stock, par value $.01 per share

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  o Yes     þ No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  o Yes     þ No

 

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.  þ Yes     o No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

o Large Accelerated Filer     þ Accelerated Filer     o Non-Accelerated Filer

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  o Yes     þ No

 

The aggregate market value of the voting stock held by non-affiliates of the registrant as of the last business day of the most recently completed second fiscal quarter, April 30, 2006, was approximately $267,445,000.

 

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

 

At December 6, 2006, there were outstanding 10,953,846 shares of the registrant’s common stock, par value $0.01 per share.

 

Documents Incorporated By Reference

 

Portions of the registrant’s definitive Proxy Statement for the 2007 annual meeting of stockholders to be filed not later than 120 days after September 30, 2006, are incorporated by reference into Part III of this Form 10-K.

 

 

POWELL INDUSTRIES, INC.
TABLE OF CONTENTS

 

 

Forward-Looking Statements

 

This Annual Report on Form 10-K includes forward-looking statements based on the Company’s current expectations, which are subject to risks and uncertainties. Forward-looking statements include information concerning future results of operations and financial condition. Statements that contain words such as “believes,” “expects,” “anticipates,” “intends,” “estimates,” “continue,” “should,” “could,” “may,” “plan,” “project,” “predict,” “will,” or similar expressions may be forward-looking statements. These forward-looking statements are subject to risks and uncertainties, and many factors could affect the future financial results and condition of the Company. Factors that may have a material effect on our revenues, expenses and operating results include adverse business or market conditions, the Company’s ability to secure and satisfy customers, the availability and cost of materials from suppliers, adverse competitive developments and changes in customer requirements as well as those circumstances discussed under “Item 1A. Risk Factors,” below. Accordingly, actual results may differ materially from those expressed or implied by the forward-looking statements contained in this Annual Report. Any forward-looking statements made by or on our behalf are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

 

The forward-looking statements contained in this Annual Report are based on current assumptions that the Company will continue to develop, market, manufacture, and ship products and provide services on a competitive and timely basis, that competitive conditions in the Company’s markets will not change in a materially adverse way, that the Company will accurately identify and meet customer needs for products and services, that the Company will be able to retain and hire key employees, that the Company’s capabilities will remain competitive, that risks related to shifts in customer demand are minimized and that there will be no material adverse change in the operations or business of the Company. Assumptions relating to these factors involve judgments that are based on available information, which may not be complete, and are subject to changes in many factors beyond the control of the Company that can materially affect results. Because of these and other factors that affect our operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

 

Overview

 

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, energy, industrial, and utility industries.

 

Powell Industries, Inc. (“we,” “us,” “our,” “Powell,” or the “Company”) was incorporated in the state of Delaware in 2004 as a successor to a Nevada company incorporated in 1968. The Nevada corporation was the successor to a company founded by William E. Powell in 1947, which merged into the Company in 1977. Our major subsidiaries, all of which are wholly owned, include: Powell Electrical Systems, Inc., Transdyn, Inc., Powell Industries International, Inc., Switchgear & Instrumentation Limited, and Switchgear & Instrumentation Properties Limited.

 

Our website address is www.powellind.com. We make available free of charge on or through our website copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Paper or electronic copies of such material may also be requested by contacting the Company at our corporate offices.

 

On December 13, 2005, we announced a change in our fiscal year end from October 31 to September 30, effective September 30, 2006. The change was designed to align our financial reporting with calendar quarters and to reduce the impact holidays have on our reporting timeline. As a result, the current period will be reported as an 11 month period ending on September 30, 2006 (“Fiscal 2006”).

 

Our business operations are consolidated into two business segments: Electrical Power Products and Process Control Systems. Approximately 70%, 75% and 86% of our consolidated revenues for the fiscal years ended September 30, 2006, October 31, 2005 and October 31, 2004, respectively, were generated in the United States of America. Approximately 85% of our long-lived assets were located in the United States at September 30, 2006, with the remaining balance located primarily in the United Kingdom. Financial information related to our business and geographical segments is included in Note L of Notes to Consolidated Financial Statements.

 

On August 7, 2006, we purchased certain assets related to the manufacturing of American National Standards Institute (“ANSI”) medium voltage switchgear and circuit breaker business of General Electric Company’s (“GE”) Consumer & Industrial unit located at its West Burlington, Iowa, facility for $32.0 million, not including expenses. The purchase price was paid from existing cash and short-term marketable securities and from borrowings under our revolving credit agreement. In connection with the acquisition, we entered into a 15 year supply agreement with GE pursuant to which GE will purchase from the Company (subject to limited conditions for exceptions) all of its requirements for ANSI medium voltage switchgear and circuit breakers and other related equipment and components. We have also agreed to purchase certain of our required product components and subassemblies from GE. In addition, GE has agreed to provide services related to transitioning the product line from West Burlington, Iowa, to the Company’s facilities in Houston, Texas. The relocation of the product line includes all related product technology and design information, engineering, manufacturing and related activities and is currently estimated to be completed during the first half of 2008. GE is continuing to manufacture the products and supply them to Powell during the transition period. The new product line will be manufactured in Houston, Texas, and will require between 300 and 350 employees. In connection with this acquisition, we entered into a lease agreement for a facility in Houston, Texas, which increased our manufacturing space by approximately 140,000 square feet. We refer to the acquired product line herein as “Power/Vac^®.” The operating results of Power/Vac^® are included in our Electrical Power Products business segment from the acquisition date. For further information on Power/Vac^®, see Note D of Notes to Consolidated Financial Statements.

 

On July 14, 2006, we acquired certain assets and hired the service and administrative employees of an electrical services company in Louisiana for approximately $1.5 million. The purchase price was paid from existing

cash and short-term marketable securities. Approximately $0.6 million of the purchase price was allocated to property, plant and equipment, $0.1 million to a non-compete agreement, $0.6 million to assembled workforce and the remaining $0.2 million to goodwill. The operating results of this acquisition are included in our Electrical Power Products segment from the acquisition date. For further information on this acquisition, see Note D of Notes to Consolidated Financial Statements.

 

On July 4, 2005, we acquired selected assets and assumed certain operating liabilities and contracts of Switchgear & Instrumentation Limited in the United Kingdom. We refer to the acquired business herein as “S&I.” The operating results of S&I are included in our Electrical Power Products segment from that date. Total consideration paid for S&I was approximately $19.2 million, of which approximately $10.3 million of the purchase price was funded from existing cash and investments and the balance was provided through additional debt financing. For further information on S&I, see Note D of Notes to Consolidated Financial Statements.

 

Electrical Power Products

 

Our Electrical Power Products segment designs, develops, manufactures, and markets engineered-to-order electrical power distribution and control systems designed (1) to distribute, monitor and control the flow of electrical energy and (2) to provide protection to motors, transformers and other electrically powered equipment. Our principal products include power control room packages, switchgear, offshore modules, motor control centers, and bus duct systems. These products are designed for application voltages ranging from 480 volts to in excess of 38,000 volts and are used in the transportation, industrial and utility markets.

 

On August 7, 2006, we purchased the Power/Vac^® product line described above and in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview. We believe that this acquisition strengthens our strategic position in the electrical power products business and allows us to reach a broader base of customer.

 

On July 14, 2006, we acquired certain assets and hired the service and administrative employees of an electrical services company in Louisiana. This acquisition allows us to extend sales and service to the Eastern Gulf Coast Region.

 

On July 4, 2005, we acquired selected assets and assumed certain operating liabilities and contracts of Switchgear & Instrumentation Limited in the United Kingdom, as described above and in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview. S&I’s primary manufacturing facility is in the United Kingdom. This acquisition is part of the Company’s overall strategy to increase its international presence. S&I affords Powell the opportunity to serve customers with products covering a wider range of electrical standards and opens new geographic markets previously closed due to our lack of product portfolio that met international electrical design and test standards. The fit, culture and market position of Powell and S&I are favorably comparable to companies with similar reputations in engineered-to-order solutions.

 

Customers and Markets

 

This segment’s principal products are designed for use by and marketed to technologically sophisticated users of large amounts of electrical energy that typically have a need for complex combinations of electrical components and systems. Our customers include oil and gas producers, oil and gas pipelines, refineries, petrochemical plants, electrical power generators, public and private utilities, co-generation facilities, mining/metals, pulp and paper plants, transportation systems, governmental agencies, and other large industrial customers.

 

Products and services are principally sold directly to the end-user or to an engineering, procurement and construction (“EPC”) firm on behalf of the end-user. Each project is specifically tailored to meet the exact specifications and requirements of the individual customer. Powell’s expertise is in the engineering and packaging of the various systems into a single, functional and working deliverable. We market and sell our products and services to a wide variety of customers, markets and geographic regions. During each of the past three fiscal years, we did not have any one customer that accounted for more than 10% of annual segment revenues. Accordingly, we do not believe that the loss of any specific customer would have a material adverse effect on our business. While we are not dependent upon any one customer for revenues, we could be adversely impacted by a significant reduction in

business volume from a particular industry which we currently serve. As a result of the supply agreement we entered into on August 7, 2006 with GE, in the future we expect GE will become a significant customer and will account for more than 10% of annual segment and total revenues.

 

During each of the past three fiscal years, no one country, except for the United States, accounted for more than 10% of segment revenues. For information on the geographic areas in which our consolidated revenues were recorded in each of the past three years, see Note L of Notes to Consolidated Financial Statements.

 

Competition

 

Our Electrical Power Products segment operates in a competitive market where competition for each project varies. The competition may include large multinational firms as well as small regional low-cost providers, depending upon the type of project. This segment’s products and systems are engineered-to-order and packaged to meet the exact specifications of our customers. Many repeat customers seek our involvement in finding solutions to specific project-related issues including physical size, rating, application, installation, and commissioning. We consider our engineering, manufacturing, and service capabilities vital to the success of our business, and believe our technical and project management strengths, together with our responsiveness and flexibility to the needs of our customers, give us a competitive advantage in our markets. Ultimately, our competitive position is dependent upon our ability to provide quality products and systems on a timely basis at a competitive price.

 

Backlog

 

Orders in the Electrical Power Products segment backlog at September 30, 2006 totaled $324.7 million compared to $212.9 million at the end of the previous fiscal year. We anticipate that approximately $290.0 million of our ending 2006 backlog will be fulfilled during our fiscal year 2007. A portion of the increase in backlog relates to the Power/Vac^® acquisition. Orders included in our backlog are represented by customer purchase orders and contracts, which we believe to be firm. However, conditions outside of our control have caused us to experience some customer delays and cancellations of certain projects in the past.

 

Raw Materials and Suppliers

 

The principal raw materials used in Electrical Power Products’ operations include steel, copper, aluminum, and various electrical components. These raw material costs represented approximately 53.7% of our revenues in fiscal 2006. Unanticipated increases in raw material requirements or price increases could increase production costs and adversely affect profitability.

 

We purchase certain key electrical components on a sole-sourced basis and maintain a qualification and performance monitoring program to control risk associated with sole-sourced items. Changes in our design to accommodate similar components from other suppliers could be implemented to resolve a supply problem related to a sole-sourced component. In this circumstance, supply problems could result in short-term delays in our ability to meet commitments to our customers. We believe that sources of supply for raw materials and components are generally sufficient and have no reason to believe a shortage of raw materials will cause any material adverse impact during fiscal year 2007. While we are not dependent on any one supplier for a material amount of our raw materials, we are highly dependent on our suppliers in order to meet commitments to our customers. We did not experience significant or unusual problems in the purchase of key raw materials and commodities in the past three years.

 

Inflation

 

This segment is subject to the effects of changing prices. During fiscal 2005 and 2006, we experienced increased costs for certain commodities, in particular steel, copper and aluminum products, which are used in the production of our products. While the cost outlook for commodities used in production of our products is not certain, we believe we can manage these inflationary pressures through contract pricing adjustments and by actively pursuing internal cost reduction efforts. We did not enter into any derivative contracts to hedge our exposure to commodity price changes in fiscal years 2006, 2005 or 2004.

Employees

 

At September 30, 2006, the Electrical Power Products segment had 1,690 full-time employees located in the United States, the United Kingdom and Singapore. Our employees are not represented by unions, and we believe that our relationship with employees is good.

 

Research and Development

 

This segment’s research and development activities are directed toward the development of new products and processes as well as improvements in existing products and processes. Research and development expenditures were $3.7 million, $2.1 million and $2.7 million in fiscal years 2006, 2005 and 2004, respectively.

 

Intellectual Property

 

While we are the holder of various patents, trademarks, and licenses relating to this segment, we do not consider any individual intellectual property to be material to our consolidated business operations.

 

Process Control Systems

 

Our Process Control Systems segment designs and delivers technology solutions that help our customers manage their critical transportation, environmental, energy, industrial, and utility facilities. We offer a diverse set of professional services that specialize in the design, integration, and support of high-availability control, security/surveillance, and communications systems. These systems allow our customers to safely and effectively manage their vital processes and facilities.

 

Customers and Markets

 

This segment’s products and services are principally sold directly to end-users in the transportation, environmental, energy, and industrial sectors. We may be dependent , from time to time, on one specific contract or customer for a significant percentage of our revenues due to the nature of large, long-term construction projects common to this segment. For example, during 2004, we received a contract to design and build Intelligent Transportation Systems (ITS) for the Port Authority of New York and New Jersey, which accounted for 44% of segment revenues in both fiscal 2004 and fiscal 2005 and 21% in fiscal 2006. In each of the past three fiscal years, we had revenues with one or more customers that individually accounted for more than 10% of our segment revenues. Revenues from these customers totaled $7.9 million, $17.1 million and $14.8 million in fiscal 2006, 2005 and 2004, respectively. Our contracts often represent large-scale, single-need projects with an individual customer. By their nature, these projects are typically nonrecurring for those customers, and multiple and/or continuous requirements of similar magnitude with the same customer are rare. Thus, the inability to successfully replace a completed large contract with one or more contracts of combined similar magnitude could have a material adverse effect on segment revenues.

 

During each of the past three fiscal years, no one country, except for the United States, accounted for more than 10% of segment revenues. For information on the geographic areas in which our consolidated revenues were recorded in each of the past three years, see Note L of Notes to Consolidated Financial Statements.

 

Competition

 

This segment operates in a competitive market where competition for each contract varies. The competition may include large multinational firms as well as small regional low-cost providers, depending upon the type of system and customer requirements.

 

Our customized systems are designed to meet the specifications of our customers. Each order is designed, delivered, and installed to the unique requirements of the particular application. We consider our engineering, systems integration, installation, and support capabilities vital to the success of our business. We believe our technical software products and project management strengths, together with our responsiveness, our flexibility, financial strength, and our over thirty-year history of supporting mission-critical systems give us a competitive advantage in our markets.

Backlog

 

Orders in the Process Control Systems segment backlog at September 30, 2006 totaled $30.4 million compared to $46.1 million at the end of the previous fiscal year. We anticipate that approximately $15.5 million of our year-end 2006 backlog will be fulfilled during our 2007 fiscal year. Orders included in our backlog are represented by customer purchase orders and contracts, which we believe to be firm. We have not experienced a material amount of canceled orders during the past three fiscal years.

 

Employees

 

The Process Control Systems segment had 110 full-time employees at September 30, 2006, all located in the United States. Our employees are not represented by unions and we believe that our relationship with employees is good.

 

Research and Development

 

The majority of research and development activities of this segment are directed toward the development of our software suites for the management and control of the critical processes and facilities of our customers. Research and development expenditures were $0.6 million, $0.7 million and $0.8 million in fiscal years 2006, 2005 and 2004, respectively.

 

Intellectual Property

 

While we are the holder of various copyrights related to software for this segment, we do not consider any individual intellectual property to be material to our consolidated business operations.

 

Our business is subject to a variety of risks, including the risks described below. While we believe that the risks and uncertainties described below are the most significant risks and uncertainties facing our business, they are not the only ones facing our company. Additional risks and uncertainties not known to us or not described below may also impair our business operations. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed and we may not be able to achieve our goals. This Annual Report also includes statements reflecting assumptions, expectations, projections, intentions or beliefs about future events that are intended as “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 and should be read in conjunction with the discussion under Forward-Looking Statements, above.

 

Our industry is highly competitive

 

Many of our competitors are significantly larger and have substantially greater resources than we do. Competition in the industry depends on a number of factors, including price. Certain of our competitors may have lower cost structures and may, therefore, be able to provide their products or services at lower prices than we are able to provide. We cannot be certain that our competitors will not develop the expertise, experience and resources to provide services that are superior in both price and quality to our services. Similarly, we cannot be certain that we will be able to maintain or enhance our competitive position within our industry, maintain our customer base at current levels or increase our customer base.

 

An economic downturn may lead to lower demand for our services

 

If the general level of economic activity deteriorates from current levels, our customers may delay or cancel new projects. A number of factors, including financing conditions for and potential bankruptcies in the industries we serve, could adversely affect our customers and their ability or willingness to fund capital expenditures in the future or pay for services. In addition, consolidation, competition or capital constraints in the industries we serve may result in reduced spending by, or the loss of, one or more of our customers.

International and political events may adversely affect our operations

 

International sales accounted for approximately 30% of our revenues in fiscal 2006, including sales from our operations in the United Kingdom. We primarily operate in developed countries with stable operating and fiscal environments. The occurrence of any of the risks described below could have an adverse effect on our consolidated results of operations, cash flows and financial condition:

 

 

Fluctuations in the price and supply of raw materials used to manufacture our products may reduce our profits

 

Our raw material costs represented approximately 53% of our revenues for the 11 months ended September 30, 2006. We purchase a wide variety of raw materials to manufacture our products including steel, aluminum, copper, and various electrical components. Unanticipated increases in raw material requirements or price increases could increase production costs and adversely affect profitability.

 

Our dependence upon fixed-price contracts could result in reduced profits, or in some cases, losses, if costs increase above our estimates

 

We currently generate, and expect to continue to generate, a significant portion of our revenues under fixed-price contracts. We must estimate the costs of completing a particular project to bid for fixed-price contracts. The cost of labor and materials, however, may vary from the costs we originally estimated. These variations, along with other risks inherent in performing fixed-price contracts, may cause actual revenue and gross profits for a project to differ from those we originally estimated and could result in reduced profitability or losses on projects. Depending upon the size of a particular project, variations from the estimated contract costs could have a significant impact on our operating results for any fiscal quarter or year.

 

Our acquisition strategy involves a number of risks

 

Our strategy has been to pursue growth and product diversification through the acquisition of companies or assets that will enable us to expand our product and service offerings. We routinely review potential acquisitions. However, we may be unable to implement this strategy if we cannot reach agreement on potential strategic acquisitions on acceptable terms or for other reasons. Moreover, our acquisition strategy involves certain risks, including:

 

 

Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on attractive terms.

 

Our use of percentage-of-completion accounting could result in a reduction or elimination of previously reported profits

 

As discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” and in Notes to Consolidated Financial Statements, a significant portion of our revenues is recognized on a percentage-of-completion method of accounting. The percentage-of-completion accounting practice we use results in our recognizing contract revenues and earnings ratably over the contract term in proportion to our incurrence of contract costs, primarily labor. The earnings or losses recognized on individual contracts are based on estimates of contract revenues, costs and profitability. Contract losses are recognized in full when determined, and contract profit estimates are adjusted based on ongoing reviews of contract profitability. Previously recorded estimates are adjusted as the project is completed. In certain circumstances, it is possible that such adjustments could be significant.

 

We may not be able to fully realize the revenue value reported in our backlog

 

We have a backlog of work to be completed on contracts. Orders included in our backlog are represented by customer purchase orders and contracts, which we believe to be firm. Backlog develops as a result of new business taken, which represents the revenue value of new project commitments received by us during a given period. Backlog consists of projects which have either (1) not yet been started or (2) are in progress and are not yet complete. In the latter case, the revenue value reported in backlog is the remaining value associated with work that has not yet been completed. From time to time, projects are canceled that appeared to have a high certainty of going forward at the time they were recorded as new business taken. In the event of a project cancellation, we may be reimbursed for certain costs but typically have no contractual right to the total revenue reflected in our backlog. In addition to being unable to recover certain direct costs, canceled projects may also result in additional unrecoverable costs due to the resulting under utilization of our assets.

 

Our operating results may vary significantly from quarter to quarter

 

Our quarterly results may be materially and adversely affected by:

 

 

Accordingly, our operating results in any particular quarter may not be indicative of the results that you can expect for any other quarter or for an entire year.

We may be unsuccessful at generating internal growth

 

Our ability to generate internal growth will be affected by, among other factors, our ability to:

 

 

In addition, our customers may reduce the number or size of projects available to us. Many of the factors affecting our ability to generate internal growth may be beyond our control, and we cannot be certain that our strategies will be successful or that we will be able to generate cash flow sufficient to fund our operations and to support internal growth. If we are unsuccessful, we may not be able to achieve internal growth, expand our operations or grow our business.

 

The departure of key personnel could disrupt our business

 

We depend on the continued efforts of our executive officers and senior management. We cannot be certain that any individual will continue in such capacity for any particular period of time. The loss of key personnel, or the inability to hire and retain qualified employees, could negatively impact our ability to manage our business.

 

Our business requires skilled labor, and we may be unable to attract and retain qualified employees

 

Our ability to maintain our productivity and profitability will be limited by our ability to employ, train and retain skilled personnel necessary to meet our requirements. We may experience shortages of qualified personnel. We cannot be certain that we will be able to maintain an adequate skilled labor force necessary to operate efficiently and to support our growth strategy or that our labor expenses will not increase as a result of a shortage in the supply of skilled personnel. Labor shortages or increased labor costs could impair our ability to maintain our business or grow our revenues.

 

Unforeseen difficulties with the implementation or operation of our enterprise resource planning system could adversely affect our internal controls and our business

 

We contracted with an independent consultant to assist us with the configuration and implementation of an enterprise resource planning system that supports our human resources, accounting, estimating, financial, job management, and customer systems. We are currently implementing this system. The efficient execution of our business is dependent upon the proper functioning of our internal systems. Any significant failure or malfunction of our enterprise resource planning system may result in disruption of our operations. Our results of operations could be adversely affected if we encounter unforeseen problems with respect to the operation of this system.

 

Failure to successfully comply with Section 404 of the Sarbanes-Oxley Act of 2002 on a timely basis could seriously harm our business

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on our internal controls over financial reporting and also requires our independent registered public accountants to attest to this report. Although we have historically been able to successfully comply with Section 404, in the future, we may not be successful in complying with Section 404 on a timely basis. The failure to comply with Section 404 could negatively impact our financial condition and results of operations.

 

Actual and potential claims, lawsuits and proceedings could ultimately reduce our profitability and liquidity and weaken our financial condition

 

We are likely to continue to be named as a defendant in legal proceedings claiming damages from us in connection with the operation of our business. Most of the actions against us arise out of the normal course of our performing services or manufacturing equipment. We are and will likely continue to be a plaintiff in legal proceedings

against customers, in which we seek to recover payment of contractual amounts due to us as well as claims for increased costs incurred by us. When appropriate, we establish provisions against certain legal exposures, and we adjust such provisions from time to time according to ongoing developments related to each exposure. If in the future our assumptions and estimates related to such exposures prove to be inadequate or wrong, our consolidated results of operations, cash flows and financial condition, could be adversely affected. In addition, claims, lawsuits and proceedings may harm our reputation or divert management resources away from operating our business.

 

Technological innovations by competitors may make existing products and production methods obsolete

 

All of the products manufactured and sold by the Company depend upon the best available technology for success in the market place. The competitive environment is highly sensitive to technological innovation in both segments of our business. It is possible for competitors (both domestic and foreign) to develop products or production methods, which will make current products obsolete or at least hasten their obsolescence.

 

None.

 

We have manufacturing facilities, sales offices, field offices, and repair centers located throughout the United States, and we have a manufacturing facility in the United Kingdom. We also rent manufacturing space in Singapore on an as needed basis. Our facilities are generally located in areas that are readily accessible to raw materials and labor pools and are maintained in good condition. These facilities, together with recent expansions, are expected to meet our needs for the foreseeable future.

 

Our principal manufacturing locations by segment as of September 30, 2006, are as follows:

 

 

In connection with the acquisition of the Power/Vac^® product line, we entered into a lease agreement for a facility in Houston, Texas which increased our manufacturing space by 138,600 square feet. For further information on Power/Vac^®, see Note D of Notes to Consolidated Financial Statements.

 

All leased properties are subject to long-term leases with remaining lease terms ranging from one to seven years as of September 30, 2006. We do not anticipate experiencing significant difficulty in retaining occupancy of any of our leased facilities through lease renewals prior to expiration or through month-to-month occupancy, or in replacing them with equivalent facilities.

 

We previously entered into a construction joint venture agreement to supply, install and commission a Supervisory Control and Data Acquisition System (“SCADA”) to monitor and control the distribution and delivery of fresh water to the City and County of San Francisco Public Utility Commission (“Commission”). The project was substantially completed and has been performing to the satisfaction of the Commission. However, various factors outside the control of the Company and its joint venture partner caused numerous changes and additions to the work

that in turn delayed the completion of the project. The Commission has withheld liquidated damages and earned contract payments from the joint venture. The Company has made claims against the Commission for various matters including compensation for extra work and delay to the project.

 

The Company is currently pursuing the recovery of amounts owed under the contract, as well as legal and other costs incurred to prosecute its claim. Unless this matter is otherwise resolved, it is expected to go to trial in fiscal 2007 in Alameda County Superior Court, State of California. As of September 30, 2006, the Company had approximately $1.6 million recorded in the consolidated balance sheet for contractually owed amounts in accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts related to its portion of this contract. During the last three fiscal years, the Company’s gross profit has been reduced by approximately $2.3 million in fiscal 2006, $2.9 million in fiscal 2005 and $0.9 million in fiscal 2004 related to direct costs, including legal fees related to this dispute. Consistent with Company policy, only contractual cost and costs of directed change orders have been recorded by the Company. No amounts have been recorded by the Company related to the Company’s claims and counterclaims alleging breach of the agreement. Although a failure to recover the amounts recorded could have a material adverse effect on the Company’s results of operations, the Company believes that, under the circumstances and on the basis of information now available, an unfavorable outcome is unlikely.

 

We did not submit any matter to a vote of our stockholders during the fourth quarter of fiscal year 2006.

 

 

Price Range of Common Stock

 

Our common stock trades on the Nasdaq Global Market (formerly the Nasdaq National Market) under the symbol “POWL.” The following table sets forth, for the periods indicated, the high and low sales prices per share as reported on the Nasdaq Global Market for our common stock.

 

 

As of December 6, 2006, the last reported sales price of our common stock on the Nasdaq Global Market was $27.92 per share. As of December 6, 2006, there were 612 stockholders of record of our common stock. All common stock held in broker accounts are recorded in the Company’s stock register as being held by one stockholder.

 

See Part III, Item 12 for information regarding securities authorized for issuance under our equity compensation plan.

 

Dividend Policy

 

Our current credit agreements limit the payment of dividends, other than dividends payable solely in our capital stock, without prior consent of our lenders. To date, we have not paid cash dividends on our common stock,

and for the foreseeable future we intend to retain earnings for the development of our business. Future decisions to pay cash dividends will be at the discretion of the Board of Directors and will depend upon our results of operations, financial condition and capital expenditure plans and restrictive covenants under our credit facilities, along with other relevant factors.

 

The selected financial data shown below for the past five years (including the 11 month period ended September 30, 2006) was derived from our audited financial statements. The historical results are not necessarily indicative of the operating results to be expected in the future. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

 

On August 7, 2006, we purchased certain assets related to the American National Standards Institute (“ANSI”) medium voltage switchgear and circuit breaker business of General Electric Company’s (“GE”) Consumer & Industrial unit located at its West Burlington, Iowa facility. We refer to the acquired product line as “Power/Vac^®.” The operating results of the Power/Vac^® product line are included from that date.

 

On July 14, 2006, we acquired certain assets and hired the service and administrative employees of an electrical services company in Louisiana. The operating results of this acquisition are included in our Electrical Power Products segment from that date.

 

On July 4, 2005, we acquired selected assets and assumed certain operating liabilities and contracts of Switchgear & Instrumentation Limited in the United Kingdom. We refer to the acquired business as “S&I.” The operating results of S&I are included from that date.

 

 

 

The following discussion should be read in conjunction with the accompanying consolidated financial statements and related notes. Any forward-looking statements made by or on our behalf are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Readers are cautioned that such forward-looking statements involve risks and uncertainties in that the actual results may differ materially from those projected in the forward-looking statements. For a description of the risks and uncertainties, please see “Cautionary Statement Regarding Forward-Looking Statements; Risk Factors” and “Item 1A. Risk Factors” contained in this Form 10-K.

 

Overview

 

We have experienced a marked improvement in market demand for our products and services. In fiscal 2006, our markets improved considerably over the difficult market conditions that existed in fiscal 2004 and 2005. Additionally, market price levels have improved as the overall volume of business activity has increased. We believe this improvement in the market should benefit our operating results in fiscal 2007.

 

This past year, we continued our strategy of strengthening our capabilities in our Electrical Power Products business segment with the acquisition of the Power/Vac^® medium voltage switchgear product line from General Electric. The Power/Vac^® switchgear product line enhances our product offering, comes with a large installed base and has a broad customer base across utility, industrial and commercial markets. In connection with the acquisition, we entered into a 15-year supply agreement with GE in which GE will purchase from Powell (subject to limited conditions for exceptions) all of its requirements for ANSI medium voltage switchgear and circuit breakers and other related equipment and components. The Power/Vac^® product line, together with our long-term commercial alliance with GE, is expected to significantly strengthen our position in the marketplace and will enable us to reach a broader market and gain access to new customers. Additional information concerning this acquisition, related debt and business segments, is included in Notes D, H and L, respectively, of Notes to Consolidated Financial Statements. The operating results of the Power/Vac^® product line are included in our Electrical Power Products segment from the acquisition date.

 

In 2005, we significantly enhanced our international presence and improved our capability to serve our existing base of global customers with the acquisition of an International Electrotechnical Commission (“IEC”) switchgear product portfolio. S&I is a leading supplier of IEC equipment, including medium and low voltage switchgear, intelligent motor control systems and power distribution solutions to a wide range of process industries with a focus on oil and gas, petrochemical, and other process-related industries. S&I’s primary manufacturing facility is located in the United Kingdom. We anticipate opportunities outside of the United States to continue to grow, and with the integration with our U.S. operations, S&I will continue to significantly improve our ability to support the worldwide investment in oil and gas production, refineries and petrochemical facilities. Additional information concerning this acquisition, related debt and business segments is included in Notes D, H and L,

respectively, of Notes to Consolidated Financial Statements. The operating results of S&I are included in our Electrical Power Products segment from the acquisition date.

 

Beginning in late fiscal 2005, our principal industry and utility markets entered into a new investment cycle. Customer inquiries, or requests for proposals, steadily strengthened during the second half of fiscal 2005 which led to a strengthening in new orders in fiscal 2006. One of the positive trends we have experienced is an increase in new order activity. Orders received during the second half of fiscal 2006 totaled $278.2 million versus $226.8 million in the same period a year ago. We currently anticipate that this higher level of business activity will continue into fiscal 2007.

 

Results of Operations

 

Eleven Months Ended September 30, 2006 (“Fiscal 2006”) Compared to Twelve Months Ended October 31, 2005 (“Fiscal 2005”)

 

Revenue and Gross Profit

 

Consolidated revenues increased $117.9 million to $374.5 million in Fiscal 2006 compared to $256.6 million in Fiscal 2005. Our previously described acquisitions of the Power/Vac^® product line in August 2006 and S&I in July 2005 added revenues of $70.7 million and $19.9 million in Fiscal 2006 and Fiscal 2005, respectively. Domestic revenues in Fiscal 2006 were $263.1 million compared to $191.7 million in Fiscal 2005. Total international revenues were $111.5 million in Fiscal 2006 compared to $64.9 million in Fiscal 2005. International revenue accounted for 29.8% of consolidated revenues in Fiscal 2006 compared to 25.3% in Fiscal 2005; the increase was primarily due to acquisition related revenues. Gross profit in Fiscal 2006 increased by approximately $27.4 million compared to Fiscal 2005 as a result of improved backlog volume and pricing. The increase in gross profit was partially offset by $0.8 million for estimated costs related to the resolution of a specific product performance issue in Fiscal 2006.

 

Electrical Power Products

 

Our Electrical Power Products segment recorded revenues of $347.9 million in Fiscal 2006 compared to $220.1 million in Fiscal 2005. Our previously described acquisitions of the Power/Vac^® product line in August 2006 and S&I in July 2005 added revenues of $70.7 million and $19.9 million in Fiscal 2006 and Fiscal 2005, respectively. During Fiscal 2006, revenues in all our major markets strengthened compared to the prior year. In Fiscal 2006, revenues from public and private utilities were approximately $113.6 million, an increase of $35.2 million compared to Fiscal 2005. Revenues from industrial customers totaled $204.4 million in Fiscal 2006, a 54% increase over Fiscal 2005. Municipal and transit projects generated revenues of $29.9 million in Fiscal 2006 compared to $8.6 million in Fiscal 2005.

 

Segment gross profit as a percentage of revenues increased to 18.3% in Fiscal 2006 from 15.2% in Fiscal 2005. This increase in gross profit resulted from improved pricing, operating efficiencies resulting from increased volume, as well as increased services and replacement projects as a result of the hurricanes of 2005 along the Gulf Coast Region. Direct material costs increased approximately 2.1%, or $3.7 million, during Fiscal 2006 compared to Fiscal 2005 primarily due to higher unit prices for copper. In addition, incremental production costs of approximately $0.6 million were incurred during Fiscal 2005 due to start-up difficulties and inefficiencies related to the relocation of our distribution switch product line.

 

Process Control Systems

 

Revenues in our Process Control Systems segment decreased to $26.6 million in Fiscal 2006 from $36.5 million in Fiscal 2005. This decrease in revenues is attributable to a decrease in the proportion of subcontracted installation activities and the substantial completion of various large projects in 2005 and early 2006. Process Control Systems recorded revenues and profit of $1.7 million from the settlement of a claim related to the Central Artery/Tunnel Project in Fiscal 2005.

 

Segment gross profit decreased to $7.6 million in Fiscal 2006 compared to $10.5 million in Fiscal 2005 primarily related to the settlement of the claim related to the Central Artery/Tunnel Project mentioned above. Gross

profit was negatively impacted by approximately $2.3 million and $2.9 million in Fiscal 2006 and Fiscal 2005, respectively, primarily due to legal and other costs incurred related to the recovery of amounts owed on a previously completed contract.

 

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

 

Consolidated Selling, General and Administrative Expenses

 

Consolidated selling, general and administrative expenses decreased to 14.8% of revenues in Fiscal 2006 compared to 16.3% of revenues in Fiscal 2005. Selling, general and administrative expenses were $55.3 million in Fiscal 2006, an increase of $13.5 million over Fiscal 2005, of which the operating activities of the S&I and Power/Vac^® acquisitions accounted for $7.1 million of the increase. Research and development expenditures were $4.2 million in Fiscal 2006 compared to $2.8 million in Fiscal 2005. The adoption of SFAS No. 123R and the vesting modification increased selling, general, and administrative expenses by approximately $2.0 million in Fiscal 2006. Salaries and incentive wages increased by approximately $1.2 million in Fiscal 2006 compared to Fiscal 2005. In addition, amortization expense increased approximately $0.7 million, of which $0.5 million was attributable to our recent acquisitions. The remaining increase of $1.1 million is primarily attributable to increased professional fees as well as an overall increase due to the increase in volume discussed above.

 

Interest Income and Expense

 

Interest expense was approximately $1.6 million in Fiscal 2006, an increase of approximately $0.9 million compared to Fiscal 2005. The increase in interest expense is primarily due to additional debt incurred to partially finance acquisitions and interest payments to state taxing authorities.

 

Interest income was $0.9 million in Fiscal 2006 compared to $1.1 million in Fiscal 2005. This decrease was a result of decreased marketable securities.

 

Provision for Income Taxes

 

Our provision (benefit) for income taxes reflects an effective tax rate on earnings before income taxes of 35.0% in Fiscal 2006 compared to 33.0% in Fiscal 2005. Our effective tax rate will generally be lower due to income generated in the United Kingdom which has a lower statutory rate than the United States; however, the lower statutory rate will be offset by certain expenses that are not deductible for tax purposes in the United Kingdom, such as amortization of intangible assets.

 

The lower tax rate for Fiscal 2005 resulted 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 in connection with the reconciliation of the income tax provision to the prior year income tax return.

 

In addition, adjustments to estimated tax accruals are analyzed and adjusted quarterly as events occur to warrant such change. Adjustments to tax accruals are a component of the effective tax rate.

 

Net Income

 

In Fiscal 2006 we recorded net income of $9.8 million, or $0.89 per diluted share, compared to $2.3 million, or $0.21 per diluted share for Fiscal 2005. Higher revenues and improved gross profits in our Electrical Power Products business segment, partially offset by increased selling, general and administrative expenses associated with higher levels of business activity including the effect of our acquisitions, have improved net income in Fiscal 2006 compared to Fiscal 2005. These increases were partially offset by the reduction in net income in Fiscal 2006 by non-cash compensation expense related to stock options and additional sales tax expense recorded due to an unfavorable outcome from a state audit. Additionally, net income in Fiscal 2005 was increased by the favorable settlement of the Central Artery/Tunnel Project.

Backlog

 

The order backlog on September 30, 2006 was $355.1 million, compared to $259.0 million at October 31, 2005. New orders placed during Fiscal 2006 totaled $470.7 million compared to $360.5 million in Fiscal 2005. This increase in orders is primarily related to our acquisition of the Power/Vac^® product line.

 

Year ended October 31, 2005 Compared to Year Ended October 31, 2004

 

Revenue and Gross Profit

 

Consolidated revenues increased 24.5% to $256.6 million in fiscal 2005 compared to fiscal 2004 revenues of $206.1 million. Revenues increased primarily due to general market recovery, a concerted sales effort aimed at strengthening our backlog and our acquisition of S&I in July 2005. The S&I acquisition added revenues of $19.9 million, all outside the United States, in fiscal 2005. For the twelve months ended October 31, 2005, revenues in the United States increased by 8% to $191.7 million. Revenues outside of the United States were $64.9 million in fiscal 2005 compared to $29.0 million in the prior year, primarily due to our acquisition of S&I. Revenues outside of the United States accounted for 25% of consolidated revenues in fiscal 2005 compared to 14% in fiscal 2004, primarily due to our acquisition of S&I.

 

Electrical Power Products

 

Our Electrical Power Products segment recorded revenues of $220.1 million in fiscal 2005, which includes revenues of $19.9 million from our July 2005 acquisition of S&I, compared to $173.5 million for the previous year. During fiscal 2005, revenues from utility markets and from industrial customers strengthened compared to the prior year. In fiscal 2005, revenues from public and private utilities were approximately $78.4 million, an increase of $19.6 million compared to fiscal 2004. Revenues from industrial customers totaled $133.1 million in fiscal 2005, a 36% increase over the prior year. Municipal and transit projects generated revenues of $8.6 million in fiscal 2005 compared to $16.7 million in fiscal 2004.

 

The Electrical Power Products segment reported gross profit, as a percentage of revenues, of 15.2% in fiscal 2005, compared to 16.8% in fiscal 2004. Material costs for basic commodities increased $1.5 million in fiscal 2005 compared to fiscal 2004, primarily due to higher unit prices for copper, aluminum and steel. In addition, gross profit margins were adversely impacted in fiscal 2005 due to competitive pricing pressures as a result of depressed market levels when projects were bid in previous periods. Gross profit in fiscal 2004 was adversely impacted by one-time expenses of $1.8 million associated with our decision to close certain underutilized operating facilities. These expenses included employee severance, training and equipment relocation costs.

 

Process Control Systems

 

Revenues in our Process Control Systems segment increased to $36.5 million in fiscal 2005 from $32.7 million in fiscal 2004. The strength of our revenues is related, in part, to our contract to design and build the Intelligent Transportation Systems (ITS) for the Holland and Lincoln tunnels. Revenues in fiscal 2005 also include $1.7 million related to the favorable settlement of a claim which was not recorded by the Company related to the Central Artery/Tunnel Project.

 

Segment gross profit, as a percentage of revenues, improved to 28.7% in fiscal 2005 compared to 21.0% in fiscal 2004. This increase in gross profit margin can be attributed to improved execution on a number of projects nearing completion and the recovery of previously recognized costs on the Central Artery/Tunnel Project. Additionally, gross profit was negatively impacted by approximately $2.9 million in 2005 and $0.9 million in 2004 related primarily to legal costs incurred related to the recovery of amounts owed on a previously completed contract.

 

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

Consolidated Selling, General and Administrative Expenses

 

Consolidated selling, general and administrative expenses increased 18.1% to $41.8 million in fiscal 2005 compared to $35.4 million in fiscal 2004. Approximately 33% of this increase is related to the business activities of S&I, acquired in July 2005. Commission expenses for sales representatives as well as direct sales expenses increased by approximately $1.7 million in fiscal 2005 compared to fiscal 2004 due to the concerted effort to increase revenues and backlog discussed above. Accounting and professional fees have increased by $1.5 million primarily due to costs incurred for Sarbanes-Oxley compliance and costs associated with on-going acquisition activities. These increases in selling, general and administrative costs were partially offset by one-time costs incurred in fiscal 2004 of approximately $0.4 million and reduced costs in 2005 resulting from the closing of certain manufacturing facilities. Additionally, research and development expenditures decreased to $2.8 million in fiscal 2005 from $3.5 million in fiscal 2004. Selling, general and administrative expenses have also increased due to the commensurate increase in revenue.

 

Interest Income and Expense

 

Interest expense increased by $0.6 million to $0.7 million in fiscal 2005. This increase is primarily related to interest on debt incurred in July 2005 related to our acquisition of S&I and interest payments to state taxing authorities.

 

We earned approximately $1.1 million of interest income in fiscal 2005 compared to approximately $0.9 million in fiscal 2004. Interest income increased primarily due to higher market interest rates in fiscal 2005 compared to fiscal 2004.

 

Provision for Income Taxes

 

Our provision for income taxes reflects an effective tax rate on earnings before income taxes of 33.0% in fiscal 2005 compared to a benefit of 20.7% in fiscal 2004.

 

During 2005 and 2004, we recorded several tax adjustments related to the following items:

 

a) A $0.4 million benefit was recorded for the years ended 2005 and 2004 primarily for the benefit of revised extraterritorial income exclusion amounts. This benefit was derived by calculating the extraterritorial income exclusion amount on a transaction by transaction basis in 2004 and 2003, as opposed to an aggregate basis as originally estimated;

 

b) A $0.3 million valuation allowance related to capital losses was released in 2004. We entered into an agreement in 2004 to sell a capital asset that will trigger enough capital gain to utilize the capital loss carry forward;

 

c) We reduced our income tax provision by $0.2 million in 2004 due to acceptance by certain state taxing authorities of voluntary disclosure agreements in 2004; and

 

d) We increased our income tax provision by $0.3 million in 2005 related to certain adjustments from audits of our prior year federal tax returns.

 

Net Income

 

In fiscal 2005, we generated net income of $2.3 million, or $0.21 per diluted share, compared to net income of $1.7 million, or $0.15 per diluted share, in fiscal 2004. Higher gross profits from our Process Control Systems business segment and S&I, our sale of land and building, partially offset by higher selling, general and administrative expenses and interest expense have contributed to the overall increase in net income in fiscal 2005 compared to fiscal 2004.

 

Backlog

 

The order backlog on October 31, 2005 was $259.0 million, compared to $134.3 million at fiscal year end 2004, an increase of 93%. Orders included in backlog are represented by customer purchase orders and contracts,

which we believe to be firm. New orders placed during the year totaled $360.5 million compared to $182.9 million in fiscal 2004. A portion of the increase in backlog related to a contract totaling approximately $51.0 million over a four-year period. This contract is with a municipal agency and production began in the first quarter of fiscal 2006.

 

Liquidity and Capital Resources

 

We have maintained a positive liquidity position. Working capital was $96.7 million at September 30, 2006, compared to $103.4 million at October 31, 2005. As of September 30, 2006, current assets exceeded current liabilities by 2.0 times and our debt to total capitalization ratio was 21.1%.

 

At September 30, 2006, we had cash, cash equivalents and marketable securities of $10.5 million, compared to $33.0 million at October 31, 2005. Long-term debt and capital lease obligations, including current maturities, totaled $42.4 million at September 30, 2006, compared to $21.5 million at October 31, 2005. In addition to our long-term debt, we have a $42.0 million revolving credit agreement in support of our U.S. debt requirements and an additional £4.0 million (approximately $7.5 million) revolving credit agreement in the United Kingdom, both of which expire December 2010. As of September 30, 2006, there was approximately $5.4 million borrowed under these lines of credit. For further information regarding our debt, see Note H and K of Notes to Consolidated Financial Statements.

 

Operating Activities

 

During Fiscal 2006 and Fiscal 2005, cash used in operating activities was $4.7 million and $21.2 million, respectively, compared to cash provided by operations of $24.9 million in fiscal 2004. This was principally a result of the growth in accounts receivable, inventories and costs related to uncompleted contracts which have not been billed and the acquisitions previously described. We have used this cash, among other things, for working capital to support our increased levels of business activity. Lower levels of business activity in 2005 and 2004 resulted in lower levels of working capital required to support operating needs.

 

Investing Activities

 

Investments in property, plant and equipment during Fiscal 2006 totaled $8.4 million compared to $6.1 million and $6.5 million in fiscal 2005 and 2004, respectively. The majority of our 2006 capital investments were used to improve our capabilities to manufacture switchgear and electrical power control rooms as well as investments in a new ERP system. We have incurred approximately $6.6 million as of September 30, 2006 related to the implementation of the ERP system at our domestic Electrical Power Products operations. This implementation will continue into 2007 and will include our operation in the United Kingdom. During 2005 and 2004, the majority of our capital expenditures were used to increase our manufacturing capabilities to produce switchgear, electrical power control and power control modules. In 2006, investing activities included cash expenditures of $9.7 million for the acquisition of the Power/Vac^® product line from GE (which does not include the total $32.0 million purchase price payable over 40 months) and $1.5 million for the acquisition of the services business in Louisiana previously described. In 2005, investing activities included costs of $19.2 million for the acquisition of S&I.

 

Proceeds from the sale of fixed assets provided cash of $0.8 million and $0.9 million in Fiscal 2006 and 2005, respectively, primarily from the sale of idled manufacturing facilities.

 

Net proceeds from the sale and purchase of marketable securities were $8.2 million in Fiscal 2006 compared to $42.2 million in fiscal 2005. Marketable securities were sold to finance working capital requirements of the business in Fiscal 2006. During 2004, net cash of $22.6 million was used to purchase various types of marketable securities as a result of positive operating cash flow in 2004.

 

Financing Activities

 

Net cash provided by financing activities was $0.7 million, $15.4 million and $0.6 million in Fiscal 2006, 2005 and 2004, respectively. The primary source of cash from financing activities in Fiscal 2006 and fiscal 2004 was proceeds from the exercise of stock options. Additionally, in Fiscal 2005 net cash provided by financing activities

from borrowings associated with our acquisition of S&I of $10.6 million and $4.3 million under the UK Term Loan and UK revolving line of credit.

 

Contractual Obligations

 

At September 30, 2006, our long-term contractual obligations were limited to debt and leases. The table below details our commitments by type of obligation, including interest if applicable, and the period that the payment will become due (in thousands).

 

 

Other Commercial Commitments

 

The following table reflects other commercial commitments or potential cash outflows that may result from a contingent event (in thousands):

 

 

We are contingently liable for secured and unsecured letters of credit of $13.6 million as of September 30, 2006, of which $12.7 million reduces our borrowing capacity. We also had performance bonds totaling approximately $122.6 million that were outstanding at September 30, 2006. Performance bonds are used to guarantee contract performance to our customers.

 

Outlook for Fiscal 2007

 

Our backlog of orders going into fiscal 2007 is approximately $355.1 million, the strongest in the history of the Company. Customer inquiries, or requests for proposals have strengthened during the last three fiscal years. We anticipate that strong business activities will continue into fiscal 2007.

 

Our Electrical Power Products segment has reported increased backlog for the last three fiscal years. Backlog growth has been driven by strong market demand in petrochemical, utility and transportation markets. Additionally, our recent acquisitions have strengthened our strategic position in the electrical power products market and enhanced our product offering in the utility, industrial and commercial markets. We have enhanced our capabilities with the addition of medium and low voltage IEC switchgear, intelligent motor control systems and power distribution solutions. Our product offering has been enhanced by the Power/Vac^® switchgear product line acquired from GE which has a large installed base and a broad customer base across utility, industrial and commercial markets and the previous acquisition of S&I. Together, these acquisitions have provided Powell a significantly broader product portfolio and enhanced our capabilities to meet market demands around the world. We have also significantly enhanced our ability to reach a broader market and gain access to new customers with a long-term commercial alliance with GE. Over the next 15 years, GE will purchase from Powell all of its requirements for ANSI medium voltage switchgear and circuit breakers and other related equipment and components. New products

and new channels to new markets have strengthened Powell in our Electrical Power Products business and positioned the Company for continued growth.

 

Our Process Controls Systems segment has been impacted by soft market conditions which we believe will begin to strengthen in 2007.

 

We anticipate that we will continue to reinvest a portion of our cash generated from operations into working capital in fiscal 2007. Working capital needs are anticipated to increase with growing levels of business activity. We believe that working capital, borrowing capabilities, and funds generated from operations will be sufficient to finance anticipated operational activities, capital improvements and debt repayment for the foreseeable future. Any strategic acquisition of a new business(es) or product line(s) could require additional borrowings.

 

Effects of Inflation

 

The pace of new orders significantly strengthened as 2006 progressed and we ended the year with an order rate that we have not previously experienced since 2002. We anticipate that these conditions will continue into 2007. This is a marked improvement over 2004 and 2005 in which we experienced a significant deterioration in business volume due to the effects of the U.S. economy on our markets and customers. During those years, new investments in infrastructure projects were curtailed in both our utility and industrial market segments, and our municipal customers faced a reduced tax base with which to fund infrastructure projects. Beginning in 2005, there were indications of an improving U.S. economy, and new business inquiry levels strengthened throughout 2006.

 

We have experienced significant price pressures related to raw materials, primarily copper, aluminum and steel since the U.S. economy began to show signs of improvement in 2005. Competitive market pressures limited our ability to pass these cost increases to our customers; thus eroding our earnings in 2005 and 2006. We anticipate that these inflationary pressures will continue to adversely impact our operations in 2007.

 

Critical Accounting Policies and Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. We believe the following accounting policies and estimates to be critical in the preparation and reporting of our consolidated financial statements.

 

Revenue Recognition

 

Our revenues are primarily generated from engineering and manufacturing of custom products under long-term contracts that may last from one month to several years, depending on the contract. Revenues from long-term contracts are recognized on the percentage-of-completion method of accounting as provided by the American Institute for Certified Public Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”).

 

Under the percentage-of-completion method of accounting, revenues are recognized as work is performed primarily based on the estimated completion to date calculated by multiplying the total contract price by percentage of performance to date, based on total labor dollars or hours incurred to date to the total estimated labor dollars or hours estimated at completion. Application of the percentage-of-completion method of accounting requires the use of estimates of costs to be incurred for the performance of the contract. Contract costs include all direct material, direct labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, and all costs associated with operation of equipment. The cost estimation process is based upon the professional knowledge and experience of the Company’s engineers, project managers, and financial professionals. Factors that are considered in estimating the work to be completed and ultimate contract recovery include the availability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in performance, and the recoverability of any claims.

Changes in job performance, job conditions, estimated profitability, and final contract settlements may result in revisions to costs and income and their effects are recognized in the period in which the revisions are determined. Whenever revisions of estimated contract costs and contract values indicate that the contract costs will exceed estimated revenues, thus creating a loss, a provision for the total estimated loss is recorded in that period.

 

Revenues associated with maintenance, repair and service contracts are recognized when the services are performed in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition, Revised and Updated.” Expenses related to these types of services are recognized as incurred.

 

Allowance for Doubtful Accounts

 

We maintain and continually assess the adequacy of an allowance for doubtful accounts representing our estimate for losses resulting from the inability of our customers to pay amounts due to us. This estimated allowance is based on historical experience of uncollected accounts, the level of past due accounts, the overall level of outstanding accounts receivable, information about specific customers with respect to their inability to make payments, and expectations of future conditions that could impact the collectibility of accounts receivable. However, future changes in our customers’ operating performance and cash flows or in general economic conditions could have an impact on their ability to fully pay these amounts, which could have a material impact on our operating results.

 

Impairment of Long-Lived Assets

 

We evaluate the recoverability of the carrying amount of long-lived assets, including intangible assets with definite useful lives, whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable. The review for impairment of these long-lived assets takes into account estimates of future cash flows. For assets held for sale or disposal, the fair value of the asset is measured using quoted market prices or an estimation of net realizable value. An impairment loss exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount.

 

Intangible Assets

 

We account for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” This statement requires that goodwill and other intangible assets with indefinite useful lives are no longer amortized but instead requires a test for impairment to be performed annually, or immediately if conditions indicate that impairment could exist. Intangible assets with definite useful lives are amortized over their estimated useful lives.

 

Accruals for Contingent Liabilities

 

From time to time, contingencies, such as insurance and legal claims, arise in the normal course of business. Pursuant to current accounting standards, we must evaluate such contingencies to subjectively determine the likelihood that an asset has been impaired or a liability has been incurred at the date of the financial statements, as well as evaluating whether the amount of the loss can be reasonably estimated. If the likelihood is determined to be probable and it can be reasonably estimated, the estimated loss is recorded. The amounts we record for insurance claims, warranties, legal, and other contingent liabilities require judgments regarding the amount of expenses that will ultimately be incurred. We use past experience and history, as well as the specific circumstances surrounding each contingent liability, in evaluating the amount of liability that should be recorded. Actual results could differ from our estimates.

 

Accounting for Income Taxes

 

We account for income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Developing our provision for income taxes requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required

for deferred tax assets. We have not recorded any valuation allowances as of September 30, 2006 because we believe that future taxable income will, more likely than not, be sufficient to realize the benefits of those assets as the temporary differences in basis reverse over time. Our judgments and tax strategies are subject to audit by various taxing authorities.

 

Foreign Currency Translation

 

The functional currency for our foreign subsidiaries is the local currency in which the entity is located. The financial statements of all subsidiaries with a functional currency other than the U.S. Dollar have been translated into U.S. Dollars in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation.” All assets and liabilities of foreign operations are translated into U.S. Dollars using year-end exchange rates, and all revenues and expenses are translated at average rates during the respective period. The U.S. Dollar results that arise from such translation, as well as exchange gains and losses on intercompany balances of a long-term investment nature, are included in the cumulative currency translation adjustments in accumulated other comprehensive income in stockholders’ equity.

 

Hedging Activities

 

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 a 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.

 

New Accounting Pronouncements

 

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the Company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the “more likely than not” recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. FIN 48 is effective for our fiscal year beginning October 1, 2007. The Company is currently evaluating the impact of adopting FIN 48.

 

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements” (“SAB 108”). SAB 108 provides guidance on the approach that companies must follow in quantifying misstatements of their financial statements. SAB 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB 108 is effective for our fiscal year beginning October 1, 2006. We do not expect the adoption of SAB 108 to have a material impact on our consolidated financial position, results of operations or cash flows.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. SFAS No. 157 is effective for our fiscal year beginning October 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 157.

In September 2006, the FASB issued SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Benefits, an Amendment of SFAS No. 87, 88, 106 and 123R.” SFAS No. 158 requires an employer with a defined benefit pension plan to (1) recognize the funded status of the benefit plan in its statement of financial position, (2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to SFAS No. 87 or SFAS No. 106, (3) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, and (4) disclose in the notes to the financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. SFAS No. 158 is effective for our fiscal year beginning October 1, 2006. We do not expect the adoption of SFAS No. 158 to have a material impact on our consolidated financial position, results of operations or cash flows.

 

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.

 

Interest Rate Risk

 

We are subject to market risk resulting from changes in interest rates related to our floating rate bank credit facility. At September 30, 2006, $21.4 million was outstanding bearing interest at approximately 7.25% per year. A hypothetical 100 basis point increase in variable interest rates would result in a total annual increase in interest expense of approximately $400,000. 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. During each of the past three years, we have not experienced a significant effect on our business due to changes in interest rates.

 

Foreign Currency Transaction Risk

 

We have significant operations that expose us to currency risk in the British Pound Sterling and to a lesser extent the Euro. We believe the exposure to the effects that fluctuating foreign currencies have on our consolidated results of operations is limited because the foreign operations primarily invoice customers and collect obligations in their respective currencies or U.S. Dollars and a portion of our credit facility is payable in British Pound Sterling. Additionally, expenses associated with these transactions are generally contracted and paid for in the same local currencies.

 

While we do not currently have any derivative contracts to hedge our exposure to foreign currency exchange risk, we have in the past and may in the future enter into such contracts.

 

Commodity Price Risk

 

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 a negative effect on profit margin. 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 2006. We continue to experience price increases with some of our key raw materials. Competitive market pressures have limited our ability to pass these cost increases to our customers, thus negatively impacting our earnings. Fluctuations in commodity prices may have a material impact on our future earnings and cash flows.

 

 

To the Board of Directors and Stockholders of Powell Industries, Inc.:

 

We have completed integrated audits of Powell Industries, Inc.’s 2006 and 2005 consolidated financial statements and of its internal control over financial reporting as of September 30, 2006 and an audit of its 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Powell Industries, Inc. and its subsidiaries at September 30, 2006 and October 31, 2005, and the results of their operations and their cash flows for the eleven months ended September 30, 2006 and each of the two years in the period ended October 30, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of September 30, 2006 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2006, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded General Electric Company’s Medium Voltage Switchgear and Circuit Breakers business (“Power/Vac^®”) from its assessment of internal control over financial reporting as of September 30, 2006 because it was acquired by the Company in a purchase business combination during the year ended September 30, 2006. We have also excluded the Power/Vac^® business from our audit of internal control over financial reporting. The Power/Vac^® business’s total revenues and total assets represent 4% and 16%, respectively, of the related consolidated financial statement amounts as of and for the year ended September 30, 2006.

 

 

Houston, Texas

December 8, 2006

POWELL INDUSTRIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

POWELL INDUSTRIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

POWELL INDUSTRIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

POWELL INDUSTRIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

POWELL INDUSTRIES, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

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.

 

Powell Industries, Inc. (“we,” “us,” “our,” “Powell,” or the “Company”) was incorporated in the state of Delaware in 2004 as a successor to a Nevada company incorporated in 1968. The Nevada corporation was the successor to a company founded by William E. Powell in 1947, which merged into the Company in 1977. Our major subsidiaries, all of which are wholly owned, include: Powell Electrical Systems, Inc., Transdyn, Inc., Powell Industries International, Inc., Switchgear & Instrumentation Limited and Switchgear & Instrumentation Properties Limited.

 

On December 13, 2005, we announced a change in our fiscal year end from October 31 to September 30, effective September 30, 2006. The change was designed to align our financial reporting with calendar quarters and to reduce the impact holidays have on our reporting timeline. As a result, the current fiscal year will be reported as an 11 month period ending on September 30, 2006 (“Fiscal 2006”).

 

On August 7, 2006, we purchased certain assets related to the American National Standards Institute (“ANSI”) medium voltage switchgear and circuit breaker business of General Electric Company’s (“GE”) Consumer & Industrial unit located at its West Burlington, Iowa facility. We refer to the acquired product line herein as “Power/Vac^®.” The operating results of the Power/Vac^® product line are included from the acquisition date.

 

On July 14, 2006, we acquired certain assets and hired the service and administrative employees of an electrical services company in Louisiana. The operating results of this acquisition are included from the acquisition date.

 

On July 4, 2005, we acquired selected assets and assumed certain operating liabilities and contracts of Switchgear & Instrumentation Limited in the United Kingdom. We refer to the acquired business herein as “S&I.” The operating results of S&I are included from the acquisition date.

 

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Powell Industries, Inc. and its wholly owned subsidiaries. The financial position and results of operation of our Singapore joint venture, in which we acquired a majority ownership on August 1, 2004, have been consolidated since August 1, 2004. As a result of this consolidation, we recorded minority interest on our balance sheet for our joint venture partner’s share of equity. All significant intercompany accounts and transactions are eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying footnotes. The amounts we record for insurance claims, warranties, legal and other contingent liabilities require judgments regarding the amount of expenses that will ultimately be incurred. We base our estimates on historical experience and on various other assumptions, as well as the specific circumstances surrounding these contingent liabilities in evaluating the amount of liability that should be recorded. Estimates may change as new events occur, additional information becomes available or operating environments change. Actual results may differ from our estimates. The most significant estimates used in the Company’s financial statements affect revenue and cost recognition for construction contracts, the allowance for doubtful accounts, self-insurance, warranty accruals, and postretirement benefit obligations.

 

POWELL INDUSTRIES, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand, deposits with banks and highly liquid investments with original maturities of three months or less.