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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-27460
PERFORMANCE TECHNOLOGIES, INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 16-1158413
(State or other jurisdiction of (I.R.S. Employer
incorporation) Identification No.)
205 Indigo Creek Drive, Rochester, New York 14626
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (585) 256-0200
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
The number of shares outstanding of the registrant's common stock was
12,871,297 as of July 27, 2005.
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PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Consolidated Balance Sheets as of June 30, 2005 (unaudited)
and December 31, 2004 3
Consolidated Statements of Income for the Three and Six
Months Ended June 30, 2005 and 2004 (unaudited) 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2005 and 2004 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits 23
Signatures 24
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30, December 31,
2005 2004
--------------- ---------------
(unaudited)
Current assets:
Cash and cash equivalents $10,829,000 $10,361,000
Investments 18,600,000 15,250,000
Accounts receivable, net 8,505,000 10,185,000
Inventories, net 6,336,000 6,573,000
Prepaid income taxes 640,000 771,000
Prepaid expenses and other assets 416,000 801,000
Deferred taxes 3,092,000 3,088,000
--------------- ---------------
Total current assets 48,418,000 47,029,000
Property, equipment and improvements, net 1,940,000 2,186,000
Software development costs, net 4,057,000 3,653,000
Goodwill 4,143,000 4,143,000
--------------- ---------------
Total assets $58,558,000 $57,011,000
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,219,000 $ 1,476,000
Accrued expenses 3,746,000 3,916,000
--------------- ---------------
Total current liabilities 4,965,000 5,392,000
Deferred taxes 1,412,000 1,198,000
--------------- ---------------
Total liabilities 6,377,000 6,590,000
--------------- ---------------
Stockholders' equity:
Preferred stock - $.01 par value;
1,000,000 shares authorized; none issued
Common stock - $.01 par value; 50,000,000
shares authorized; 13,260,038 shares
issued 133,000 133,000
Additional paid-in capital 13,631,000 13,476,000
Retained earnings 42,328,000 41,978,000
Treasury stock - at cost; 390,775 and
482,681 shares held at June 30, 2005 and
December 31, 2004, respectively (3,911,000) (5,188,000)
Accumulated other comprehensive income 22,000
--------------- ---------------
Total stockholders' equity 52,181,000 50,421,000
--------------- ---------------
Total liabilities and stockholders'
equity $58,558,000 $57,011,000
=============== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Sales $10,802,000 $13,273,000 $23,959,000 $28,839,000
Cost of goods sold 5,916,000 6,653,000 12,378,000 14,241,000
------------ ------------ ------------ ------------
Gross profit 4,886,000 6,620,000 11,581,000 14,598,000
------------ ------------ ------------ ------------
Operating expenses:
Selling and marketing 1,369,000 1,572,000 2,846,000 3,200,000
Research and development 2,327,000 2,621,000 4,872,000 5,212,000
General and administrative 1,094,000 1,199,000 2,527,000 2,542,000
Restructuring charges 139,000 196,000
In-process research and
development 218,000
------------ ------------ ------------ ------------
Total operating expenses 4,929,000 5,392,000 10,441,000 11,172,000
------------ ------------ ------------ ------------
Income(loss)from operations (43,000) 1,228,000 1,140,000 3,426,000
Other income, net 330,000 151,000 625,000 289,000
------------ ------------ ------------ ------------
Income before income taxes
and equity in income of
unconsolidated company 287,000 1,379,000 1,765,000 3,715,000
Income tax provision 83,000 428,000 512,000 1,219,000
------------ ------------ ------------ ------------
Income before equity in
income of unconsolidated
company 204,000 951,000 1,253,000 2,496,000
Equity in income of
unconsolidated company 80,000 92,000
------------ ------------ ------------ ------------
Net income $ 204,000 $ 1,031,000 $ 1,253,000 $ 2,588,000
============ ============ ============ ============
Basic earnings per share $ .02 $ .08 $ .10 $ .20
============ ============ ============ ============
Diluted earnings per share $ .02 $ .08 $ .10 $ .19
============ ============ ============ ============
Weighted average number of
common shares used in
basic earnings per share 12,863,345 12,741,867 12,836,333 12,673,917
Potential common shares 180,747 680,294 293,643 855,534
Weighted average number of
common shares used in ------------ ------------ ------------ ------------
diluted earnings per 13,044,092 13,422,161 13,129,976 13,529,451
share ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
June 30,
2005 2004
--------------- ---------------
Cash flows from operating activities:
Net income $ 1,253,000 $ 2,588,000
Non-cash adjustments:
Depreciation and amortization 1,325,000 1,352,000
Reserve for inventory obsolescence 656,000 383,000
Tax benefit from stock option exercises 143,000
Deferred taxes 210,000 115,000
In-process research and development 218,000
Equity in income of unconsolidated company (92,000)
Other 41,000 43,000
Changes in operating assets and liabilities,
net of effects of acquisition:
Accounts receivable 1,653,000 (2,562,000)
Inventories (419,000) (1,663,000)
Prepaid expenses and other assets 385,000 252,000
Accounts payable and accrued expenses (427,000) (483,000)
Income taxes payable and prepaid income
taxes 131,000 (1,353,000)
--------------- ---------------
Net cash provided (used) by operating
activities 4,951,000 (1,202,000)
--------------- ---------------
Cash flows from investing activities:
Purchases of property, equipment and
improvements (198,000) (248,000)
Capitalized software development costs (1,308,000) (1,124,000)
Purchases of investments (32,900,000) (29,050,000)
Proceeds from sales of investments 29,550,000 30,900,000
Loan to unconsolidated company (1,300,000)
Business acquisition (7,044,000)
--------------- ---------------
Net cash used by investing activities (4,856,000) (7,866,000)
--------------- ---------------
Cash flows from financing activities:
Proceeds from exercise of stock options 373,000 2,911,000
--------------- ---------------
Net cash provided by financing activities 373,000 2,911,000
--------------- ---------------
Net increase (decrease) in cash and cash
equivalents 468,000 (6,157,000)
Cash and cash equivalents at beginning of
period 10,361,000 12,639,000
--------------- ---------------
Cash and cash equivalents at end of period $ 10,829,000 $ 6,482,000
=============== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note A - Basis of Presentation
---------------------
The unaudited Consolidated Financial Statements of Performance Technologies,
Incorporated and Subsidiaries (the "Company") have been prepared in accordance
with generally accepted accounting principles in the United States of America
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X of the Securities and Exchange Commission.
Accordingly, the Consolidated Financial Statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included. The results for
the interim periods are not necessarily indicative of the results to be expected
for the year. The accompanying Consolidated Financial Statements should be read
in conjunction with the audited Consolidated Financial Statements of the Company
as of December 31, 2004, as reported in its Annual Report on Form 10-K filed
with the Securities and Exchange Commission.
Note B - Stock-Based Compensation and Earnings Per Share
-----------------------------------------------
At June 30, 2005, the Company had stock options outstanding under three stock
option plans. The Company accounts for the stock option plans under the
recognition and measurement principles of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no stock-based compensation cost has been recognized in net income
for the stock option plans. On March 25, 2005, the Company accelerated the
vesting of 408,285 stock options whose exercise prices were greater than $15.11
to be fully vested on that date. As a result of the acceleration, the Company
expects to reduce its exposure to the effects of Statement of Financial
Accounting Standards (SFAS) No. 123 (Revised), "Share-Based Payment." Had
compensation cost for the stock option awards under the plans been determined
based on the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net income (loss) and earnings (loss)
per share would have been as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net income, as reported $ 204,000 $ 1,031,000 $ 1,253,000 $ 2,588,000
Add: Restricted stock
compensation expense,
net of tax 4,000 6,000 7,000 21,000
Deduct: Total stock-based
compensation expense
determined under fair
value based method for all
awards, net of related tax
effects (154,000) (764,000) (2,290,000) (1,223,000)
------------ ------------ ------------ ------------
Pro forma net income (loss) $ 54,000 $ 273,000 $(1,030,000) $ 1,386,000
============ ============ ============ ============
Earnings (loss) per share:
Basic - as reported $ .02 $ .08 $ .10 $ .20
============ ============ ============ ============
Basic - pro forma $ .00 $ .02 $ (.08) $ .11
============ ============ ============ ============
Diluted - as reported $ .02 $ .08 $ .10 $ .19
============ ============ ============ ============
Diluted - pro forma $ .00 $ .02 $ (.08) $ .10
============ ============ ============ ============
During the six months ended June 30, 2005, the Company granted 204,000 stock
options. The assumption for vesting of stock options granted in 2005 and 2004
was generally 33% per year. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in 2005 and 2004:
Dividend yields of 0% for both years; expected volatility ranges of 65% to 70%
in 2005 and 68% to 69% in 2004, risk-free interest rate ranges of 3.3% to 3.7%
in 2005 and 2.1% to 3.5% in 2004, and expected life ranges of one to three years
for both years.
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share calculations reflect the assumed exercise of dilutive stock options and
unvested restricted stock, applying the treasury stock method. Diluted earnings
per share calculations exclude the effect of approximately 1,330,000 and
1,075,000 options for the three months ended June 30, 2005 and 2004,
respectively, and 1,144,000 and 621,000, for the six months ended June 30, 2005
and 2004, respectively, since such options have an exercise price in excess of
the average market price of the Company's common stock for the respective
periods.
During the six months ended June 30, 2005, 91,906 common shares were issued upon
exercise of stock options.
Note C - Acquisition
-----------
On January 23, 2004, the Company acquired substantially all of the assets and
assumed certain liabilities of Mapletree Networks, Inc., a company that provided
voice, data and fax processing technology to original equipment manufacturers.
The products acquired in this acquisition broaden the Company's product offering
to its customers. In accordance with the purchase agreement, the Company paid
$6,625,000 at closing and incurred $418,000 of other acquisition related costs.
The Company accounted for the acquisition under the provisions of SFAS No. 141,
"Business Combinations." Acquired in-process research and development (IPR&D),
which was related to certain voice processing products, amounted to $218,000 and
was charged to operations during the first quarter 2004. As a component of the
acquisition, the Company acquired certain software development costs which
amounted to $577,000 at the date of acquisition. The Company also acquired
certain net assets which amounted to $574,000 and were comprised principally of
accounts receivable, inventory, accounts payable and accrued expenses. During
the fourth quarter 2004, the Company resolved certain matters related to the
acquisition resulting in a payment to the Company of $1,749,000, which
represented a partial return of purchase price and was recorded as a reduction
of goodwill. The excess of purchase price over the fair value of the net assets
acquired totaled $4,143,000 and is included in goodwill on the accompanying
Consolidated Balance Sheets. Operating results of the acquired group have been
included in the Consolidated Statements of Income from the date of acquisition.
Note D - Inventories, net
----------------
Inventories consisted of the following:
June 30, December 31,
2005 2004
------------------- --------------------
Purchased parts and components $ 3,700,000 $ 3,638,000
Work in process 3,909,000 3,947,000
Finished goods 2,134,000 2,487,000
------------------- --------------------
9,743,000 10,072,000
Less: reserve for inventory
obsolescence (3,407,000) (3,499,000)
------------------- --------------------
Net $ 6,336,000 $ 6,573,000
=================== ====================
Note E - Investments
-----------
In connection with the preparation of the Company's Annual Report on Form 10-K
for 2004, the Company concluded that it was appropriate to classify auction rate
municipal securities as investments. Previously, such investments were
classified as cash equivalents. Accordingly, the Company revised the
classification to report these securities as investments on the Consolidated
Balance Sheets as of December 31, 2004. The Company recorded corresponding
reclassifications in the accompanying Consolidated Statement of Cash Flows for
the six months ended June 30, 2004, to reflect the gross purchases and sales of
these securities as investing activities. This change in classification did not
affect previously reported cash flows from operations or from financing
activities or previously reported net income for any period.
For the six months ended June 30, 2004, net cash provided by investing
activities related to these investments totaled $1,850,000, which was previously
included in cash and cash equivalents in the Company's Consolidated Statements
of Cash Flows.
At June 30, 2005, investments consisted of high grade, auction rate municipal
securities which the Company has classified as available-for-sale. The
contractual maturities of the available-for-sale securities at June 30, 2005 all
exceeded five years.
These investments are recorded at cost, which approximates fair market value due
to their variable interest rates. These investments typically reset on
approximately a monthly basis, and, despite the long-term nature of their stated
contractual maturities, the Company has historically had the ability to quickly
liquidate these securities. All income generated from these investments was
recorded as interest income.
Note F - Warranty Obligations
--------------------
The Company has warranty obligations in connection with the sale of certain of
its products. The warranty period for its products is generally one year. The
costs incurred to provide for these warranty obligations are estimated and
recorded as an accrued liability at the time of sale. The Company estimates its
future warranty costs based on product-based historical performance rates and
related costs to repair. The changes in the Company's accrued warranty
obligations for the six months ended June 30, 2005 and 2004 were as follows:
2005 2004
---------------- ----------------
Accrued warranty obligations, January 1, $288,000 $233,000
Actual warranty experience (57,000) (274,000)
Warranty provisions 69,000 285,000
---------------- ----------------
Accrued warranty obligations, June 30, $300,000 $244,000
================ ================
Note G - Investment in Unconsolidated Company
------------------------------------
On February 18, 2004, the Company entered into an agreement to invest up to
$3,000,000 in InSciTek Microsystems, Inc. (InSciTek), an unrelated company, in
the form of an interest bearing convertible note. During 2004, the Company
invested $3,000,000 in conjunction with this agreement. As of December 31, 2004,
InSciTek had not raised sufficient outside capital to assure its future as a
going concern. Therefore, during the fourth quarter 2004, the Company recorded a
valuation charge related to this note receivable in the amount of $3,000,000 as
collection of this note was doubtful. The Company has the option to acquire
ownership of InSciTek during a future specified period. The note bears interest
at 10% annually and is convertible into shares of common stock of InSciTek. All
unpaid accrued interest and all outstanding principal on the note is payable in
full to the Company on December 31, 2008. InSciTek is currently negotiating
with an outside party to raise additional funds. Under the terms currently
being negotiated, the Company would forfeit its option to acquire ownership of
InSciTek during a future specified period.
Note H - Subsequent Event
----------------
On July 11, 2005, the Company announced that its Board of Directors authorized
the Company to repurchase shares of its common stock for an aggregate amount not
to exceed $10,000,000. Under this program, shares of the Company's common stock
may be repurchased through open market or private transactions, including block
purchases, over the next twelve months. Repurchased shares will be used for the
Company's stock option plan, potential acquisition initiatives and general
corporate purposes. To date, there have been no repurchases of shares under this
program.
Note I - Recently Issued Accounting Pronouncements
-----------------------------------------
In December 2004, SFAS No. 123 "Accounting for Stock-Based Compensation (Revised
2004)" was issued. This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This statement requires an entity to measure the cost of employee
services received in exchange for an award of equity instruments, based on the
fair value of the award at the grant date. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award. The effective date of this statement was extended by the Securities
and Exchange Commission and will be effective for the Company beginning January
1, 2006. As of the required effective date, all entities that used the
fair-value-based method for either recognition or disclosure under SFAS No. 123
may apply this statement using a modified version of prospective application. An
alternative method of application is available under SFAS No. 123R. Under the
modified version of prospective application, compensation cost is recognized for
the portion of outstanding stock-based awards for which the requisite service
has not yet been rendered. The Company is currently assessing the impact this
statement will have on its financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment
of ARB No. 43, Chapter 4." SFAS No. 151 states that abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage) should
be recognized as current-period charges. Additionally, SFAS No. 151 requires
that allocation of fixed production overheads to the costs of conversion be
based on the normal capacity of the production facilities. The Company is
required to adopt SFAS No. 151 effective January 1, 2006. The Company does not
expect the adoption of SFAS No. 151 will have a material impact on its
consolidated results of operations and financial condition.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
- An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions."
SFAS No. 153 is based on the principle that nonmonetary asset exchanges should
be recorded and measured at the fair value of the assets exchanged, with certain
exceptions. This standard requires exchanges of productive assets to be
accounted for at fair value, rather than at carryover basis, unless (1) neither
the asset received nor the asset surrendered has a fair value that is
determinable within reasonable limits or (2) the transactions lack commercial
substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The Company is required to adopt SFAS
No. 153 effective for its fiscal quarter beginning after June 15, 2005, and does
not expect the adoption of SFAS No. 153 will have a material impact on its
consolidated results of operations and financial condition.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which replaces APB Opinion No. 20, "Accounting Changes," and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements."
SFAS No. 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Upon the adoption of SFAS No. 154 beginning
January 1, 2006, the Company will apply the standard's guidance to changes in
accounting methods as required. At this time, the Company does not expect the
adoption of SFAS No. 154 will have a material impact on its consolidated results
of operations and financial condition.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Matters discussed in Management's Discussion and Analysis of Financial Condition
and Results of Operations and elsewhere in this Form 10-Q include
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, and are subject to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. The Company's actual results could
differ materially from those discussed in the forward-looking statements.
Critical Accounting Estimates and Assumptions
In preparing the financial statements in accordance with GAAP, management is
required to make estimates and assumptions that have an impact on the assets,
liabilities, revenue and expense amounts reported. These estimates can also
affect supplemental information disclosures by the Company, including
information about contingencies, risk and financial condition. The Company
generally cannot make estimates until preliminary results for a financial
quarter are known and analyzed. The Company believes, given current facts and
circumstances, its estimates and assumptions are reasonable, adhere to GAAP, and
are consistently applied. Inherent in the nature of an estimate or assumption is
the fact that actual results may differ from estimates and estimates may vary as
new facts and circumstances arise. The critical accounting policies, judgments
and estimates that management believes have the most significant effect on the
financial statements are set forth below:
o Revenue Recognition
o Software Development Costs
o Valuation of Inventories
o Income Taxes
o Product Warranty
o Carrying Value of Goodwill
Revenue Recognition: The Company recognizes revenue from product sales in
accordance with the SEC Staff Accounting Bulletin (SAB) No. 104, "Revenue
Recognition." Product sales represent the majority of the Company's revenue and
include hardware products and hardware products with embedded software. The
Company recognizes revenue from these product sales when persuasive evidence of
an arrangement exists, delivery has occurred or services have been provided, the
sale price is fixed or determinable, and collectability is reasonably assured.
Additionally, the Company sells its products on terms which transfer title and
risk of loss at a specified location, typically shipping point. Accordingly,
revenue recognition from product sales occurs when all factors are met,
including transfer of title and risk of loss, which typically occurs upon
shipment by the Company. If these conditions are not met, the Company will defer
revenue recognition until such time these conditions have been satisfied.
Revenue earned from arrangements for software is accounted for under the
provisions of Statement of Position 97-2, "Software Revenue Recognition" and
EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables". Revenue
from software requiring significant production, modification, or customization
is recognized using the percentage of completion method of accounting. Any
anticipated losses on contracts are charged to operations as soon as such losses
are determined. If all conditions of revenue recognition are not met, the
Company defers revenue recognition and will recognize revenue when the Company
has fulfilled its obligations under the arrangement. Revenue from software
maintenance contracts is recognized ratably over the contractual period.
Revenue from consulting and other services is recognized at the time the
services are rendered. The Company also sells certain products through
distributors who are granted limited rights of return. Potential returns are
accounted for at the time of sale.
The Company believes that the accounting estimate related to revenue recognition
is a "critical accounting estimate" because the Company's terms of sale can
vary, and management exercises judgment in determining whether to defer revenue
recognition. Such judgments may materially affect net sales for any period.
Management exercises judgment within the parameters of GAAP in determining when
contractual obligations are met, title and risk of loss are transferred, sales
price is fixed or determinable and collectability is reasonably assured.
Software Development Costs: All software development costs incurred in
establishing the technological feasibility of computer software products to be
sold are research and development costs. Software development costs incurred
subsequent to the establishment of technological feasibility of a computer
software product to be sold and prior to general release of that product are
capitalized. Amounts capitalized are amortized commencing after general release
of that product over the estimated remaining economic life of that product,
generally three years, or using the ratio of current revenues to current and
anticipated revenues from such product, whichever provides greater amortization.
If in the judgment of management, technological feasibility for a particular
project has not been met or recoverability of amounts capitalized is in doubt,
project costs are expensed as research and development or charged to costs of
goods sold, as applicable. The Company believes that the accounting estimate
related to software development costs is a "critical accounting estimate"
because the Company's management exercises judgment in determining whether
project costs are expensed as research and development or capitalized as an
asset. Such judgments may materially affect expense amounts for any period.
Management exercises judgment within the parameters of GAAP in determining when
technological feasibility has been met and recoverability of software
development costs is reasonably assured.
Valuation of Inventories: Inventories are stated at the lower of cost or market,
using the first-in, first-out method. The Company's inventory includes purchased
parts and components, work in process and finished goods. The Company provides
inventory reserves for excess, obsolete or slow moving inventory after periodic
evaluation of historical sales, current economic trends, forecasted sales,
estimated product lifecycles and estimated inventory levels. The factors that
contribute to inventory valuation risks are the Company's purchasing practices,
electronic component obsolescence, accuracy of sales and production forecasts,
introduction of new products, product lifecycles, product support and foreign
regulations governing hazardous materials (see LIQUIDITY AND CAPITAL RESOURCES
for futher information on foreign regulations). The Company manages its exposure
to inventory valuation risks by maintaining safety stocks, minimum purchase
lots, managing product end-of-life issues brought on by aging components or new
product introductions, and by utilizing certain inventory minimization
strategies such as vendor-managed inventories. The Company believes that the
accounting estimate related to valuation of inventories is a "critical
accounting estimate" because it is susceptible to changes from period-to-period
due to the requirement for management to make estimates relative to each of the
underlying factors ranging from purchasing, to sales, to production, to
after-sale support. If actual demand, market conditions or product lifecycles
are adversely different from those estimated by management, inventory
adjustments to lower market values would result in a reduction to the carrying
value of inventory, an increase in inventory write-offs and a decrease to gross
margins.
Income Taxes: The Company accounts for income taxes using the asset and
liability approach which requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of the temporary differences
between the carrying amounts and the tax basis of such assets and liabilities.
The Company would record a valuation allowance to reduce deferred tax assets to
the amount that is more likely than not to be realized. The Company believes
that the accounting estimate related to income taxes is a "critical accounting
estimate" because the Company exercises judgment in estimating future taxable
income, including prudent and feasible tax planning strategies, in assessing the
need for any valuation allowance. If the Company should determine that it would
not be able to realize all or part of its net deferred tax assets in the future,
an adjustment to the deferred tax asset would be charged to income in the period
such determination was made. Likewise, in the event that the Company were to
determine that it would be able to realize its deferred tax assets in the future
in excess of the net recorded amount, an adjustment to the deferred tax asset
would increase income in the period such determination was made.
Product Warranty: The Company has warranty obligations in connection with the
sale of certain of its products. The warranty period for these products is
generally one year. The costs incurred to provide for these warranty obligations
are estimated and recorded as an accrued liability at the time of sale. The
Company estimates its future warranty costs based on historical performance
rates and related costs to repair given products. The Company believes that the
accounting estimate related to product warranty is a "critical accounting
estimate" because the Company exercises judgment in determining future estimated
warranty costs. Should actual performance rates or repair costs differ from
estimates, revisions to the estimated warranty liability would be required.
Carrying Value of Goodwill: The Company conducts tests for impairments of
goodwill annually or more frequently if circumstances indicate that the asset
might be impaired. The Company believes that the accounting estimate related to
goodwill is a "critical accounting estimate" because these impairment tests
include management estimates of future cash flows that are dependent upon
subjective assumptions regarding future operating results including growth
rates, discount rates, capital requirements and other factors that impact the
estimated fair value. An impairment loss is recognized to the extent that an
asset's carrying amount exceeds its fair value.
Overview
The following contains forward-looking statements within the meaning of the
Securities Act of 1933 and Securities Exchange Act of 1934 and is subject to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The Company is a leading developer of platforms, components, software and
services for the embedded systems market. This marketplace is comprised of
several sectors, with telecommunications being the largest. The Company markets
its products through its direct worldwide sales force under a variety of brand
names including IPnexus(TM), SEGway(TM), NexusWare(TM) and Advanced Managed
Platforms. These products are sold individually or can be mixed and matched to
construct highly integrated, packet-based platforms for the embedded systems
marketplace. When sold as integrated platforms (Advanced Managed Platforms)
these products offer customers distinct cost advantages, increase overall system
reliability and performance, and improve time-to-market for their products.
Advanced Managed Platforms, based on the PICMG 2.16 standard, are applicable to
the broader embedded systems market, not just telecommunications. Since its
introduction in 2003, this product line has realized more than 30 new design
wins of varying sizes. Only a small number of these design wins have reached
production levels.
Over the past two quarters, the Company has announced and released several new
products. Those products include: the new AdvancedTCA (ATCA) Advanced Managed
Platform offering, a variety of media and packet-processing slot components
including a quad-processor and media gateway blade, and new additions to the
Signaling product family, including several Signaling Gateway and IP-STP
advancements. Management believes that these new products build upon the
Company's platform and software strategy, and provide high growth prospects for
future revenue.
The telecommunications market is dependent upon carrier spending to upgrade
network infrastructure to next-generation equipment. As the Company entered
2005, there were announcements by major domestic wireless carriers for new
spending programs directed at upgrading networks to the third generation (3G) of
mobile network capabilities. During the second quarter 2005, actual shipments by
the Company to the telecommunications equipment providers for this equipment
were less than forecasted volumes. Three customers accounted for the greater
part of the revenue shortfall. Despite weakness in a number of end markets,
shipments of Advanced Managed Platforms accelerated during the second quarter.
Management expects that ongoing competitive pressures on the North American
wireless carriers will result in deployment of the previously announced network
and data services upgrades during the later part of 2005 and into 2006.
Unfortunately, forward-looking visibility of customers' orders continues to be
very limited.
Operating expenses for the second quarter 2005 were lower than the first quarter
2005 and reflect continuing progress of the Company's centralization and
streamlining plan announced in October 2004. At that time, management began
formulating a plan to reduce annualized expenses by approximately $2.0 million
with a primary focus on centralizing its multi-location operations and
streamlining the organization. During the fourth quarter 2004, the Company
completed integration of the Voice Technology Group (VTG) sales, marketing and
administrative functions into its corporate operations. During the first quarter
2005, the Company completed integration of the accounting functions for VTG and
the Computing Products Group into corporate accounting in Rochester, New York.
During the second quarter 2005, transition of manufacturing operations for VTG
products was completed and substantial progress was realized in transitioning
the manufacturing of the Computing Products to Rochester. This centralization
plan is expected to be completed in September 2005. While the Company continues
to pursue its centralization plan, some part of these savings will be reinvested
to stimulate future growth.
During the first quarter 2005, the Company announced that its current president
and chief executive officer, Donald Turrell, will leave the Company's executive
management at the end of the year. The Succession Committee of the Board of
Directors has retained an executive search firm to assist in the process of
identifying qualified individuals for this position and candidates are being
interviewed. Mr. Turrell will maintain active involvement throughout the
transition of the Company's change in leadership and expects to remain as a
board member thereafter.
On July 11, 2005, the Company announced that its Board of Directors authorized
the Company to repurchase shares of its common stock for an aggregate amount not
to exceed $10.0 million. Under this program, shares of the Company's common
stock may be repurchased through open market or private transactions, including
block purchases, over the next twelve months. Repurchased shares will be used
for the Company's stock option plan, potential acquisition initiatives and
general corporate purposes. To date, there have been no repurchases of shares
under this program.
Strategy: The Company has a history of successfully adapting its products and
services to a constantly changing technology-driven marketplace. This adaptation
has been demonstrated through the course of several business cycles that have
occurred since its founding in 1981. During the most recent economic downturn,
the Company maintained its commitment to aggressively fund new product
development, as well as to use its strong balance sheet to acquire additional
products and technologies to strengthen its market position.
The Company's IPnexus product line, based on open system architectures, consists
of a wide range of embedded building blocks, which can be mixed and matched to
construct highly integrated, packet-based platforms. In September 2003, the
Company introduced a new line of application ready platforms marketed under the
trade name Advanced Managed Platform (AMP). Initially, this platform line was
based on an architecture referred to as PICMG 2.16, which is an embedded
technology developed by the Company and adopted as an industry standard. In June
2005, the Company introduced its new AdvancedTCA (ATCA) Advanced Managed
Platform offering which incorporates a new architecture specifically targeted at
telecommunications applications. Today, the Advanced Managed Platform product
line contains the Company's latest generation of configurable, fully-managed and
redundant packet-based platforms targeted at communications applications, which
leverage all of the Company's IPnexus component-based products. Advanced Managed
Platforms offer customers distinct cost advantages, increase overall system
reliability and performance, and improve time-to-market for their products. From
a market perspective, the Advanced Managed Platform line continues to prove
itself as a viable alternative to proprietary platforms and directly addresses
equipment manufacturers' requirements for using a flexible and scalable
architecture.
In the next phase of its product strategy, the Company is developing and
introducing a number of products for selected high growth IP-based applications
including media gateway, media server, wireless, voice-over-cable and satellite
communications. The thrust of this effort is to combine certain hardware and
software elements from the Company's product portfolio to form intelligent
embedded solutions which add value for application providers in these target
markets.
Historically, the Company's growth has been generated through a combination of
internal growth and acquisition of new products or complementary technologies.
In October 2002, the Company acquired a portion of Intel Corporation's
Communications Platform Group for its chassis and computing products. In January
2004, the Company completed the acquisition of the assets of Mapletree Networks
to acquire its voice processing technology. The products from both acquisitions
have enhanced the Company's product offerings to its customers.
There are identifiable risks associated with carrying out the Company's
expansive product strategies in the current uncertain economic climate. Many of
the Company's end markets are forecasted to show only modest growth in 2005. In
order to realize growth in this environment, the Company will have to gain
market share from competitors, many of whom are larger, more established
companies with greater resources than the Company. However, management believes
that based on its analysis of the marketplace and the Company's strengthened and
innovative product portfolio, the identified risks are manageable.
If successful, management believes these initiatives will continue to strengthen
the organization as an important strategic partner with its customers, thereby
increasing their utilization of the Company's broadened product capabilities.
Financial Information
Beginning on January 23, 2004, the Company's revenue and expenses reflect the
operations of the Voice Technology Group (acquired from Mapletree Networks).
Revenue:
-------
Revenue in the second quarter 2005 amounted to $10.8 million, compared to $13.3
million in the corresponding quarter a year earlier. Revenue for the six months
ended June 30, 2005 amounted to $24.0 million, compared to $28.8 million for the
first six months of 2004.
Earnings:
--------
GAAP Information:
On a GAAP earnings basis, net income for the second quarter 2005 amounted to $.2
million, or $.02 per diluted share including restructuring charges related to
cost improvement efforts amounting to $.1 million, or $.00 per diluted share,
based on 13.0 million shares outstanding. Net income for the second quarter 2004
amounted to $1.0 million, or $.08 per diluted share based on 13.4 million shares
outstanding.
GAAP net income for the six months ended June 30, 2005 amounted to $1.3 million,
or $.10 per diluted share including restructuring charges related to cost
improvement efforts amounting to $.2 million, or $.01 per diluted share, based
on 13.1 million shares outstanding. Net income for the first six months of 2004
amounted to $2.6 million, or $.19 per diluted share based upon 13.5 million
shares outstanding.
Non-GAAP Information:
Upon the occurrence of certain non-recurring items, the Company will also
calculate and report its results excluding these items from its GAAP net income
to arrive at a non-GAAP measure of net income. Management believes that the
presentation and disclosure of this non-GAAP net income measure provides another
view of the operations and financial condition of the Company on the basis in
which management operates the Company and the Board of Directors reviews its
results. This non-GAAP net income measure is calculated by adjusting net income
reported on a GAAP basis for items that the Company deems to be non-recurring
and unusual or infrequent in their nature. The Company adjusts for these
non-recurring items as these items are excluded from the Company's operational
analysis, budgeting and forecasting functions. The use of this non-GAAP measure
by the Company could result in potential limitations related to possible bank
lending covenant violations, where certain covenants may be measured on GAAP
results. The Company compensates for this potential limitation by attempting to
enter into lending agreements under which covenants are calculated utilizing the
Company's non-GAAP net income measure. At June 30, 2005, the Company was not a
party to any lending arrangements. There can be no assurance that the Company
will be successful in its efforts to obtain lending arrangements under which
certain covenants are calculated utilizing the non-GAAP net income measure
described above.
There was no difference between GAAP net income and non-GAAP net income in the
second quarter 2005, the second quarter 2004 or in the first six months of 2005.
During the first quarter 2004, the Company recorded in-process research and
development costs associated with the acquisition of Mapletree Networks in the
amount of $.2 million, or $.02 per diluted share. On a non-GAAP basis, excluding
the $.2 million of in-process research and development costs, net income for the
first six months of 2004 amounted to $2.8 million, or $.21 per diluted share
based on 13.5 million shares outstanding. A reconciliation of GAAP net income to
non-GAAP net income for the first six months of 2004 is as follows:
2004
--------------
Net income, GAAP basis $2,588
Add: Non-recurring item - In-process research
and development costs 218
--------------
Net income, non-GAAP basis $2,806
==============
Liquidity:
---------
Cash, cash equivalents and investments amounted to $29.4 million and $25.6
million at June 30, 2005 and December 31, 2004, respectively, and the Company
had no long-term debt at either date.
Centralization of Functions:
---------------------------
In October 2004, management began formulating a plan to reduce annualized
expenses by approximately $2.0 million with a primary focus on centralizing its
multi-location operations and streamlining the organization. When this
centralization plan is completed in September 2005, operating expenses (selling,
general and administrative) are expected to be reduced by $1.3 million annually
and manufacturing overhead (cost of goods sold) is expected to be reduced by $.7
million. During the fourth quarter 2004, the Company completed integration of
the Voice Technology Group (VTG) sales, marketing and administrative functions
into its corporate operations. During the first quarter 2005, the Company
completed integration of the accounting functions for VTG and the Computing
Products Group into corporate accounting in Rochester, New York. During the
second quarter 2005, transition of manufacturing operations for VTG products was
completed and substantial progress was realized in transitioning the
manufacturing of the Computing Products to Rochester. Most of the expected
operating (selling, general and administrative) expense reductions associated
with this program were realized by the end of the second quarter. During the
second quarter 2005, the Company incurred charges of $.1 million related to
these restructuring efforts and for the first six months of 2005, the Company
incurred charges totaling $.2 million related to this plan. Additional charges
related to restructuring actions are expected in the range of $.05 million to
$.15 million during the remainder of 2005. While the Company continues to pursue
its centralization plan, some part of these savings will be reinvested to
stimulate future growth.
Forward Looking Guidance for the Third Quarter 2005 (published July 28, 2005):
The following contains forward-looking statements within the meaning of the
Securities Act of 1933 and Securities Exchange Act of 1934 and is subject to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The Company provides guidance related to earnings per share expected in future
quarters. Any additional information provided, such as revenue forecasts, is
provided as supplementary information to the earnings per share guidance.
During weak or uncertain economic periods, the visibility for customers' orders
is limited which frequently causes delays in the placement of orders. These
factors often result in a substantial portion of the Company's revenue being
derived from orders placed within a quarter and shipped in the final month of
the same quarter. Unfortunately, forward-looking visibility on customer orders
continues to be very limited.
Management expects diluted earnings per share in the third quarter 2005 to be in
the range of $.04 to $.07, before any restructuring charges. Based upon the
current business mix, the current backlog and review of sales forecasts, revenue
is forecasted to be in the range of $11.5 million to $12.5 million in the third
quarter 2005. Gross margin is expected to be approximately 45.5% to 47.5% and
the effective income tax rate for the third quarter 2005 is expected to be 29%.
Key Performance Indicators:
The Company's platforms, components, software and service solutions are
incorporated into current and next-generation embedded systems infrastructure.
Traditionally, design wins have been an important metric for management to judge
the Company's product acceptance in its marketplace. Design wins, if
implemented, reach production volumes at varying rates, generally beginning
twelve to eighteen months after the design win occurs. A variety of risks such
as schedule delays, cancellations, changes in customer markets and economic
conditions can adversely affect a design win before production is reached, or
during deployment.
The Company modified its criteria for the measurement of "design wins" in the
third quarter 2004 to provide greater accuracy in predicting forward looking
potential for the Company and to assist in measuring day-to-day execution of
product, sales and marketing programs. Prior the third quarter 2004, the Company
reported design wins that were expected to generate greater than $1.0 million of
annualized revenue. Upon the change in the measurement criteria, the Company
began reporting design wins that were expected to generate greater than $.5
million of annualized revenue. During the second quarter 2005, the Company was
notified of six design wins for its integrated platform solutions (with multiple
products) (3), individual component design wins for IPnexus network access (2)
and for a product that combines the technologies of network access and voice
processing (1). During the second quarter 2004, the Company was notified of four
new design wins, each for an integrated platform solution incorporating multiple
products. Regardless of the change in the measurement metric, management
believes that the growth in the number of design wins for integrated platform
solutions in 2005 reflects increasing customer demand for more complete platform
solutions from a single vendor, such as the Company.
Management believes another key indicator for the Company's business is the
volume of orders received from its customers. During weak economic periods,
customers' visibility deteriorates causing delays in the placement of orders.
While forward-looking visibility on customer orders continues to be very
limited, shipments to customers in the second quarter 2005 amounted to $10.8
million, compared to $13.3 million in second quarter 2004. The shortfall in
revenue in the second quarter 2005 was primarily the result of less than
expected shipments to three customers.
More in-depth discussions of the Company's strategy and financial performance
can be found in the Company's Annual Report on Form 10-K and other filings with
the Securities and Exchange Commission.
Three and Six Months Ended June 30, 2005, Compared with
Three and Six Months Ended June 30, 2004
The following table presents the percentage of sales represented by each item in
the Company's consolidated statements of income for the periods indicated. The
table includes the results of operations of the Voice Technology Group, acquired
by the Company in January 2004.
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
-------- -------- -------- --------
Sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 54.8 50.1 51.7 49.4
-------- -------- -------- --------
Gross profit 45.2 49.9 48.3 50.6
-------- -------- -------- --------
Operating expenses:
Selling and marketing 12.7 11.8 11.9 11.1
Research and development 21.5 19.7 20.3 18.1
General and administrative 10.1 9.1 10.5 8.8
Restructuring charges 1.3 0.8
In-process research and
development 0.7
-------- -------- -------- --------
Total operating expense 45.6 40.6 43.5 38.7
-------- -------- -------- --------
Income (loss) from operations (0.4) 9.3 4.8 11.9
Other income, net 3.1 1.1 2.6 1.0
-------- -------- -------- --------
Income before income taxes and
equity in income of unconsolidated
company 2.7 10.4 7.4 12.9
Income tax provision 0.8 3.2 2.2 4.2
-------- -------- -------- --------
Income before equity in income of
unconsolidated company 1.9 7.2 5.2 8.7
Equity in income of unconsolidated
company 0.6 0.3
-------- -------- -------- --------
Net income 1.9% 7.8% 5.2% 9.0%
======== ======== ======== ========
Sales. Total revenue for the second quarter 2005 amounted to $10.8 million,
compared to $13.3 million for the same quarter in 2004. Revenue for the six
months ended June 30, 2005 totaled $24.0 million, compared to $28.8 million in
the same period of 2004. In both the second quarter 2005 and 2004, the Voice
Technology Group contributed $.4 million to revenue. For the six months ended
June 30, 2005, the Voice Technology Group contributed $.7 million, or 3% of
revenue, compared to a contribution of $1.6 million, or 6%, of revenue in the
first six months of 2004.
In the second quarter 2005, the Company had two customers that each represented
greater than 10% of sales, and the Company's four largest customers represented
42% of sales. During the second quarter 2004, the Company had two customers that
each comprised greater than 10% of revenue and the Company's four largest
customers represented 43% of sales.
For the six months ended June 30, 2005, the Company had two customers who each
represented greater than 10% of revenue and the Company's four largest customers
contributed 45% to revenue. For the six months ended June 30, 2004, three
customers each represented greater than 10% of revenue and the Company's four
largest customers contributed 43% to revenue.
Shipments to customers outside of the United States represented 49% and 32% of
sales during the second quarter 2005 and 2004, respectively and 40% and 30% of
revenue for the six months ended June 30, 2005 and 2004, respectively. In the
second quarter 2005 and for the six months ended June 30, 2005, shipments to the
United Kingdom represented 18% and 12% of revenue, respectively. Total shipments
to a single foreign country did not exceed 10% of revenue during the second
quarter 2004 or for the six months ended June 30, 2004.
For the periods indicated, the Company's products are grouped into four distinct
categories in one market segment: Communications (network access, signaling and
voice) products, Computing products, IPnexus switching products and Other
products. Revenue from each product category is expressed as a percentage of
sales for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
--------- --------- --------- ----------
Communications products 49% 41% 49% 50%
Computing products 32% 40% 26% 34%
IPnexus switching products 18% 18% 24% 14%
Other products 1% 1% 1% 2%
--------- --------- --------- ----------
Total 100% 100% 100% 100%
========= ========= ========= ==========
Communications products:
Communications products are comprised of network access, SEGway signaling and
Voice Technology products. Network access products provide a connection between
embedded systems platforms and a variety of networks and are used to control the
network and/or process information being transported over networks. Many of the
Company's signaling products enable the transport of signaling messages over
packet-switched (IP) networks. Voice Technology products enable voice, data and
fax processing for communications applications.
Revenue from Communications products amounted to $5.3 million and $5.5 million
in the second quarter of 2005 and 2004, respectively. The decline in revenue
during the second quarter 2005, compared to a year earlier, was attributable to
a general decrease in customer purchases due to a weaker market which was
partially offset by increased shipments to one customer and a variety of early
stage customers contributing smaller seed shipments.
Communications product revenue decreased from $14.5 million in the six months
ended June 30, 2004 to $11.7 million in the respective period in 2005. This
decrease of $2.8 million, or 19%, was primarily due to a decrease related to one
major customer that, due to market conditions, unexpectedly decreased product
requirements, as well as an overall decrease due to a weaker market. These
decreases were partially offset by increased sales to one customer in the first
six months of 2005.
Computing products:
Computing products includes integrated platform solutions, a range of single
board computers, a variety of embedded system chassis and associated chassis
management products.
Computing products revenue amounted to $3.5 million in the second quarter 2005,
compared to $5.3 million in the second quarter 2004. The significant decrease in
revenue of $1.8 million was primarily attributable to two major customers whose
product requirements, due to market conditions, began declining during the
second half of 2004 and had ceased altogether by the end of 2004. This decrease
was partially offset by increased shipments to a major customer in 2005.
Revenue for Computing products in the first six months of 2005 totaled $6.2
million, compared to $9.9 million for the first six months of 2004. This
decrease of $3.7 million is primarily attributable to two major customers who,
due to market conditions, ceased purchasing product by the end of 2004, offset
by increased shipments to a major customer in 2005.
IPnexus switching products:
The Company's IPnexus switching product family has been designed for the
rigorous requirements of the embedded systems that use the industry standard
PICMG 2.16 architecture.
Revenue from switching products amounted to $1.9 million in the second quarter
2005 compared to $2.4 million the second quarter 2004. This decrease of $.5
million was a result of reduced orders from a major customer during the second
quarter 2005.
For the six months ended June 30, 2005, revenue from switching products amounted
to $5.8 million compared to $4.0 million for the same period in 2004. This
increase in revenue of $1.8 million was primarily attributable to increased
sales to one major customer and a variety of early stage customers in this
product category.
Other products:
This revenue is primarily related to legacy products. Many of these products are
project oriented and shipments can fluctuate on a quarterly and annual basis.
Gross profit. Gross profit consists of sales, less cost of goods sold including
material costs, manufacturing expenses, depreciation, amortization of software
development costs, and expenses associated with engineering contracts and the
technical support function. Gross margin was 45.2% and 49.9% of sales for the
second quarter 2005 and 2004, respectively. Gross margin was 48.3% and 50.6%
for the six months ended June 30, 2005 and 2004, respectively. For both the
second quarter and the six months ended June 30, 2005 compared to the same
periods of 2004, the change in the product mix from the 2004 periods to the 2005
periods resulted in a modest improvement in gross margin, but was more than
offset by a decline in the volume of shipments, which caused the fixed
manufacturing overhead to be spread over fewer units, thereby reducing the
overall gross margin.
Total Operating Expenses. Total operating expenses in the second quarter 2005
amounted to $4.9 million, compared to $5.4 million in the second quarter 2004.
For the six months ended June 30, 2005 and 2004, total operating expenses
amounted to $10.4 million and $11.2 million, respectively. For 2004, the
operating expenses of the Voice Technology Group (VTG) are included from the
date of acquisition of January 23, 2004. During the third quarter 2004,
management began formulating plans to reduce annualized expenses by
approximately $2.0 million with a primary focus on centralizing its
multi-location operations and streamlining the organization. When this
centralization plan is completed in September 2005, operating expenses are
expected to be reduced by $1.3 million annually. Most of the expected operating
expense reductions associated with this program were realized by the end of the
second quarter. While the Company continues to pursue its centralization plan,
some part of these savings will be reinvested to stimulate future growth.
Selling and marketing expenses were $1.4 million and $1.6 million for the second
quarter 2005 and 2004, respectively, and $2.8 million and $3.2 million for the
six months ended June 30, 2005, and 2004, respectively. The overall decreases in
selling and marketing expense for both comparative periods are a result of staff
reductions in the Company's effort to centralize its sales organization.
Research and development expenses were $2.3 million and $2.6 million in the
second quarter 2005 and 2004, respectively. The decrease in expense primarily
reflects increased capitalized software development costs and reductions related
to the Company's effort to centralize operations. The Company capitalizes
certain software development costs, which reduces the amount of software
development charged to operating expenses. Amounts capitalized were $.7 million
and $.6 million during the second quarter 2005 and 2004, respectively. Research
and development expenses amounted to $4.9 million and $5.2 million, for the six
months ended June 30, 2005 and 2004, respectively. The decrease in research and
development expenses for this period was primarily a result of increased
capitalized software development costs and reductions related to the Company's
centralization plan, partially offset by the inclusion of VTG expenses for the
full period in 2005. Amounts capitalized related to software development were
$1.3 million and $1.1 million during the six months ended June 30, 2005 and
2004, respectively.
General and administrative expenses were $1.1 million in the second quarter
2005, compared to $1.2 million in the second quarter 2004. This decrease was a
result of reduced costs related to the Company's efforts to centralize
operations, partially offset by increases in corporate governance costs. For
each of the six months ended June 30, 2005 and 2004, general and administrative
expenses totaled $2.5 million.
Restructuring charges amounted to $.1 million in the second quarter 2005 and $.2
million in the six months ended June 30, 2005, compared to no restructuring
charges incurred during 2004. Restructuring charges in 2005 relate primarily to
severance payments associated with the Company's efforts to centralize its
operations.
In the first quarter 2004, the Company recorded in-process research and
development expense of $.2 million. This amount represented a charge for
in-process research and development costs associated with the Mapletree Networks
acquisition that were expensed in accordance with Financial Accounting Standards
Board Interpretation No. 4 "Applicability of SFAS No. 2 to Business Combinations
Accounted for by the Purchase Method." This charge relates to research and
development projects that had not reached technological feasibility at the time
of the acquisition.
Other Income, net. Other income consists primarily of interest income. The
Company's funds are primarily invested in high quality auction rate municipal
securities. An increase in the funds available for investment as well as higher
interest rates in 2005, resulted in increased interest income for both the
second quarter 2005 and for the six months ended June 30, 2005, compared to the
corresponding periods of 2004. Also contributing to higher interest income was
an increase in interest from a note receivable from an unconsolidated company
based upon an increase in the principal amount.
Income taxes. The Company's effective income tax rate is a combination of
federal, state and foreign tax rates and is generally lower than statutory rates
because it includes benefits derived from the Company's international
operations, research activities, tax exempt interest and foreign sales. For the
second quarter 2005 and 2004, the Company's effective tax rate was 29% and 31%,
respectively. For the six months ended June 30, 2005 and 2004, the Company's
effective tax rate was 29% and 33%, respectively. Decreases in the effective tax
rate for the comparative periods were the result of changes in certain permanent
items. On October 22, 2004, President Bush signed into law the American Jobs
Creation Act of 2004 (H.R. 4520). The Act contains numerous corporate tax
provisions which could affect the Company's current and future tax provisions.
The Company is currently assessing any potential impact of these provisions.
Equity in Income of Unconsolidated Company. In the third quarter 2004, the
Company sold its ownership interest in Momentum Computer, Inc., a developer of
specialized single board computer products. During both the second quarter 2004
and for the six months ended June 30, 2004, the Company's allocation of
Momentum's income amounted to $.1 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity is its cash, cash equivalents and
investments which totaled $29.4 million at June 30, 2005. The Company had
working capital of $43.5 million and $41.6 million at June 30, 2005 and December
31, 2004, respectively.
Cash provided by operating activities amounted to $5.0 million for the first six
months of 2005. This amount included net income of $1.3 million, non-cash
charges related to depreciation and amortization of $1.3 million, and the
reserve for inventory obsolescence of $.7 million. Cash provided by operations
due to changes in operating assets and liabilities included a decrease in
accounts receivable of $1.7 million resulting from decreased sales and improved
collections during the six months ended June 30, 2005. A decrease in prepaid
expenses related to the timing of income tax and other certain payments also
resulted in an increase in operating cash of $.5 million.
On July 1, 2006, the Restriction of Certain Hazardous Substances Directive
("RoHS") issued by the European Union will become effective. This directive
restricts the distribution of products within the EU containing certain
substances, including lead. While the enabling legislation of a number of EU
member countries has not yet been adopted, it is expected that the Company will
not be able to sell non-RoHS compliant product to certain customers who intend
to sell their finished goods in the EU after the effective date. At the present
time, the majority of the Company's inventory contains substances prohibited by
the RoHS directive. Upon effectiveness of the RoHS legislation, a portion of the
Company's inventory may become obsolete and unsaleable and, as a result, may
have to be written off. In addition, prior to the effectiveness, the Company
expects that its overall inventory balances will increase as it builds RoHS
compliant product prior to the effective date. The Company is working closely
with its customers and suppliers to minimize this impact. At this time, the
Company is unable to quantify the potential financial impact, if any, of such
obsolete inventory or increases in inventory levels.
Cash used by investing activities during the first six months of 2005 totaled
$4.9 million. This utilization was primarily the result of net purchases of
auction rate municipal securities of $3.4 million and the capitalization of
software development costs amounting to $1.3 million.
Cash provided by financing activities amounted to $.4 million in the first six
months of 2005 resulting from the exercise of stock options. On July 11, 2005,
the Company announced that its Board of Directors authorized the Company to
repurchase shares of its common stock for an aggregate amount not to exceed
$10.0 million. Under this program, shares of the Company's common stock may be
repurchased through open market or private transactions, including block
purchases, over the next twelve months. Repurchased shares will be used for the
Company's stock option plan, potential acquisition initiatives and general
corporate purposes. To date, there have been no repurchases of shares under this
program.
Off-Balance Sheet Arrangements:
The Company did not enter into any off-balance sheet arrangements during the
first six months of 2005.
Contractual Obligations:
The Company did not enter into any other significant contractual obligations
during the first six months of 2005.
Current Position:
Assuming there is no significant change in the Company's business, management
believes that its current cash, cash equivalents and investments together with
cash generated from operations should be sufficient to meet the Company's
anticipated operating needs, including working capital and capital expenditure
requirements, for at least the next twelve months. However, management is
continuing its strategic acquisition program to further accelerate its growth
and market penetration efforts. A future acqusition could have an impact on the
Company's working capital, liquidity or capital resources, and the Company may
need to raise additional capital to facilitate these efforts.
Recently Issued Accounting Pronouncements
In December 2004, SFAS No. 123 "Accounting for Stock-Based Compensation (Revised
2004)" was issued. This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This statement requires an entity to measure the cost of employee
services received in exchange for an award of equity instruments, based on the
fair value of the award at the grant date. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award. The effective date of this statement was extended by the Securities
and Exchange Commission and will be effective for the Company beginning January
1, 2006. As of the required effective date, all entities that used the
fair-value-based method for either recognition or disclosure under SFAS No. 123
may apply this statement using a modified version of prospective application. An
alternative method of application is available under SFAS No. 123R. Under the
modified version of prospective application, compensation cost is recognized for
the portion of outstanding stock-based awards for which the requisite service
has not yet been rendered. The Company is currently assessing the impact this
statement will have on its financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment
of ARB No. 43, Chapter 4." SFAS No. 151 states that abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage) should
be recognized as current-period charges. Additionally, SFAS No. 151 requires
that allocation of fixed production overheads to the costs of conversion be
based on the normal capacity of the production facilities. The Company is
required to adopt SFAS No. 151 effective January 1, 2006. The Company does not
expect the adoption of SFAS No. 151 will have a material impact on its
consolidated results of operations and financial condition.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
- An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions."
SFAS No. 153 is based on the principle that nonmonetary asset exchanges should
be recorded and measured at the fair value of the assets exchanged, with certain
exceptions. This standard requires exchanges of productive assets to be
accounted for at fair value, rather than at carryover basis, unless (1) neither
the asset received nor the asset surrendered has a fair value that is
determinable within reasonable limits or (2) the transactions lack commercial
substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The Company is required to adopt SFAS
No. 153 effective for its fiscal quarter beginning after June 15, 2005, and does
not expect the adoption of SFAS No. 153 will have a material impact on its
consolidated results of operations and financial condition.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which replaces APB Opinion No. 20, "Accounting Changes," and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements."
SFAS No. 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Upon the adoption of SFAS No. 154 beginning
January 1, 2006, the Company will apply the standard's guidance to changes in
accounting methods as required. At this time, the Company does not expect the
adoption of SFAS No. 154 will have a material impact on its consolidated results
of operations and financial condition.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This Quarterly Report on Form 10-Q contains forward-looking statements, which
reflect the Company's current views with respect to future events and financial
performance, within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 and is subject to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements are subject to certain risks and uncertainties,
including those identified below, which could cause actual results to differ
materially from historical results or those anticipated. The words "believes,"
"anticipates," "plans," "may," "intend," "estimate," "will," "should," "could,"
"feels," "is optimistic," "expects," and other expressions which indicate future
events and trends also identify forward-looking statements. However, the absence
of such words does not mean that a statement is not forward-looking.
The Company's future operating results are subject to various risks and
uncertainties and could differ materially from those discussed in the
forward-looking statements and may be affected by various trends and factors
which are beyond the Company's control. These risks and uncertainties include,
among other factors, general business and economic conditions, rapid
technological changes accompanied by frequent new product introductions,
competitive pressures, dependence on key customers, the attainment of design
wins, fluctuations in quarterly and annual results, the reliance on a limited
number of third party suppliers, limitations of the Company's manufacturing
arrangements, the protection of the Company's proprietary technology, the
dependence on key personnel, changes in critical accounting estimates, potential
delays associated with the purchase and implementation of an advanced planning
and scheduling system, potential impairments of investments, and foreign
regulations. These statements should be read in conjunction with the audited
Consolidated Financial Statements, the Notes thereto, and Management's
Discussion and Analysis of Financial Condition and Results of Operations of the
Company as of December 31, 2004, as reported in its Annual Report on Form 10-K,
and other documents as filed with the Securities and Exchange Commission.
Stockholders are cautioned not to place undue reliance on the forward-looking
statements which speak as of the date of this Quarterly Report or the date of
the documents incorporated by reference in this Quarterly Report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various market risks in the normal course of business,
primarily interest rate risk and changes in the market value of its investments
and believes its exposure to such risk is minimal. The Company's investments are
made in accordance with the Company's investment policy and primarily consist of
auction rate municipal securities. The Company is also subject to foreign
exchange risk related to its operations in Ottawa, Canada. The Company believes
that its exposure to foreign currency risk is minimal. The Company does not
participate in the investment of derivative financial instruments.
ITEM 4. CONTROLS AND PROCEDURES
A. Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and its Chief Financial Officer
have evaluated the Company's disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of
the period covered by this quarterly report. Based on this evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that
the Company's disclosure controls and procedures were effective as of
such date.
B. Changes in Internal Controls Over Financial Reporting
During the first quarter 2005, the Company completed the integration of
the ERP systems and accounting functions of the Company's Voice
Technology Group and Computing Products Group into the corporate ERP
system and accounting function in Rochester, New York. During the
second quarter 2005, transition of manufacturing operations for VTG
products was completed and substantial progress was realized in
transitioning the manufacturing of the Computing Products to Rochester.
The Company's Chief Executive Officer and Chief Financial Officer
evaluated these changes and concluded that the changes have not
materially affected, or are not reasonably likely to materially affect,
the Company's internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2005 Annual Meeting of Stockholders was held June 2, 2005. The Directors
elected at the meeting were as follows:
Votes Cast
Nominees For Withheld
-------- ---------- ----------
Bernard Kozel 11,453,292 335,649
Charles E. Maginness 9,964,871 1,824,070
E. Mark Rajkowski 11,599,053 189,888
John M. Slusser, Stuart B. Meisenzahl, Robert L. Tillman and Donald L. Turrell
continue as Directors until the next Annual Meeting, or such times as their
respective terms expire.
The stockholders also voted to ratify the appointment of PricewaterhouseCoopers
LLP as the Company's independent registered public accounting firm for 2005.
11,772,788 shares of common stock were voted in favor of this proposal, 10,903
shares of common stock were voted against this proposal, and 5,250 shares of
common stock abstained.
ITEM 6. EXHIBITS
A. Exhibits
10.1 Named Executive Officer Compensation Summary Sheet
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PERFORMANCE TECHNOLOGIES, INCORPORATED
August 9, 2005 By: /s/ Donald L. Turrell
------------------------------
Donald L. Turrell
President and
Chief Executive Officer
August 9, 2005 By: /s/ Dorrance W. Lamb
------------------------------
Dorrance W. Lamb
Chief Financial Officer and
Vice President of Finance
Exhibit 10.1
Named Executive Officer
Compensation
Summary Sheet
The named executive officers of the Company serve at the discretion of the Board
of Directors. From time to time, the Compensation Committee of the Board of
Directors reviews and determines the salaries that are paid to the Company's
named executive officers. The following table sets forth the annual salary rates
for the Company's current named executive officers as of the date of this report
on Form 10-Q (1)(2):
Donald L. Turrell
President and Chief Executive Officer $237,000
Dorrance W. Lamb
Chief Financial Officer and Vice President of Finance $197,600
John J. Grana
Vice President of Engineering $163,000
John J. Peters
Vice President of Engineering $163,000
William E. Mahuson
Vice President $141,250
(1) The named executive officers were determined by reference to the Company's
Proxy Statement dated May 2, 2005.
(2) For information regarding stock options and bonuses, see the Company's
report on Form 8-K filed on May 24, 2005.
Exhibit 31.1
Certification of Chief Executive Officer
I, Donald L. Turrell certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Performance Technologies, Incorporated;
2. Based on my knowledge, this report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in
light of the circumstances under which such statements
were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a. Designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material
information relating to the registrant, including its
consolidated subsidiaries, is made known to us by
others within those entities, particularly during the
period in which this report is being prepared;
b. Designed such internal control over financial
reporting, or caused such internal control over
financial reporting to be designed under our
supervision, 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;
c. Evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end
of the period covered by this report based on such
evaluation; and
d. Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's second fiscal quarter) that has materially
affected, or is reasonably likely to materially affect,
the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's
auditors and the audit committee of the registrant's Board
of Directors (or persons performing the equivalent
functions):
a. All significant deficiencies and material weaknesses in
the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information;
and
b. Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over
financial reporting.
Date: August 9, 2005 By:/s/ Donald L. Turrell
----------------------------
Donald L. Turrell
Chief Executive Officer
Exhibit 31.2
Certification of Chief Financial Officer
I, Dorrance W. Lamb certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Performance Technologies, Incorporated;
2. Based on my knowledge, this report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in
light of the circumstances under which such statements
were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a Designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material
information relating to the registrant, including its
consolidated subsidiaries, is made known to us by
others within those entities, particularly during the
period in which this report is being prepared;
b. Designed such internal control over financial
reporting, or caused such internal control over
financial reporting to be designed under our
supervision, 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;
c. Evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end
of the period covered by this report based on such
evaluation; and
d. Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's second fiscal quarter) that has materially
affected, or is reasonably likely to materially affect,
the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's
auditors and the audit committee of the registrant's Board
of Directors (or persons performing the equivalent
functions):
a. All significant deficiencies and material weaknesses in
the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information;
and
b. Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over
financial reporting.
Date: August 9, 2005 By:/s/ Dorrance W. Lamb
-----------------------------
Dorrance W. Lamb
Chief Financial Officer
Exhibit 32.1
Section 1350 Certification
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 ("Section 906"), Donald L. Turrell and Dorrance W.
Lamb, the Chief Executive Officer and Chief Financial Officer, respectively, of
Performance Technologies, Incorporated, certify that (i) the quarterly report on
Form 10-Q for the quarter ended June 30, 2005 fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934
and (ii) the information contained in such report fairly presents, in all
material respects, the financial condition and results of operations of
Performance Technologies, Incorporated.
A signed original of this written statement required by Section 906 has been
provided to Performance Technologies, Incorporated and will be retained by
Performance Technologies, Incorporated and furnished to the Securities and
Exchange Commission or its staff upon request.
Date: August 9, 2005 By:/s/ Donald L. Turrell
-------------------------------
Donald L. Turrell
President and Chief
Executive Officer
Date: August 9, 2005 By:/s/ Dorrance W. Lamb
-------------------------------
Dorrance W. Lamb
Chief Financial Officer and
Vice President of Finance