Powell Industries, Inc.
Q4 2008 Earnings Call Transcript

Published: 10 Dec 2008

[Operator:]

Good morning, ladies and gentlemen, welcome to the Powell Industries fourth quarter earnings conference call. (Operator Instructions) We will now turn the conference over to Miss Karen Roan with DRG&E, please go ahead.

[Karen Roan:]

Thank you, Michael. Good morning, everyone. We appreciate your joining us for Powell Industries conference call today to review fiscal 2008 fourth quarter results. We would also like to welcome our internet participants listening to the call simulcast live over the internet. Before I turn the call over to management, I have the normal details to cover. You could have received a fax or email of the news release this morning. Occasionally, there are technical difficulties experienced during these broadcasts. If you did not get yours, please call our offices at DRG&E at (713) 5296600 and we will get one to you. Also, if you would like to be on the permanent email distribution list, please relay that information to us. There will be a replay of today's call, and it will be available by webcast by going to the company's website at www.powellind.com or a recorded replay will be available until December 17, 2008, and information on how to access the replay was provided in today's news release. Please note that information reported on this call speaks only as of today, December 10, 2008. Therefore, you are advised that timesensitive information may no longer be accurate as of the time of the replay. As you know, this conference call contains certain statements including statements related to the company's expectations of its future operating results that may be deemed to be forwardlooking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forwardlooking statements involve risks and uncertainties and that actual results may differ materially from those projected in the forwardlooking statements. The risks and uncertainties include, but are 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 strategies. For further information, please refer to the company's filings with the Securities and Exchange Commission. Now with me this morning are Pat McDonald, President and Chief Executive Officer, and Don Madison, Executive Vice President and Chief Financial and Administrative Officer. I will now turn the call over to Pat.

[Pat McDonald:]

Good morning, everyone. Thank you for joining us today to review our fourth quarter and fiscal 2008 results. Since our last conference call, there have been a number of significant events, both local and global, that deserve comment. In September, Houston was hit by Hurricane Ike. Our facilities and our people weathered the storm, and the physical impact to our facilities was minimal. We lost a number of production days due to storm preparation, poststorm power outages, and work restart. Our disaster planning and communication systems worked well, although we are taking this opportunity to review the processes and determine how we might even better be prepared for any similar emergency in the future. On a more global scale, 90 days ago, I don't think any of us could have imagined the impact of the financial market's turmoil, the resulting stock market declines, and the dramatic decline in oil prices. The question most often asked is, what impact do these events have on Powell and our operations. Powell participates in projects that are, for the most part, very large, complex, capitalintensive investments. These projects are in the planning and execution stages for years and generally are not affected by shortterm market volatility. We have seen oil prices fall from $150 to below $50 per barrel. Just as we all believe that $150 was not supply and demand driven, neither is $50. We think somewhere in between is a true supplydemand driven price. The same holds true for the timing and return on investments by companies producing oil, refining oil, and oil byproducts. In the shortterm, a few of our customers in the oil and gas segment are delaying projects, as they attempt to better determine where the price of oil and the associated construction costs will stabilize. The longterm outlook for the oil and gas industry will be greater demand and higher prices. What is not predictable is how fast or slow the price and demand will increase. It is clear that longterm demand for fossil fuels will grow, and the ability to supply it will be more challenging. This country wants to become more independent of foreign oil and oil products. To achieve this goal, the U.S. must invest domestically in oil production and refining capacity since we are unable to meet current domestic demand. Powell has the solutions that are wellsuited to meet these challenges as they unfold. On the utility side of our business, there is greater interest in alternative sources of energy, including nuclear, wind, and clean coal technologies. More efficient use of energy is also a key element in the plans of most utility companies. Despite the current global economic downturn, the U.S. will be consuming everincreasing amounts of electrical energy in the future; and the supply, especially from alternative generation methods, is not yet in place to meet future needs. To meet these demands, more investment must be made in generation of all types and in electrical distribution networks. Powell's engineered solutions are wellsuited to fulfill the current and future needs of our utility market customers. The elections did demonstrate a growing desire from the public to invest in mass transportation systems as voters approved billions of dollars for mass transit projects. These projects are among those being discussed in Washington as politicians talk of infrastructure investments. Powell is the leader in power systems for light rail, and intelligent transportation systems will benefit from this activity as well. No doubt, there is current economic turmoil. Shortterm forecasting and timing of projects are not under our control. As opposed to some other sectors, we believe that the markets and demand for our products have longterm sustainable growth potential; and we are wellpositioned to deliver these engineered products, solutions, and systems to our customers. To date, we have seen no cancellations. Our backlog for fiscal 2009 is strong, and quotation activity is good. While we cannot be sure what the future holds, our current outlook is definitely positive. Now I would like to turn the call over to our Chief Financial Officer, Don Madison, to review the financial results.

[Don Madison:]

Thank you, Pat. Revenues in the fourth quarter were $167.1 million compared to $150.5 million in the fourth quarter of fiscal 2007. Hurricane Ike reduced fourth quarter revenues, primarily due to the loss of electrical power in some of our facilities. Lost revenues due to hurricane preparation, loss of electrical power, and startup are estimated at $6 million to $9 million. Gross margin was 20.4% in the fourth quarter compared to 16.8% in last year's fourth quarter. Excluding results of the acquired Power/Vac product line, gross margin for the quarter was 21.8% compared to 20% a year ago. Selling, general, and administrative expenses decreased as a percentage of revenue from 13.8% a year ago to 12.7% in the fourth quarter due to higher levels of business activity. SG&A expenses were $21.2 million compared to $20.8 million in last year's fourth quarter. Interest expense was $559,000 in the fourth quarter, a decrease of $413,000 from a year ago. Interest income was $95,000 compared to $148,000 in the fourth quarter of 2007. Net income in the fourth quarter of fiscal 2008 was $8.3 million or $0.72 per diluted share, compared to $2.5 million or $0.22 per diluted share in the fourth quarter of fiscal 2007. Lower revenues and incremental costs related to Hurricane Ike activities reduced fourth quarter earnings by an estimated $0.05 to $0.08 per diluted share. For the year ended September 30, 2008, revenues were a record $638.7 million, an increase of $74.4 million or 13.2% over fiscal 2007. Revenues have increased as we improved throughput across the company by investing in our people and processes and responding to a strong backlog. Gross margin was 19.8% for the 12month period compared to 16.9% a year ago. Excluding the results of the acquired Power/Vac product line, gross margin for the fiscal year was 21.8% compared to 20% last year. Selling, general, and administrative expenses were 13.2% of revenues compared to 13.7% of revenues for fiscal 2007. For the year, SG&A expenses totaled $84 million compared to $77.2 million a year ago. Our provision for income taxes deflects an effective tax rate on earnings before income taxes of 35.3% compared to 35.5% for fiscal 2007. For the 12 months ended September 30, 2008, net income was a record $25.8 million, or $2.26 per diluted share, compared to $9.9 million, or $0.88 per diluted share, a year ago. As of September 30, 2008, our order backlog was $518.6 million compared to $464.5 million at September 30, 2007. New orders for the year totaled $705.4 million compared to $667.1 million for fiscal 2007. For fiscal 2008, cash used for operating activities was $5.2 million. Cash flow from operations is primarily influenced by demand for our products and services and is negatively impacted as our progress payment terms on projects with our customers typically extend beyond the payment terms with suppliers. Investments in property, plant, and equipment during fiscal 2008 totaled approximately $3.4 million compared to $14.3 million during fiscal 2007. At September 30, 2008, we had cash and cash equivalents of $10.1 million compared to $5.3 million at September 30, 2007. Longterm debt, capital lease obligations, including current maturities totaled $41.8 million at September 30, 2008, compared to $35.8 million at September 30, 2007. Looking ahead, we expect fullyear fiscal 2009 revenues to range between $700 million and $725 million and fullyear earnings to range between $2.60 and $2.85 per diluted share. At this point, I will turn it back to Pat.

[Pat McDonald:]

Thank you, Don. Let me make a few more remarks, and then we will be happy to take your questions. Powell is in a projectsrelated business. Due to the nature of that business, shortterm quartertoquarter results may not be the best indicator of our business results. We know that the longterm outlook for our business is solid. The world will need more, not less, energy from oil and gas in the future. The world will need more electrical energy to keep pace with demand. The world will search and find alternatives to supplant supply and find ways to operate more efficiently. In all of these cases, Powell engineered solutions will play a significant role. At this point, we will be happy to answer any questions that you might have. Thank you.

[Operator:]

(Operator Instructions) Our first question is from Fred Buonocore CJS Securities.

[Fred Buonocore CJS Securities:]

Good morning. Nice quarter in the face of some challenges. My first question relates to your '09 guidance, assuming SG&A remains roughly similar, tax rate roughly similar, all things being equal in that regard, your guidance appears to imply fairly minimal gross margin improvement relative to the second half of '08. Even given higher volumes, what would I expect maybe lower raw material costs, and what one would hope would be efficiency improvements at Power/Vac, can you kind of reconcile that for us please?

[Pat McDonald:]

That's a long reconciliation question, Fred. As we have talked about on various conference calls, we have been improving all throughout the year. As we always give in our guidance that says we are trying to get back to the best period of our peak before. We're getting pretty close to that. I don't know that we're going to see the step function changes that we have seen in the past over the quarters as it relates to operating efficiencies and productivity. I think we will continue to see improvement, but it's not going be the size that we saw in this last fiscal year.

[Don Madison:]

Incrementally, we will continue to show improvements as we go forward. Again, as we talked about, quartertoquarter performance will vary based on the projects that are actually shipped during the period. But the rate of improvement will become more and more challenging as we go forward.

[Fred Buonocore CJS Securities:]

Then my followup relates to the sequential bookings decline. Should we take that to indicate maybe a slowing in demand from the oil and gas sector, realizing your quote activity is still good? Or is this kind of just quartertoquarter lumpiness?

[Pat McDonald:]

As we have talked about, we do have a lot of quartertoquarter lumpiness, especially with some of the size of the projects that we have. I think we would be remiss to say that there are not some issues as it relates to the timing of jobs going forward in the future. We do believe that our order input in the fourth quarter was impacted by the hurricane because not only were we down, but our customers were down and not placing orders at the same time. As I think right now, we can probably say that our first quarter order input will exceed our fourth quarter order input.

[Fred Buonocore CJS Securities:]

Any way to quantify the impact of the hurricane on orders?

[Pat McDonald:]

That one is almost impossible.

[Operator:]

Our next question comes from John Franzreb Sidoti and Company.

[John Franzreb Sidoti and Company:]

Good morning. I was wondering on a historical perspective, do you have a sense what kind of treasure threshold price on oil that your customers are more apt to go forward with projects and what kind of threshold price on oil is when they start to pull back on orders?

[Pat McDonald:]

We don't have anything quantified. The only thing I can allude to is there's been a lot of articles written and some of our customers have stated they never made a single investment decision based on $150-a-barrel oil. I think the only thing that I can quantify that we have read was as it related to the tar sands projects, where they were looking at $45 to $55 to $60 a barrel made that economical. Nothing else that we have tangible that relates to where people are making their investment decisions.

[John Franzreb Sidoti and Company:]

You don't participate in tar sands work do you?

[Pat McDonald:]

Sure, we have a number of projects that we have supplied into the tar sands area, the pipelines, and coming back into the U.S.

[John Franzreb Sidoti and Company:]

I was not aware of that. Just my followup, and I will get back into queue. Remind me, did you expand your North Canton facility to kind of capitalize on transportationrelated projects?

[Pat McDonald:]

We are in the process of expanding that right now. That should be completed in our fiscal second quarter.

[John Franzreb Sidoti and Company:]

Could you just review that decision process and do you think it's a good one or bad one in light of municipal spending and also, if you will, potential infrastructure spending on the new administration. I guess there’s a put and take kind of there with that decision.

[Pat McDonald:]

I don't think I would second-guess the decision. I think we need the space and high bay area, whether it's transportation or it's utility or it's oilbased. Our deal is to supply solutions to the customers, and we need that type of overhead high bay crane space to do that with.

[Operator:]

Our next question comes from Ned Borland Next Generation Equity Research.

[Ned Borland Next Generation Equity Research:]

Just another followup on the orders question. If we're looking, I know it's not a completely linear relationship with where oil is, but is there some sort of lag in terms of like where you see a precipitous drop in oil prices to when those translate into a lower absolute level of orders? Is there any kind of relationship there?

[Pat McDonald:]

Ned, I don't have any graphs or statistics to give that. Again, when we look at projects, they are typically three to fiveyear projects. I think a lot of our customers, and I don't want to speak for them, but I think they're going to look to see that this is a spike down and there's going to be a movement back up. I do believe that we have seen probably in the chemical area more of an immediate reaction in order input for what the chemical companies are seeing, because of who they supply their product to. I think in the oil area, you are still talking three to five years on refining and production areas.

[Ned Borland Next Generation Equity Research:]

Is there any granularity you can give us on the utility business here, in terms of products or projects that may be coming down the pipe that may or may not get delayed because of credit financing or anything else?

[Pat McDonald:]

We don't have any in that area that we know of that are being delayed due to credit financing. Not to say that there aren't some out there, but we have not seen any delay as a result of credit financing.

[Operator:]

Our next question comes from Craig Bell SMH Capital.

[Craig Bell SMH Capital:]

Good morning. I wanted to followup on an earlier question with regards to some of the productivity there. In past quarters, you talked about how many people you have been hiring and the ramp up there. Number one, are you still hiring at a pretty good rate? Number two, given the hiring that you have done over the past 1218 months, is that productivity starting to kick in with those newer workers?

[Don Madison:]

Looking at what we're doing today, our overall employees remain relatively flat over the last few months. The hiring today is predominantly in replacement of individuals that leave, so our aggregate is basically flat. That number is decreasing as well because of, as we talked in the past, our highest risk period with new hires is the first six months or so. Actually, the highest risk is the first probably six weeks. After about six to nine months, we do a great job of converting a new employee into a longterm employee. Clearly, we have seen productivity improvements. In a project business, it's hard to develop the same metrics you do in repetitive manufacturing. I think, across the board, we're very comfortable that stability in the work force is improving and the benefits of that are beginning to be seen in our overall operating costs.

[Craig Bell SMH Capital:]

Thinking a little bit longer term, if you look at your business in terms of your growth prospects, looking forward do you think it's equally weighted among your industrial utility side or is it going to be more getting greater penetration on the utility side while growing the industrial is a little bit slower?

[Pat McDonald:]

I would say that's probably a pretty good statement at the end. We definitely want to increase our penetration into the utility market space and still continue to grow our industrial.

[Craig Bell SMH Capital:]

Did you say what your CapEx plans are for 2009?

[Pat McDonald:]

No, we didn't. We would expect it to rebound back to our average of $8 million to $10 million in CapEx spending in 2009.

[Operator:]

Our next question comes from Brent Thielman D.A. Davidson.

[Brent Thielman D.A. Davidson:]

Good morning. Congratulations on the quarter. Don, I am hoping you can quantify the revenues through electric power products just from your industrial utilities and traction power customers.

[Don Madison:]

Give me a second. Looking at our fullyear fiscal 2008, utility market basically totaled around $172 million in total revenues, industrial market segment is around $400 million, traction power was just under $40 million, were basically electrical power products of the $611.5 million. Then the balance of process control was $27.2 million, which is again municipal market.

[Brent Thielman D.A. Davidson:]

I guess just relevant to the Power/Vac business, can you guys talk a little bit about what you're seeing there just given its exposure to general manufacturing and commercial construction sectors?

[Pat McDonald:]

I would say if we have any area that we are seeing some volatility in the market, it would probably be the commercial market segment served by that area. But, we continue to work with our partners over there, new opportunities and quotations in market segments that are still positive. We are working hard to identify those and go capture those.

[Brent Thielman D.A. Davidson:]

One more, if I may. Were there any particular project closeout benefits during the quarter? Somewhat similar to what you saw in Q3?

[Don Madison:]

Nothing in the same magnitude as Q3.

[Operator:]

Our next question comes from George Gaspar Robert W. Baird.

[George Gaspar Robert W. Baird:]

Good morning. Good quarter, congratulations. First question on process control segment. Sales were up $2 million in the quarter to $7.3 million that recorded a loss of $560,000 versus $42,000 profit a year ago. Can you just highlight what's responsible for the loss and how do you view that segment going forward?

[Don Madison:]

The biggest impact occurred in the fourth quarter as basically our costs related to the claim we have with the City and County of San Francisco. The cost basically of that unusual item continues to impact the results of the segment.

[George Gaspar Robert W. Baird:]

Do you anticipate that you have got additional cost structure that you are going to have to swing through there on that particular issue?

[Don Madison:]

At this point in time, we have a judge ruling that is in our favor. What is in front of us is going through any appeals processes that we anticipate. That could impact, from a timetable standpoint, could impact throughout fiscal 2009. But should not be to the same magnitude as we saw in 2008.

[George Gaspar Robert W. Baird:]

If I can just followup on a backlog question. Can you break out domestic versus international in your backlog, and can you highlight anything in particular about your U.K. business progress?

[Don Madison:]

I do not have the breakout in front of me. Basically, the international participation relative to last year is probably, my understanding, about flat. Most of the backlog improvement we have seen in fiscal 2008 was due to strong domestic spending predominantly in domestic refining. When you are looking at, we don't break out individual businesses, but I can report that our acquisition in the U.K. continues to perform very well. We are very pleased with that acquisition.

[Operator:]

Our next question comes from Tom Spiro Spiro Capital Management.

[Tom Spiro Spiro Capital Management:]

Good morning. Just a question about the backlog. As a contractual matter, what are the circumstances in which a customer can either delay or cancel a project?

[Pat McDonald:]

Delay. Typically, if the job is already on the floor, delays are in construction delays. We work with the customer all the time in those types of delays. If the job is not on the floor and we have not started that job, delays or deferrals or cancellations would be subject to cancellation clauses.

[Tom Spiro Spiro Capital Management:]

Do those clauses typically provide severe financial penalties or rather modest financial penalties? I guess related is a pragmatic business question is when a significant customer asks to cancel, how do you respond?

[Pat McDonald:]

Most of our cancellation policies would be to make us whole. That's also another reason why we do progress billings, especially if we are already into the project. We have done progress billings to try to make sure that we are capturing the cash in a flow related to the cost of that project.

[Tom Spiro Spiro Capital Management:]

When you say make whole, you mean reimburse for costs expended or also for the profit opportunity now lost?

[Pat McDonald:]

For the costs expended.

[Tom Spiro Spiro Capital Management:]

To the extent a project has not yet begun, I would imagine the costs expended are modest, not zero, but not particularly large.

[Pat McDonald:]

Fairly modest, yes. Engineering mostly. Remember, as soon as we get a project, we start our engineering and then production may start sometime after that.

[Operator:]

John Franzreb, please go ahead with your followup question.

[John Franzreb Sidoti and Company:]

How much of your backlog is in the oil and gas sector?

[Don Madison:]

We really don't have that statistic. Again, it comes back to the standpoint we get orders directly from the end client, we get orders, purchase orders, that actually come through [ENC] firms. So, even if you were to look into our backlog and tried to run a report, it's not easily ascertained. When you are looking at overall aggregate, I would expect it to be similar to what we've seen in the revenue side. As we have talked in the past, probably anywhere from 60% to 80%, depending on the year, of our industrial segment comes from the oil and gas and oil and gas related projects, depending on how you want to characterize the oil and gas segment.

[John Franzreb Sidoti and Company:]

I might have missed this, apologize. Based on what you characterized as the lumpiness in the Power/Vac business, how long until you think it achieves company like margin contribution?

[Pat McDonald:]

We had always said two to four quarters, we're still into 2009 where we thought we were going to get. We have gotten faster than what we had anticipated. There's no doubt about that. I think we are within a couple quarters of being at a rate that is where we expect it to be when we acquired that Power/Vac product line. The ramp is not nearly what it was a year ago.

[Don Madison:]

The only thing I will add to that is basically is that when we look at that business, we look at comparable margins for comparable products in comparable markets. Not all markets, not all projects, all products, have the exact same margin. We are approaching that comparability, as Pat was saying, we're weeks away from it, not quarters away from it.

[John Franzreb Sidoti and Company:]

Given the retrenchment in the oil market, has the bidding process become more competitive out there or are you not seeing any of that?

[Don Madison:]

First, I don't know that we have seen a retrenchment in the oil market yet. We have seen lumpiness in orders.

[Pat McDonald:]

I would say all of our projects are competitive. We have to make sure that we understand what the customer wants and who is quoting at each time and I would say that when we see the quotations, when we see the bids coming out with names of capable bidders, those names are growing in scope.

[John Franzreb Sidoti and Company:]

So you say that the competition has been solid on pricing recently at least?

[Pat McDonald:]

Again, our competition, the number of people who are bidding on jobs is growing. To date, we have not seen any change in way people are bidding these jobs.

[Don Madison:]

Keep in mind that we talked about it in the past, is that the electrical industry, from a producer's standpoint is relatively small. But each manufacturer typically has a sweet spot. If that manufacturer had a sweet spot in the commercial market and the commercial market softens, they look for opportunities elsewhere. As we spoke at the last call, many of them are moving into the oil segment because they see the strength of the oil segment.

[Operator:]

Our next question comes from Tim Chatard Sterling Capital.

[Tim Chatard Sterling Capital:]

Your guidance for the next fiscal year implies an operating margin for the full year of roughly 7%. Is there any, can you help me, is there any seasonality related to that as you move through the quarters of the 2009 fiscal year?

[Don Madison:]

There's no seasonality from a market standpoint. There are continuous improvement projects that we've had, as well as the integration of the Power/Vac product line. I would typically expect to see, and we expect to see, improvements in the second half over the first half. It's from internal activities as opposed to the external market forces.

[Tim Chatard:]

So a better second half operating marginwise than the first half. It would average out to about 7%.

[Don Madison:]

The 7%, I can't necessarily comment to, but it's probably not far off from what our guidance would imply.

[Tim Chatard:]

Commodity prices, steel, copper wire, aluminum, etc., are they going to, looking into the fiscal year 2009, are they going to help or hurt gross margin?

[Pat McDonald:]

I think considering in the direction they have been going, we anticipate some modest improvement in our overall results as a result of commodity pricing.

[Tim Chatard:]

What do you anticipate getting the most benefit from? Which particular item would you say is going to be easier for you to negotiate next year?

[Pat McDonald:]

We've always talked about that our single biggest buy is in the copper area. That is one that we will continue to watch very closely and monitor and have the greatest amount of leverage for us.

[Tim Chatard:]

On steel, are you seeing any real decline in your steel buys in terms of prices right now?

[Pat McDonald:]

We have seen some decline, but nothing to the extent of what copper has done here recently.

[Operator:]

George Gaspar, please go ahead with your followup question.

[George Gaspar Robert W. Baird:]

Thank you. On the revenue loss in the quarter that was from the Hurricane Ike, can you outline if that revenue volume comes through in the first quarter here or was there a basic loss that would not be recoverable and did you experience any further fallout in October, which would be the first month of your new quarter here?

[Pat McDonald:]

Again, remember our business with the stackup of products and projects that we have. There's no doubt the projects that impacted the fourth quarter are flowing through into the first quarter. What still happens though, are the projects that were expecting those jobs to come off the floor now got delayed and pushed out a little bit. It's going to probably take at least four months for us to get all of that flow back into the entire works to where we're back to where we think we're on top of the business again.

[George Gaspar Robert W. Baird:]

Then on the new activity, are there any particular areas that are creating new opportunities for you that you haven't been associated with in the past from the standpoint of R&D or innovation that's domestic or international in terms of project profile that's giving you opportunities that you haven't seen before?

[Pat McDonald:]

You know, we always talk about we will continue to invest in our R&D and we continue to invest in our R&D even today. We will continue to invest higher than what other people are investing. We have none that I would say are job specific, but we have a number of projects that we are working on right now that will be helping us in the future.

[George Gaspar Robert W. Baird:]

One last on the Power/Vac, the transfer out of Iowa. In terms of, I know you made some comments about it, is that pretty much at a full operational point in Houston now relative to what GE was experiencing in Iowa? How does that compare at this point in time?

[Don Madison:]

We completed moving all of the operations out of the GE facility around the end of February. Since the end of February, what we have been doing is fine-tuning and refining our own internal processes. That's what we're working on today. As we spoke earlier, I think we will have accomplished what we anticipated and set forth with the acquisition no later than the second quarter, which is at this point, weeks away.

[Operator:]

Our next question comes from J.D. Padgett Boston Company.

[J.D. Padgett Boston Company:]

Couple quick ones. The tax rate that you're assuming for next year would be what?

[Don Madison:]

At this point in time, I would expect it to be no material change from the last couple of years. Basically been around 35.5%.

[J.D. Padgett Boston Company:]

Then the other question I had was related to some of the discussions on the San Francisco thing that was impacting process control. Can you just remind me what that's about?

[Don Madison:]

Basically, we had a project with the City of San Francisco that ran into some delays as a result of early on issues that our position came from delays due to the city itself as opposed to our operations. That project is online, it has been successful. The client is very happy with the project. In fact, it's been operational now for about two years. Basically, there was withholding of money from the contract by the city and we weren't successful in a mediation. We had to end up going to court to basically obtain the monies that we felt were due to us. That's where we are at this point in time.

[J.D. Padgett Boston Company:]

Just some legal fees and so forth which are impacting the margins there?

[Don Madison:]

Legal fees that have impacted the margin. That is correct.

[J.D. Padgett Boston Company:]

When can we see some resolution there?

[Don Madison:]

Basically, we have a ruling from the court. That ruling took place about late in the second quarter. What we have been dealing with since then, and it will continue until early part of next year, is the appeals process.

[J.D. Padgett Boston Company:]

What's the potential recovery if you're successful?

[Don Madison:]

Potential recovery would be, at this point in time, in excess of our book value of $1.9 million.

[J.D. Padgett Boston Company:]

Finally, the hurricane impact through the rest of the P&L, I know you called out the revenue and EPS impact, it's fair to assume probably there was some depressing effects on gross margin, if for no other reason than just slower throughput.

[Don Madison:]

Basically, I would say that 99% of the impact was in the gross margin area as opposed to anything in the operating or SG&A area.

[J.D. Padgett Boston Company:]

So not a lot of expenses in operating expenses for clean up and hurricane preparation, all that kind of stuff?

[Don Madison:]

Basically, most of that was done by hourly personnel and resulted in manufacturing costs. That's where the work was done and that's where the costs were incurred.

[Operator:]

Fred Buonocore, please go ahead with your followup question.

[Fred Buonocore CJS Securities:]

Just a few followups. As it relates to orders and we've been talking about, you have seen an impact in the September quarter from the storm. More relevant to the current economic situation, can you just give us a sense for trends in October and November with orders?

[Pat McDonald:]

I think we're reasonably safe to say that orders for the first quarter of this fiscal year will exceed our fourth quarter of last fiscal year. I think we're seeing a good trend.

[Fred Buonocore CJS Securities:]

Then you talked a little bit about the opportunity in mass transit, as it relates to the new administration and approval of billion of dollars for projects. Can you quantify what the opportunity is for Powell in traction and process control, I guess?

[Pat McDonald:]

We tracked a fiveyear view of projects. Those projects are ones that have been on the docket and looked at and once they potentially have federal funding, I think what we tried to address in our comments, is the overwhelming push by the public to say we want mass transit and we want you, government, to fund this, state governments to go fund this. I think, again, what I believe is the strength that we see over the fiveyear horizon says we're going to get our good fair share of that business because people really want to see funding done for mass transit projects. I can't tell you how much that is, but I think it's going to be a very strong number for us.

[Fred Buonocore CJS Securities:]

Is it safe to assume that maybe traction power becomes a greater overall portion of your EPP mix?

[Don Madison:]

Clearly as we go forward I would expect the opportunity to grow in the municipal markets, both in the transit as well as in the municipal markets for our intelligent transportation systems. You are looking at opportunities that could easily exceed several hundred thousand dollars a year. Realizing that it's still a competitive market, but we think that we're well positioned to get our fair share.

[Fred Buonocore CJS Securities:]

Finally, on working capital, how should we think about this as it relates to, and you continue to have strong orders, you're continuing to sort of finance these projects for your customers, at what point do things catch up to where your cash flow from operations is a source of cash as opposed to use.

[Don Madison:]

At this point in time, I think that the full year 2009 will result in a source of cash. When you are looking at the first quarter, the first quarter will likely continue to be a use. But at this point in time, I think that we will turn the corner and start seeing positive cash flows predominantly coming from reductions in working capital relative to revenue around midyear.

[Fred Buonocore CJS Securities:]

Thank you, and we look forward to seeing you at our conference in a few weeks.

[Operator:]

Our next question comes from Stefan Mykytiuk Pike Place Capital.

[Stefan Mykytiuk:]

Good morning. Just a followup on Fred's questions about the orders. Given what's going on in the world, seems like a lot of refiners and chemical companies been cutting back their CapEx. So, where are you seeing the strength in this December quarter for orders? What kind of end markets are still strong?

[Don Madison:]

The orders activity we have seen thus far in the first quarter continue to be representative of historical markets. It continues to have a strong impact from the oil and gas segment, both domestically as well as internationally. That comes back to, from the beginning, we really have not seen any, what I would call noticeable change in activity in the marketplace from and order activity standpoint.

[Operator:]

And a followup from Brent Thielman, please go ahead.

[Brent Thielman D.A. Davidson:]

One quick one. Just give us a quick update on the [Makita] contract and what's remaining in backlog.

[Pat McDonald:]

The project is going well. What's remaining in backlog, I don't have that number in front of me. I would think it's still a fairly substantial number that is out there yet to go.

[Brent Thielman D.A. Davidson:]

Relative to the offshore market, any sort of update that are you still seeing good activity in that particular oil and gas area?

[Pat McDonald:]

We are seeing good activity in it and good dialogue and discussions with our customers. I think that's going to be again another strong point in the future. As we look at pipelines and offshore platforms, as people look to find energy sources from other areas, the offshore plays a big role for us in the future. Because it is a less costly extraction process than other things like the tar sands. By congress allowing more offshore drilling to begin, I think that's going to bode well for us in the future.

[Operator:]

Craig Bell, please go ahead with your followup.

[Craig Bell SMH Capital:]

I wanted to circle back on the backlog and the new orders. Just wondering between the hurricane, obviously, you guys were shut down, you couldn't take orders and many clients were also impacted. Do you think that had a significant impact on new orders and backlog in the quarter or is it more just regular lumpiness?

[Pat McDonald:]

There was some impact. There's no way we can quantify it. Again, we were down, we were not able to take orders and we know all of our customers, especially in the oil area around Houston, were working to get their facilities back up online.

[Craig Bell SMH Capital:]

Have you seen any business that's come out of the impact from the hurricane? Just sort of repair work that needed to be done?

[Pat McDonald:]

We have seen some in our service business. There's no doubt about that. I think every time there's a hurricane, just as we talked about how we prepare. Our customers are doing a better job to prepare themselves. Especially in the oil and gas, they are putting all their substations up in the air. Our facilities, our control rooms and things are lifted up into the air. So, they're getting a lot smarter about the storm surge to make sure that they aren't cut down in their electrical area as a result of storms.

[Operator:]

A followup from Tom Spiro, please go ahead.

[Tom Spiro Spiro Capital Management:]

It's been asked and answered. Thanks anyway.

[Operator:]

There are no further questions at this time. Please helicopter with any closing comments.

[Pat McDonald:]

Thank you for joining us today. I would like to thank you for your interest in Powell. I would also like to take this opportunity to thank our customers and our people for making a successful year for Powell. We look forward to talking with you again next quarter.

[Operator:]

This concludes the Powell Industries fourth quarter earnings conference call. If you would like to listen to a replay of today's conference, you can do so by dialing (303) 5903000 and put the access code 11122993. Thank you very much for your participation, you may now disconnect.