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| POWL > SEC Filings for POWL > Form 10-K on 16-Jan-2004 | All Recent SEC Filings |
16-Jan-2004
Annual Report
Market conditions throughout fiscal 2003 were challenging. We experienced a significant reduction in demand for our products. In our Electrical Power Products segment, market price levels deteriorated early in the year as competition for available business volume intensified. Despite weak market conditions, we successfully increased both revenues and earnings in our Process Control Systems business segment. We also successfully expanded system modification and replacement equipment activity in both business segments.
With a depressed economy, we intensified our focus on working capital management. We achieved record levels of cash flow from operating activities during 2003. As of year end, Powell Industries held cash, cash equivalents and marketable securites of $42 million, an increase of $28 million over fiscal 2002.
We believe we are well positioned to take advantage of improving economic and market conditions.
In the course of operations, we are subject to certain risk factors, including but not limited to competition and competitive pressures, sensitivity to general economic and industry conditions, international political and economic risks, availability and price of raw materials and execution of business strategy, as more fully described above in our "Cautionary Statement Regarding Forward-Looking Statements; Risk Factors." 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 actual results may differ materially from those projected in the forward-looking statements.
The following discussion should be read in conjunction with the accompanying consolidated financial statements and related notes.
Results of Operations
Year ended October 31, 2003 compared with year ended October 31, 2002
Revenue and Gross Profit
Consolidated revenues decreased 17% to $253.4 million in fiscal 2003 as compared to fiscal year 2002 revenues of $306.4 million. Domestic revenues decreased $64.8 million to $213.6 million in 2003 compared to 2002. Despite weaknesses in domestic markets, new investments in oil and gas production facilities contributed to increased international revenues in fiscal 2003. Revenues outside of the United States accounted for 16% of consolidated revenues in 2003 compared to 9% in 2002.
Electrical Power Products
Our Electrical Power Products segment recorded revenues in fiscal 2003 of $227.0 million compared to $283.6 million in fiscal 2002. Revenues from public and private utilities fell by 55% in fiscal 2003. In particular, there was a significant decline in new investments in electrical power generation facilities. Utility revenues were $79 million in 2003 compared to a record $173 million in 2002. Our municipal customers faced a reduced tax base with which to fund infrastructure projects in 2003. Municipal and transit projects generated revenues of $23 million compared to $29 million in 2002. However, revenues from industrial customers totaled $125 million in fiscal 2003, an increase of $44 million, or 54%, over 2002. This increase in revenue from industrial customers resulted primarily from revenues related to the manufacture and delivery of power control modules for new oil and gas production facilities. These long-term projects to construct new oil and gas production facilities were initiated by our customers during 2001 and 2002.
Gross profit, as a percentage of revenues was 18.8% in fiscal 2003, compared to 22.0% in fiscal year 2002. Gross profit has been adversely impacted by lower production volumes and competitive pricing pressures. Partially offsetting adverse market conditions were the results of our efforts to reduced our costs of production by improving operating efficiencies through the implementation of lean initiatives. In addition, we incurred an impairment loss of $0.4 million to decrease the carrying value of machinery and equipment to their estimated market value. This impairment loss resulted from our decision to discontinue certain product lines. These product lines generated aggregate revenues of less than $1.0 million in fiscal 2003.
Process Control Systems
Revenues in our Process Control Systems segment increased 16% to $26.4 million compared to $22.8 million in fiscal 2002. Our most significant award during 2003 was a contract to design and build Intelligent Transportation Systems (ITS) for the Holland and Lincoln tunnels from the Port Authority of New York and New Jersey valued at $37.4 million. Revenue attributable to this project totaled $4.2 million during fiscal 2003. Gross profit, as a percentage of revenues, was 24.0% in fiscal 2003, compared to 23.6% in fiscal year 2002.
For additional information related to our business segments, see Note M of the Notes to Consolidated Financial Statements.
Operating Expenses
Selling, general and administrative expenses increased to 13.9% of revenues in fiscal 2003 compared to 12.7% of revenues in fiscal year 2002. Our commitment to continue to develop our customer markets and products resulted in an increase in operating expenses relative to our revenues. Research and development expenditures were $3.6 million in fiscal 2003 compared to $3.4 million in fiscal year 2002. Our research efforts are directed toward the discovery and development of new products and processes as well as improvements in existing products and processes.
Interest Income and Expense
We incurred $403 thousand in interest expense on our term debt and outstanding industrial development revenue bonds during fiscal 2003 compared to $508 thousand in 2002. As a result of lower levels of debt and decreased interest rates, our interest expense has declined.
Interest income increased by $280 thousand to $578 thousand in 2003 compared to the same period of the previous year. An increase in invested funds during 2003 has been partially offset by the lower interest rate environment.
Provision for Income Taxes
Our provision for income taxes reflects an effective tax rate on earnings before income taxes of 44.9% in fiscal 2003 compared to 37.1% in fiscal 2002. Included in our provision is $1.3 million for state taxes (net of federal tax benefit) of which $0.9 million reflects revised estimates in state tax exposures related to prior years. Over the past several years, our business has expanded and we are now conducting activities in more states. We have accordingly increased our estimates for such state tax exposures. Going forward, we anticipate our effective tax rate to range from 37.6% to 37.9%.
Cumulative Effect of Change in Accounting Principle
As a result of the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," we recorded a goodwill impairment loss of $510 thousand, net of $285 thousand taxes, as a cumulative effect of a change in accounting principle during the first quarter of 2003. We recorded an impairment charge of $380 thousand, net of $214 thousand taxes, to write off the full value of goodwill in our Process Control Systems segment. In our Electrical Power Products segment, we recorded an impairment charge of $130 thousand, net of $71 thousand taxes. The goodwill impairment charge accounted for a loss of $0.04 per diluted share
Net Income
Net income was $7.1 million, or $0.67 per diluted share, in fiscal year 2003 compared to $17.9 million, or $1.67 per diluted share in fiscal year 2002. The decrease in net income primarily relates to lower business volume and decreased gross profits in fiscal 2003. Additionally, net income was negatively impacted as a result of an impairment loss of $0.2 million, net of taxes, recorded to decrease the carrying value of machinery and equipment; an increase in estimates for state tax exposures related to prior years of $0.9 million, net of federal tax benefits; and the net effect of a change in accounting principle related to goodwill accounted for $0.5 million. Each of these adjustments to net income are discussed in the Notes to Consolidated Financial Statements.
Year ended October 31, 2002 compared with year ended October 31, 2001
Revenue and Gross Profit
Revenues increased 13% to a record $306.4 million in fiscal 2002 as compared to revenues in fiscal year 2001 of $271.2 million. Our Electrical Power Products segment recorded revenues in fiscal 2002 of $ 283.6 million compared to $244.8 million in fiscal 2001. During fiscal 2002 one aspect of our revenue growth was due to new worldwide investments in oil and gas production facilities. Furthermore, demand for additional electrical power generation capacities in the United States strengthened over the expansion realized in fiscal 2001. Revenues in our Process Control Systems segment were $22.8 million compared to $26.4 million in fiscal 2001. For additional information related to our business segments, see Note M of the Notes to Consolidated Financial Statements.
International revenues increased in fiscal 2002. Revenues outside of the United States accounted for 9% of consolidated revenues in fiscal 2002 compared to 8% in fiscal 2001.
Gross profit, as a percentage of revenues, improved to 22.1% in fiscal 2002, compared to 20.9% in fiscal year 2001. Higher production volumes, improved operating efficiencies, along with the quality of our backlog have all contributed to the improvement in gross profit. We continued to implement lean manufacturing initiatives to reduce costs and respond to the competitive markets that we serve.
Operating Expenses
Selling, general and administrative expenses, including research and development expenditures, were $39.0 million (12.7 % of revenues) in fiscal 2002 compared to $35.0 million (12.9% of revenues) in fiscal year 2001. The increase in operating expenses was primarily due to the growth in business volumes during the period.
Research and development expenditures were $3.4 million in fiscal 2002 compared to $3.1 million in fiscal year 2001. Our research efforts were directed toward the discovery and development of new products and processes as well as improvements in existing products and processes.
Interest Income and Expense
Net interest expense decreased to $210 thousand in fiscal 2002 from $359 thousand in fiscal 2001 due to lower levels of debt. Interest expense was related to our revolving credit facility and long-term debt. This expense was partially offset by interest income from short-term investments.
Provision for Income Taxes
Our provision for income taxes reflected an effective income tax rate on earnings before income taxes of 37.1% in fiscal 2002 compared to 36.8% in fiscal 2001. The increase in our effective tax rate was primarily a result of higher state taxes and was also partly attributable to increases in non-deductible expenses.
Net Income
Net income was $17.9 million, or $1.67 per diluted share, in fiscal year 2002 compared to $13.5 million, or $1.28 per diluted share in fiscal year 2001. Growth in business volume and increased gross profits resulted in earnings improvement in fiscal 2002.
Liquidity and Capital Resources
We have maintained a strong liquidity position. Working capital was $96.9 million at October 31, 2003 compared to $86.5 million at October 31, 2002. As of October 31, 2003, current assets exceeded current liabilities by 3.2 times and our debt to capitalization ratio was less than 0.1 to 1.
At October 31, 2003, we had cash, cash equivalents and marketable securities of $42.3 million, compared to $14.4 million at October 31, 2002. Long-term debt, including current maturities, totaled $7.4 million at October 31, 2003 compared to $12.0 million at October 31, 2002. In addition to our long-term debt, we maintain a revolving credit agreement which at year end provided for a credit facility of $15 million through February 2006. As of October 31, 2003, there were no borrowings under this line of credit. For further information regarding our debt, see Note F of the Notes to Consolidated Financial Statements.
Operating Activities
Net cash provided by operating activities was $36.5 million for fiscal 2003. A net reduction in operating assets and liabilities provided $22.3 million with the remainder of the increase related to net earnings adjusted for depreciation, amortization and other non-cash expenses. During fiscal 2002, operating activities provided net cash of $31.7 million of which $8.7 million resulted from a reduction in operating assets and liabilities.
Investing Activities
Investments in property, plant and equipment during fiscal 2003 totaled $4.5 million compared to $13.9 million in fiscal 2002. The majority of these expenditures were used to complete a project initiated during 2002 to increase our manufacturing capacity available for the manufacture of electrical power control modules. These modules are provided to the oil and gas industry for use on offshore platforms.
During 2003, we purchased $5.8 million of investment-grade corporate bonds. The maturity dates of these bonds vary from five to nine years.
Financing Activities
Financing activities used $3.7 million in fiscal 2003. Approximately $4.8 million was used for repayments on our long-term debt. Other financing activities were limited to the exercise of stock options. During fiscal 2002, net cash used by financing activities was $10.0 million, primarily from payments on long-term debt.
Contractual Obligations
At October 31, 2003 and 2002, our long-term contractual obligations were limited to debt and leases. The tables below detail our commitments by type of obligation and the period that the payment will become due (in thousands).
As of October 31, 2003 Long-term debt Capital Lease Operating Lease
payments due by period: Obligations Obligations Obligations
Less than 1 year $ 418 $ 50 $ 1,776
1 to 3 years 877 14 3016
3 to 5 years 800 -- 2048
More than 5 years 5,200 -- 479
------------- ---------- -------------
Total long-term contractual obligations $ 7,295 $ 64 $ 7,319
------------- ---------- -------------
As of October 31, 2002 Long-term debt Capital Lease Operating Lease
payments due by period: Obligations Obligations Obligations
Less than 1 year $ 4,686 $ 60 $ 1,238
1 to 3 years 800 64 2,480
3 to 5 years 800 -- 1,878
More than 5 years 5,600 -- 1,177
--------------- ----------- -------------
Total long-term contractual obligations $ 11,886 $ 124 $ 6,773
--------------- ----------- -------------
Outlook for Fiscal 2004
We expect a continued weakness and depressed price levels in the Electrical Power Product markets we serve, and anticipate a decline in consolidated revenues of 7% to 13% in fiscal 2004. We expect full year revenues to range between $220 million and $235 million. Earnings from continuing operations are expected to range between $0.48 and $0.63 per diluted share.
We anticipate that our cash position will continue to grow during the first three quarters of 2004. Fourth quarter working capital needs are anticipated to increase with growing levels of business activity. We will continue to invest in our manufacturing capabilities and expect capital expenditures during fiscal year 2004 to range between $5.0 million and $8.0 million. We believe that working capital, borrowing capabilities, and funds generated from operations should be sufficient to finance anticipated operational activities, capital improvements, debt repayment and possible future acquisitions for the foreseeable future.
Effects of Inflation and Recession
During each of the past three years, we have not experienced a significant effect of inflation on our operations. We continue to evaluate the potential impact inflation could have on our business and future operations and attempt to minimize inflationary impacts by including escalation clauses in our long-term contracts. Recent economic and industry reports indicate that the current conditions should remain relatively unchanged for the foreseeable future. We do not anticipate a significant impact on operations in 2004 due to inflation.
During 2003, we experienced a significant deterioration in business volume due to the effect of the U.S. economy on the customers we serve. New investments in infrastructure projects were curtailed by both our utility and industrial customers. Our municipal customers faced a reduced tax base with which to fund infrastructure projects in 2003. We anticipate these conditions will persist into 2004.
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 us to make estimates and judgments with respect to the selection and application of accounting policies 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 critical accounting policies have the greatest impact on the preparation of our consolidated financial statements.
Revenue Recognition
Our revenues are generated from the manufacture and delivery of custom-manufactured products. We recognize revenues under both the completed contract method and the percentage-of-completion method depending upon the duration and the scope of the project. At the onset of each project, the size and duration of the contract is reviewed to determine the appropriate revenue recognition method based upon company policy. Due to the nature of the projects in the Process Control Systems segment, all revenues are recorded using percentage-of-completion. However, projects in the Electrical Power Products segment vary widely; thus, both the completed contract and percentage-of-completion methods are used.
Under the completed contract method, revenues are recognized upon the transfer of title, which is generally at the time of shipment or delivery depending upon the terms of the contract, when all significant contractual obligations have been satisfied, the price is fixed or determinable, and collectibility is reasonably assured. We use shipping documents and customer acceptance, when applicable, to verify the transfer of title to the customer. We assess whether the price is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Collectibility is assessed based on the creditworthiness of the customer based on credit verification and the customer's payment history.
Under the percentage-of-completion method, revenues are recognized as work is performed based upon the ratio of labor dollars or hours incurred to date to total estimated labor dollars or hours to measure the stage of completion. The sales and gross profit recognized in each period are adjusted prospectively for any revisions in the total estimated contract costs, total estimated labor hours to complete the project, or total contract value. 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. Due to the number of estimates used in the percentage-of-completion calculations, conditions such as changes in job performance, job conditions, estimated contract costs and profitability may result in revisions to original assumptions, thus causing actual results to differ from original estimates.
Valuation Accounts
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain judgments and estimates regarding uncertainties. Our most significant accounting uncertainty for which a valuation account is set up is in the area of accounts receivable collectibility.
An allowance for doubtful accounts has been established to provide for estimated losses on our accounts receivable. 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. We continually assess our allowance for doubtful accounts and may increase or decrease our periodic provision as additional information regarding collectibility becomes available.
Impairment of Long-Lived Assets
We evaluate the recoverability of the carrying amount of long-lived assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable. For long-lived assets to be held and used, the evaluation is based on impairment indicators such as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements and other external market conditions or factors that may be present. If such impairment indicators are present or other factors exist that indicate that the carrying amount of the asset may not be recoverable, we determine whether impairment has occurred through the use of an undiscounted cash flows analysis of the asset at the lowest level for which identifiable cash flows exist, or quoted market prices. If an asset is considered to be impaired, a loss is recognized for the amount by which the carrying amount of the asset exceeds its fair value. 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. Assets are classified as held for sale when there is a plan for disposal and those assets meet the held for sale criteria of SFAS No. 144. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.
Accruals for Contingent Liabilities
We account for contingencies in accordance with SFAS No. 5, "Accounting for Contingencies". SFAS No. 5 requires that we record an estimated loss from a loss contingency when information available prior to the issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. 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 other specific circumstances surrounding these claims in evaluating the amount of liability that should be recorded. Actual results could differ from our estimates.
New Accounting Standards
In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." Under SFAS No. 146, companies are required to recognize costs associated with restructurings, discontinued operations, plant closings or other exit or disposal activities in the period in which the liability is incurred rather than at the date of commitment to the plan. We adopted SFAS No. 146 on January 1, 2003 and there has been no impact on our consolidated financial position, results of operations or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of the obligation assumed under the guarantee. FIN 45 also requires additional disclosures about guarantees in the interim and annual financial statements. The provisions of FIN 45 related to initial recognition and measurement of guarantee agreements were effective for any guarantees issued or modified after December 31, 2002. The adoption of these recognition and measurement provisions did not have an impact on our consolidated financial position or results of operations. In accordance with the disclosure provisions of FIN 45, we have included in Note D of the Notes to Consolidated Financial Statements a reconciliation of the changes in our product warranty liability for the years ended October 31, 2003 and 2002. We provide for estimated warranty costs at the time of sale based upon historical experience rates. Our products contain warranties for parts and service for the earlier of 18 months from the date of shipment or 12 months from the date of initial operations.
In November 2002, the FASB Emerging Issues Task Force ("EITF") reached a consensus opinion of EITF 00-21, "Revenue Arrangements with Multiple Deliverables." EITF 00-21 addresses the proper accounting treatment for goods or services, or both, that are to be delivered separately in a bundled sales arrangement. The guidance in this issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We adopted EITF 00-21 on August 1, 2003 and it did not have an impact on our consolidated financial position, results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123." This statement provides alternative methods of transition for a voluntary change in the method of accounting for stock-based employee compensation to the fair value method. The statement also amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation." Under SFAS No. 148, annual and interim financial statements are required to have prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement was effective for fiscal years ending after December 15, 2002. This statement did not have an impact on our consolidated financial statements as we have adopted only the disclosure provisions of SFAS No. 123. The additional disclosure requirements are included in Note K of these Notes to Consolidated Financial Statements.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," ("FIN 46"). FIN 46 addresses the consolidation requirements of companies that have variable interest entities. This Interpretation requires the consolidation of any variable interest entities in which a company has a controlling financial interest and requires disclosure of those that are not consolidated but in which the company has a significant variable interest. The requirements of FIN 46 will be effective for our first quarter 2004. We do not expect this Interpretation to have a material impact on our financial position, results of operations or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149, which amends and clarifies existing accounting pronouncements, addresses financial accounting and reporting for derivative or other hybrid instruments to require similar accounting treatment for contracts with comparable characteristics. This statement was effective for contracts entered into or modified after June 30, 2003 and for hedging activities designated after June 30, 2003. This statement did not have an impact on our consolidated financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for classifying and measuring as liabilities certain financial instruments that have characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument within its scope as a liability, or asset as appropriate, to represent obligations of the issuer. Many of the instruments covered by this statement have previously been classified as equity. SFAS No. 150 was effective for all financial instruments created or modified after May 31, 2003, and to other instruments as of September 1, 2003. This statement did not have an impact on our consolidated financial position, results of operations or cash flows.
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