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[November 09, 2013]
PERFORMANCE TECHNOLOGIES INC \DE\ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
(Edgar Glimpses Via Acquire Media NewsEdge) 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. 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 the accounting principles generally accepted in the United States (GAAP), estimates and assumptions are required to be made that have an impact on the assets, liabilities, revenue and expense amounts reported. These estimates can also affect supplemental information disclosures, including information about contingencies, risk and financial condition. These estimates and assumptions are made during the closing process for the quarter, after the quarter end has passed. The Company believes that given the current facts and circumstances, these 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. Management's judgments in making these estimates and relying on these assumptions may materially impact amounts reported for any period.
The critical accounting policies, judgments and estimates that we believe have the most significant effect on our financial statements are set forth below: · Revenue Recognition · Software Development Costs · Valuation of Inventories · Income Taxes · Product Warranty · Stock-Based Compensation · Restructuring Costs · Carrying Value of Long-Lived Assets Revenue Recognition: Revenue is recognized from product sales in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition." Product sales represent the majority of our revenue and include both hardware products and hardware products with embedded software. Revenue is recognized 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 collectibility is reasonably assured. Additionally, products are sold on terms which transfer title and risk of loss at a specified location, typically the 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. If these conditions are not met, revenue recognition is deferred until such time as these conditions have been satisfied.
-14- Table of contents For arrangements with multiple deliverables, the arrangement consideration is allocated at the inception of an arrangement to all deliverables using the relative selling price method. A selling price hierarchy is employed for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence ("VSOE") if available; (2) third-party evidence ("TPE") if vendor-specific objective evidence is not available; and (3) best estimated selling price ("BESP") if neither vendor-specific nor third-party evidence is available. For PT's multiple deliverable arrangements, our products and services qualify as separate units of accounting. The Company's multiple deliverable arrangements generally include a combination of telecommunications hardware and software products, services including installation and training, and support services. These arrangements typically have both software and non-software components that function together to deliver the product's essential functionality. These arrangements generally do not include any provisions for cancellation, termination, or refunds that would significantly impact recognized revenue. Because the Company rarely sells its proprietary hardware and software products on a stand-alone basis or without support, PT is not able to establish VSOE for these products. Additionally, PT generally expects that it will not be able to establish TPE due to the proprietary nature of PT's products and the markets in which we compete.
Accordingly, PT expects the selling price of its products to be based on its BESP. PT has established VSOE for its support and services and, therefore, it utilizes VSOE for these elements.
Since the adoption of this guidance on January 1, 2011, we have primarily used the same information used to set pricing strategy to determine BESP. The Company has corroborated the BESP with our historical sales prices, the anticipated margin on the deliverable, the selling price and profit margin for similar deliverables and the characteristics of the geographical markets in which the deliverables are sold. PT plans to analyze the selling prices used in our allocation of arrangement consideration at least semi-annually. Selling prices will be analyzed more frequently if a significant change in our business necessitates a more timely analysis.
For substantially all multiple deliverable arrangements, PT defers support and services revenue, and recognizes revenue for delivered products in an arrangement when persuasive evidence of an arrangement exists and delivery of the last product has occurred, provided the fee is fixed or determinable, and collection is deemed probable. In instances where final acceptance of the product is based on customer specific criteria, revenue is deferred until the earlier of the receipt of customer acceptance or the expiration of acceptance period. Support revenue is recognized ratably over the term of the support period. Services revenue is typically recognized upon completion of the services for fixed-fee service arrangements, as these services are relatively short-term in nature (typically several weeks, or in limited cases, several months). For service arrangements that are billed on a time and material basis, we recognize revenue as the services are performed.
For multiple deliverable arrangements entered into prior to January 1, 2011 and not materially modified after that date, PT recognized revenue based on the then-existing software revenue recognition guidance, which required the entire fee from the arrangement to be allocated to each respective element based on its relative selling price using VSOE. For such arrangements, when the Company was unable to establish VSOE for the delivered telecommunications products, PT utilized the residual method to allocate revenue to each of the elements of an arrangement. Under this method, PT allocated the total fee in an arrangement first to the undelivered elements (typically support and services) based on VSOE of those elements, and the remaining, or "residual" portion of the fee to the delivered elements (typically the product or products).
Revenue from software requiring significant production, modification, or customization is recognized using the percentage of completion method of accounting. Anticipated losses on contracts, if any, 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.
-15- Table of contents 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 accounting estimate related to revenue recognition is considered a "critical accounting estimate" because terms of sale can vary, and judgment is exercised in determining whether to defer revenue recognition. Such judgments may materially affect net sales for any period. Judgment is exercised 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 collectibility is reasonably assured.
Software Development Costs: All software development costs incurred in establishing the technological feasibility of computer software products to be sold are charged to expense as 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, using the straight-line method or using the ratio of current revenues to current and anticipated revenues from such product, whichever provides greater amortization. If the technological feasibility for a particular project is judged not to have been met or recoverability of amounts capitalized is in doubt, project costs are expensed as research and development or charged to cost of goods sold, as applicable. The accounting estimate related to software development costs is considered a "critical accounting estimate" because judgment is exercised 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. Judgment is exercised 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. Inventory includes purchased parts and components, work in process and finished goods. Provisions for excess, obsolete or slow moving inventory are recorded after periodic evaluation of historical sales, current economic trends, forecasted sales, estimated product life cycles and estimated inventory levels. Purchasing practices, electronic component obsolescence, accuracy of sales and production forecasts, introduction of new products, product life cycles, product support and foreign regulations governing hazardous materials are the factors that contribute to inventory valuation risks. Exposure to inventory valuation risks is managed 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 accounting estimate related to valuation of inventories is considered 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, including purchasing, sales, production, and after-sale support. If actual demand, market conditions or product life cycles differ from estimates, 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: PT provides deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws. A valuation allowance is established for deferred tax assets in amounts for which realization is not considered more likely than not to occur. The accounting estimate related to income taxes is considered a "critical accounting estimate" because judgment is exercised in estimating future taxable income, including prudent and feasible tax planning strategies, and in assessing the need for any valuation allowance. If it should be determined that all or part of a net deferred tax asset is not able to be realized in the future, an adjustment to the valuation allowance would be charged to income in the period such determination was made. Likewise, in the event that it should be determined that all or part of a net deferred tax asset in the future is realizable in excess of the net recorded amount, an adjustment to the valuation allowance would increase income to be recognized in the period such determination was made.
-16- Table of contents PT operates within multiple taxing jurisdictions worldwide and is subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although management believes that adequate provision has been made for such issues, there is the possibility that the ultimate resolution of such issues could have an adverse effect on the earnings of PT. Conversely, if these issues are resolved favorably in the future, the related provisions would be reduced, thus having a positive impact on earnings.
In addition, the calculation of PT's tax liabilities involves dealing with uncertainties in the application of complex tax regulations. PT recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires PT to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as this requires PT to determine the probability of various possible outcomes. PT re-evaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period. At September 30, 2013, there are no tax uncertainties that PT has determined are required to be recognized.
Finally, the value of PT's deferred tax assets is dependent upon PT's ability to generate future taxable income in the jurisdictions in which PT operates. These assets consist of research credit carry-forwards, capital and net operating loss carry-forwards, and the future tax effect of temporary differences between balances recorded for financial statement purposes and for tax return purposes.
It will require future pre-tax earnings in excess of $30 million in order to fully realize the value of the Company's deferred tax assets. Due to the uncertainty of PT's ability to realize its deferred tax assets, a valuation allowance has been recorded against substantially the full value of its deferred tax assets.
Product Warranty: Warranty obligations are generally incurred in connection with the sale of PT's 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. Future warranty costs are estimated based on historical performance rates and related costs to repair given products. The accounting estimate related to product warranty is considered a "critical accounting estimate" because judgment is exercised 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.
Stock-Based Compensation: PT's board of directors approves grants of stock options to employees to purchase our common stock. Stock compensation expense is recorded based upon the estimated fair value of the stock option at the date of grant. The accounting estimate related to stock-based compensation is considered a "critical accounting estimate" because estimates are made in calculating compensation expense including expected option lives, forfeiture rates and expected volatility. Expected option lives are estimated using vesting terms and contractual lives. Expected forfeiture rates and volatility are calculated using historical information. Actual option lives and forfeiture rates may be different from estimates and may result in potential future adjustments which would impact the amount of stock-based compensation expense recorded in a particular period.
-17- Table of contents Restructuring Costs: Restructuring costs generally consist of employee-related severance costs, lease termination costs and other facility-related closing expenses. Employee-related severance benefits are recorded either at the time an employee is notified or, if there are extended service periods, is estimated and recorded pro-rata over the period of each planned restructuring activity. Lease termination costs are calculated based upon fair value considering the remaining lease obligation amounts and estimates for sublease receipts. The accounting estimate related to restructuring costs is considered a "critical accounting estimate" because estimates are made in calculating the amount of employee-related severance benefits that will ultimately be paid and the amount of sublease receipts that will ultimately be received in future periods. Actual amounts paid for employee-related severance benefits can vary from these estimates depending upon the number of employees actually receiving severance payments. Actual sublease receipts received may also vary from estimates.
Carrying Value of Long-Lived Assets: PT periodically reviews the carrying values of its long-lived assets, other than capitalized software development costs and purchased intangible assets with indefinite useful lives, for impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable. PT assesses the recoverability of the carrying values of long-lived assets by first grouping its long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (the asset group) and, secondly, by estimating the undiscounted future cash flows that are directly associated with and that are expected to arise from the use of and eventual disposition of such asset group. PT estimates the undiscounted cash flows over the remaining useful life of the primary asset within the asset group. If the carrying value of the asset group exceeds the estimated undiscounted cash flows, PT records an impairment charge to the extent the carrying value of the long-lived asset exceeds its fair value. PT determines fair value through quoted market prices in active markets or, if quoted market prices are unavailable, through the performance of internal analyses of discounted cash flows. The accounting estimate related to impairment of long-lived assets is considered a "critical accounting estimate" because PT's impairment tests include estimates of future cash flows that are dependent upon subjective assumptions regarding future operating results including revenue growth rates, expense levels, discount rates, capital requirements and other factors that impact estimated future cash flows and the estimated fair value of long-lived assets.
Business Overview PT, a Delaware corporation founded in 1981, is a global supplier of advanced, high availability network communications solutions.
PT's product portfolio includes its SEGway® Diameter and SS7 Signaling Systems, which provide tightly integrated signaling and advanced routing capabilities and applications that uniquely span the mission critical demands of both existing and next-generation 4G/Long-Term Evolution ("LTE") and IMS telecommunications networks. The Company's IPnexus® Multi-Protocol Gateways and Servers enable a broad range of IP-interworking in data acquisition, sensor, radar, and control applications for aviation, weather and other infrastructure networks.
PT is headquartered in Rochester, New York and maintains direct sales and marketing offices in the U.S. in Raleigh, North Carolina and Chicago, Illinois and international offices in London, England and Shanghai, China, and has centers of engineering excellence in San Diego, California, and Kanata, Ontario, Canada, in addition to Rochester, New York.
-18- Table of contents Strategy The Company's strategy is to focus on its high value-add network communications solutions - leveraging its core competencies. In the telecommunications space, PT is building upon its seventeen years of signaling systems experience and its installed customer base for its SEGway SS7 Signaling Systems. The mobile telecommunications industry is in the early stages of building out much higher bandwidth 4G/LTE-based network architectures. As part of this network evolution, service providers' signaling infrastructure is migrating from SS7 signaling to Diameter signaling. During 2012, PT introduced its own SEGway Universal Diameter Router ("UDR"), a premier Diameter Signaling solution set for next-generation 4G/LTE networks, and during the first quarter 2013 the Company realized its first UDR product sale. Our SEGway Diameter signaling product line continues to gain traction and momentum in the 4G/LTE marketplace. The Company expects to be a key player in this growth market by providing high value proposition "best-of-breed" solutions and by taking those solutions to the global market through a combination of strong channel partners and focused direct sales activities.
Sales of our IPnexus Multi-Protocol IP-interworking solutions are typically to prime contractors and system integrators and generally reflect investment levels by various government agencies and defense branches in specific programs and projects requiring radar and sensor communications services over IP networks.
These solutions enable extremely reliable and highly available radar and sensor communications - gathering and delivering vital data such as weather, flight tracking, and ground surveillance over IP networks. We continue to work with numerous prime contractors to incorporate these products into specific programs and projects requiring these enhanced communications capabilities. Looking ahead, the Company expects to expand its IPnexus Multi-Protocol Gateways and Servers into new aerospace/defense applications as well as potentially enter new emerging markets such as Energy and Smart-Grid.
As part of its strategic realignment, which was initiated during the fourth quarter 2012, PT is well along in transitioning out of the general OEM platform business through a last-time buy and build program which ends for most customers at the end of 2013 and continues through 2014 for select customers. As of September 30, 2013, 85% of the last-time buy and build orders have been shipped, which amounted to approximately $5.9 million of revenue year-to-date. PT will continue to utilize its own open standards platforms as key elements of its network communications solutions and maintain a certain number of strategic OEM platform customers.
During 2013, the Company has increased its sales and marketing investments for our SEGway Diameter signaling product line to accelerate our penetration in this growth market.
In summary, management believes the Company's unique ability of our SEGway Signaling product portfolio to provide a state-of-the-art, unified end solution set encompassing both Diameter and SS7 signaling solidly positions PT to address the opportunities arising from the ongoing telecommunications network evolution.
There are identifiable risks associated with PT's strategy in the current economic climate. While management believes that its network communications market focus offers opportunities for growth in the long term, network infrastructure investments by carriers have continued to be sluggish; the total available market for traditional SS7-based signaling products is declining and the market for next-generation 4G/LTE network products is currently in an early-stage of growth. Despite the present economic climate, which may involve new risks not currently identified, management believes the outlook for the Company's profitability has improved because expenses have been aligned with projected revenues and we have strong channel partners actively engaged in selling our products.
-19- Table of contents Market Overview PT's business addresses one industry segment - Communications. The telecommunications market, historically our largest vertical market, is fundamentally driven by investments in network infrastructure by carriers and service providers. Industry analysts are forecasting the market for SS7 signaling products will continue for the next seven to ten years, albeit on a declining scale. While the worldwide market for these products is declining, the number of vendors selling into this market has dropped much more rapidly and now stands at four, including PT. Management believes this is an opportunity to grow its share of the SS7 signaling market. In addition, the mobile telecommunications industry is in the early stages of building out much higher bandwidth 4G/LTE-based network architectures. The extraordinary increase in the projected number of wireless subscribers and related mobile data and application demands is driving tremendous growth in signaling traffic, which was the basis for defining a new signaling infrastructure based upon the Diameter protocol.
The Diameter signaling market is at an early stage of growth and only a few of the world's wireless carriers have implemented or are currently implementing 4G/LTE on a large scale. This market is projected by industry analysts to result in an aggregate spend of over $2 billion in the next five years.
To complement its SEGway SS7 Signaling solutions for present generation telecommunications networks, during 2012 PT introduced the SEGway Universal Diameter Router - its premier Diameter Signaling solution set for next-generation 4G/LTE networks. The Company is marketing its SEGway Diameter and SS7 Signaling solutions to the global market through a combination of strong channel partners and focused direct sales activities.
Sales of our IPnexus Multi-Protocol IP-interworking solutions are typically to prime contractors and system integrators and generally reflect investment levels by various government agencies and defense branches in specific programs and projects requiring radar and sensor communications services over IP networks.
Our IPnexus Multi-Protocol Gateways and Servers enable the gathering and delivering of vital data such as weather, flight tracking, and ground surveillance over IP networks for these applications. During the second half of 2012, aerospace and defense budgets for radar and sensor communications projects were dramatically reduced and PT's prime contractor partners were unclear about future project deployment schedules. Government spending on this infrastructure is project based and continues to be highly variable from quarter-to-quarter.
Financial Overview Revenue: Revenue in the third quarter 2013 amounted to $7.3 million, compared to $4.7 million in the third quarter 2012. Revenue amounted to $20.7 million for the nine months ended September 30, 2013, compared to $18.0 million for the nine months ended September 30, 2012. The revenue increase during the third quarter 2013 over the comparable prior year period reflects increases in SEGway signaling systems revenue, IPnexus Multi-Protocol IP-interworking revenue and increased platform product shipments under the Company's last-time buy and build program, which ends for most customers at the end of 2013. The revenue increase during the nine months ended September 30, 2013 over the comparable prior year period was primarily due to increased sales to our SEGway signaling systems customers and increased platform product shipments under the Company's last-time buy and build program.Shipments to customers outside of the United States represented 41% and 47% in the third quarter of 2013 and 2012, respectively, and 42% and 47% in the nine months ended September 30, 2013 and 2012, respectively.
-20- Table of contents Net income (loss): Net income in the third quarter 2013 amounted to $.5 million, or $.04 per diluted share, including amortization of purchased intangible assets of $.02 per share and stock-based compensation expense of $.01 per share, based on 11.7 million shares outstanding. The Company incurred a net loss in the third quarter 2012 in the amount of ($1.7 million), or ($.15) per basic share, including amortization of purchased intangible assets of $.03 per share and stock-based compensation expense of $.01 per share, based on 11.1 million shares outstanding.
PT incurred a net loss for the nine months ended September 30, 2013 amounting to ($.2 million), or ($.02) per basic share, including a restructuring charge of $.02 per share, a charge for impairment of software development costs of $.01 per share, amortization of purchased intangible assets of $.06 per share, and stock-based compensation of $.02 per share, based on 11.1 million shares outstanding. The Company incurred a net loss for the nine months ended September 30, 2012 amounting to ($3.1 million), or ($.28) per basic share, including amortization of purchased intangible assets of $.08 per share and stock-based compensation of $.02 per share, based on 11.1 million shares outstanding.
Liquidity: Cash, cash equivalents and investments amounted to $13.9 million and $14.3 million at September 30, 2013 and December 31, 2012, respectively. The Company had no long-term debt at either date. Accounts receivable at September 30, 2013 amounted to $5.9 million, compared to $3.8 million at the end of 2012. The higher level of accounts receivable is primarily related to significantly higher sales in September 2013 than in December 2012.
Cash provided by operating activities amounted to $1.5 million in the nine months ended September 30, 2013, as compared to cash provided by operating activities of $2.2 million in the nine months ended September 30, 2012. The decrease in cash provided by operating activities was primarily due to a $2.1 million net increase in accounts receivable in 2013, as compared with a net decrease in accounts receivable of $1.5 million in the prior year, and a $.6 million decrease in deferred revenue in 2013, as compared with a $.4 million increase in the comparable 2012 period, partially offset by a substantial reduction of the net loss in 2013 (a loss of $.2 million in the nine months ended September 30, 2013 as compared to a loss of $3.1 million in the same period in 2012) and a $1.3 million decrease in inventories in 2013, as compared with a $.7 million decrease in 2012.
The increase in accounts receivable was attributable to the higher sales level in September 2013, as compared with the level in December 2012. The decrease in inventory is primarily attributable to the Company's ongoing efforts to manage inventory levels and the Company's last-time buy and build program for its OEM platform products. The swing in deferred revenue is primarily due to the recognition in revenue of amounts previously deferred relating to certain of the Company's signaling systems sales.
Key Performance Indicator: PT believes that a key indicator for its business is the trend for the volume of orders received from customers. PT's decision in the fourth quarter 2012 to transition out of the general OEM platform business has altered the revenue pattern for that product line, which amounted to approximately $5.8 million in 2012.
Total revenue for the first nine months of 2013 amounted to $20.7 million, an increase of $2.7 million, or 15% over the corresponding period in 2012. Total revenue for the third quarter 2013 amounted to $7.3 million, an increase of $2.6 million, or 56%, over the third quarter 2012. The revenue increase during the third quarter 2013 over the comparable prior year period reflects increases in SEGway signaling systems revenue, IPnexus Multi-Protocol IP-interworking revenue and increased platform product shipments under the Company's last-time buy and build program.
More in-depth discussions of PT's strategy can be found in PT's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.
-21- Table of contents Results of Operations Three and Nine Months Ended September 30, 2013, Compared with the Three and Nine Months Ended September 30, 2012 The following table presents the percentage of sales represented by each item in PT's consolidated statements of operations for the periods indicated: Three Months Ended Nine Months Ended September 30, September 30, 2013 2012 2013 2012 Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 50.9 61.4 52.0 53.2 Impairment of software development costs .7 Gross profit 49.1 38.6 47.3 46.8 Operating expenses: Selling and marketing 17.4 26.4 19.3 22.9 Research and development 14.7 26.1 15.9 24.1 General and administrative 10.8 21.1 11.8 17.3 Restructuring charges 1.2 Total operating expenses 42.9 73.6 48.2 64.3 Income (loss) from operations 6.2 (35.0 ) (.9 ) (17.5 ) Other income (expense), net .4 .9 .1 .2 Income (loss) before income taxes 6.6 (34.1 ) (.8 ) (17.3 ) Income tax (benefit) provision (.1 ) 1.7 .1 .1 Net income (loss) 6.7 % (35.8 )% (.9 )% (17.4 )% Sales. Total revenue for the third quarter 2013 amounted to $7.3 million, compared to $4.7 million for the corresponding quarter in 2012. The revenue increase during the third quarter 2013 over the comparable prior year period reflects increases in SEGway signaling systems revenue, IPnexus Multi-Protocol IP-interworking revenue and increased platform product shipments under the Company's last-time buy and build program. In the third quarter 2013, PT's four largest customers represented 42% of sales, compared to 48% of sales in the third quarter 2012. Two customers each accounted for 14% of the Company's sales in the third quarter of 2013.
Total revenue for the nine months ended September 30, 2013 amounted to $20.7 million, compared to $18.0 million in the comparable period in 2012. The revenue increase during the nine months ended September 30, 2013 over the comparable prior year period was primarily due to increased sales to our SEGway signaling systems customers and increased platform product shipments under the Company's last-time buy and build program. The Company's four largest customers comprised 40% and 33% of sales in the nine months ended September 30, 2013 and 2012, respectively. Two customers accounted for 15% and 11% of the Company's sales in the nine months ended September 30, 2013 and 2012, respectively.
Shipments to customers outside of the United States represented 41% and 47% of PT's sales during the third quarter of 2013 and 2012, respectively. Shipments to customers outside of the United States represented 42% and 47% of the Company's sales for the nine months ended September 30, 2013 and 2012, respectively. The period over period decreases in foreign sales was principally due to the decline in OEM platform sales to the Company's formerly largest customer located in the United Kingdom.
-22- Table of contents Looking at revenue categories: The Company has traditionally grouped revenue into two vertical markets: Telecommunications, and Military, aerospace and government systems. Our SEGway signaling products are generally included in Telecommunications revenue and our IPnexus Multi-Protocol IP-interworking solutions are primarily Military, aerospace and government systems revenue. Our OEM platform products can be sold to either Telecommunication or Military, aerospace and government systems customers.
Revenue from telecommunications customers amounted to $5.0 million and $4.2 million in the third quarter 2013 and 2012, respectively, and $15.3 million and $15.0 million in the nine months ended September 30, 2013 and 2012, respectively. Revenue from military, aerospace and government systems customers amounted to $2.3 million and $.5 million in the third quarter 2013 and 2012, respectively, and $5.4 million and $3.0 million in the nine months ended September 30, 2013 and 2012, respectively. These period over period increases were primarily the result of project variability controlled by government spending. The quarter-over-quarter increase in Telecommunications revenue of $.8 million is due to an increase in SEGway signaling solutions revenue and an increase in OEM platform product line shipments to our telecommunications customers during the quarter. The increase of revenue from our telecommunications customers of $.3 million for the first nine months of 2013 from the comparable prior year period is also primarily attributable to an increase in SEGway signaling solutions revenue.
Revenues from our IPnexus Multi-Protocol IP-interworking solutions amounted to $1.2 million and $.7 million in the third quarter 2013 and 2012, respectively, and $3.0 million and $3.3 million in the nine months ended September 30, 2013 and 2012, respectively. The period-over-period changes are due to project variability controlled by government spending.
Revenues from our OEM platform product line, which included orders from a last-time buy and build program, amounted to $2.7 million and $.8 million in the third quarter 2013 and 2012, respectively, and $6.8 million and $4.8 million in the nine months ended September 30, 2013 and 2012, respectively. The increases in the quarter and the first nine months 2013 over the comparable periods in 2012 are primarily attributable to platform product shipments under the Company's last-time buy and build program.
Gross profit. Gross profit consists of sales, less cost of goods sold including material costs, manufacturing expenses, depreciation, amortization of software development costs, amortization of purchased intangible assets, and expenses associated with engineering contracts and the technical support function. Gross profit and gross margin percentage amounted to $3.6 million and 49.1% of sales in the third quarter 2013, compared to $1.8 million and 38.6% of sales for the third quarter 2012. The improvement in gross margin percentage was primarily attributable to the effect of relatively fixed manufacturing expenses measured against substantially higher sales in 2013, the effect of the Company's substantial workforce reductions in manufacturing in late 2012 and early 2013, and lower software amortization costs in 2013.
Gross margin and gross margin percentage amounted to $9.8 million and 47.3% of sales in the nine months ended September 30, 2013, compared to $8.4 million and 46.7% for the nine months ended September 30, 2012. The improvement in gross margin and gross margin percentage was primarily attributable to lower manufacturing expenses and software amortization expenses in 2013 as compared to the prior year period, and the higher level of sales as compared to relatively fixed manufacturing expenses, offset partially by a second quarter 2013 charge recorded to impair costs associated with certain software development projects.
Total Operating Expenses. Total operating expenses amounted to $3.1 million in the third quarter 2013, as compared to $3.4 million in the third quarter 2012.
Total operating expenses amounted to $10.0 million in the nine months ended September 30, 2013, as compared to $11.6 million in the comparable 2012 period.
-23- Table of contents Selling and marketing expenseswere $1.3 million in the third quarter of both 2013 and 2012. For the nine months ended September 30, 2013 and 2012, selling and marketing expenses were $4.0 million and $4.4 million, respectively. The decrease in the nine months ended September 30, 2013 over the comparable 2012 period is primarily attributable to sales staff reductions in the Platform group in the fourth quarter 2012.
Research and development expenses were $1.1 million and $1.3 million in the third quarter 2013 and 2012, respectively. The Company capitalizes certain software development costs, which reduces the amount of software development charged to operating expenses. Amounts capitalized were $.4 million and $.6 million during the third quarter 2013 and 2012, respectively. Research and development expenses were $3.3 million and $4.6 million for the nine months ended September 30, 2013 and 2012, respectively. Nine month amounts capitalized to software development costs amounted to $1.3 million and $1.8 million in 2013 and 2012, respectively. The period-over-period decreases in research and development expenses are primarily due to the Company's staff reductions in the fourth quarter 2012 and first quarter 2013.
General and administrative expenses were $.8 million in the third quarter of both 2013 and 2012. General and administrative expenses were $2.4 million and $2.6 million in the nine months ended September 30, 2013 and 2012, respectively.
This period-over-period decrease is primarily due to the Company's staff reductions in the fourth quarter 2012.
Restructuring expenses were $.2 million in the nine months ended September 30, 2013. The Company reduced its personnel by ten employees, or 8% of its workforce, in a restructuring action commenced and completed during the first quarter 2013. All of the expense associated with this action resulted in cash expenditures.
Other (expense) income, net. Other income consists primarily of interest income and foreign currency translation adjustments relating to the Company's foreign subsidiary financial statements. Other income (expense) for the nine months ended September 30, 2012 also included a $.06 million out-of-period charge to adjust the recorded balance of accumulated other comprehensive income.
Income taxes. The Company's effective income tax rates differ from the statutory rates primarily due to a full valuation allowance provided against its U.S.
deferred tax assets, income taxes on foreign income and refundable income tax credits that differ from the U.S. income tax rate and permanent income tax differences including Canadian research activities.
PT's annual estimated effective income tax rate for 2013 is -4%, as compared to an estimated effective income tax rate of -1% for 2012. The expected annual effective income tax rate for 2013 is different than in the corresponding period in 2012 due primarily to the Company's significantly improved profitability in 2013.
Liquidity and Capital Resources The Company had working capital of $16.3 million and $15.5 million at September 30, 2013 and December 31, 2012, respectively. This increase is primarily a result of a $2.1 million increase in accounts receivable, partially offset by a $1.3 million decrease in inventories from December 31, 2012 to September 30, 2013. PT's primary sources of liquidity are cash, cash equivalents and investments, which totaled $13.9 million at September 30, 2013 and $14.3 million at December 31, 2012.
-24- Table of contents For the nine months ended September 30, 2013, cash provided by operating activities amounted to $1.5 million. This amount reflects the net loss of ($.2 million), non-cash items such as depreciation and amortization charges totaling $2.5 million, stock-based compensation expense of $.2 million, and an impairment charge against capitalized software development costs of $.1 million. Cash used by operations due to changes in operating assets and liabilities included a decrease in cash associated with a $2.1 million increase in accounts receivable and a $.6 million decrease in deferred revenue, offset partially by a $1.3 million decrease in inventories. The increase in accounts receivable was primarily attributable to the higher level of sales in the third quarter 2013, as compared with the fourth quarter 2012. The decrease in inventory was primarily attributable to the Company's efforts to manage inventory levels relative to shipments during the quarter and anticipated product demand, as well as the effect of the Company's last-time buy and build program for its OEM platform product line. The decrease in deferred revenue was primarily attributable to the recognition of revenue upon the completion and acceptance of a specific customer order.
Cash provided by investing activities during the nine months ended September 30, 2013 totaled $1.3 million. Proceeds from the maturity of investments amounted to $5.3 million, offset partially by purchases of investments totaling $2.1 million, capital expenditures of $.6 million, and capitalized software development costs which amounted to $1.3 million.
Off-Balance Sheet Arrangements: In July 2013, the Company renewed its lease for its San Diego engineering center through November 2016 on the same terms as its current lease.
Current Position: Management believes that PT's current cash, cash equivalents and investments, together with cash generated from operations will be sufficient to meet our anticipated cash requirements, including working capital and capital expenditure requirements, for at least the next twelve months.
Recent Accounting Pronouncements Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income: In February 2013, the FASB issued authoritative guidance on the reporting of amounts reclassified out of accumulated other comprehensive income ("AOCI"), which is effective for reporting periods beginning after December 15, 2012. This guidance requires companies to provide information about the amounts reclassified out of AOCI either in a single note or on the face of the financial statements. Significant amounts reclassified out of AOCI should be presented by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified in its entirety to net income in the same reporting period. For amounts not required to be reclassified in their entirety to net income, a cross-reference to other disclosures provided for in accordance with U.S. GAAP is required. The Company has adopted this authoritative guidance. To date, its adoption does not have a material impact on its consolidated financial statement disclosures.
-25- Table of contents Disclosures about Offsetting Assets and Liabilities: In December 2011, the FASB issued authoritative guidance requiring enhanced disclosures about offsetting assets and liabilities, which is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The new rules require companies to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position, as well as instruments and transactions subject to a netting arrangement. In January 2013, the FASB issued a clarification of the guidance in order to address implementation issues surrounding the scope of the standard and to clarify the scope of the offsetting disclosures and address any unintended consequences. The Company has evaluated this updated authoritative guidance, and the adoption of this guidance does not have a material impact on its consolidated financial statement disclosures.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 This report and, in particular, the Management's Discussion and Analysis of Financial Condition and Results of Operations section of this report, contain forward-looking statements.
The Private Securities Litigation Reform Act of 1995 (the "Reform Act") provides a "safe harbor" for forward-looking statements. Certain written and oral statements made by PT's management include forward-looking statements intended to qualify for the safe harbor from liability established by the Reform Act.
These forward-looking statements generally can be identified by words such as "believes," "expects," "anticipates," "projects," "foresees," "forecasts," "estimates" or other words or phrases of similar import. Words such as the "Company," "PT," "management," "we," "us," or "our," mean Performance Technologies, Incorporated and its subsidiaries. All statements herein that describe PT's business strategy, outlook, objectives, plans, intentions, goals or similar projections are also forward-looking statements within the meaning of the Reform Act. Forward-looking 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 contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2012, and other documents filed with the Securities and Exchange Commission.
All such forward-looking statements are subject to certain risks and uncertainties and should be evaluated in light of important risk factors. These risk factors include, but are not limited to, the following as well as those that are described in "Risk Factors" under Item 1A and elsewhere in the Annual Report on Form 10-K: business and economic conditions, rapid technological changes accompanied by frequent new product introductions, competitive pressures, dependence on key customers, inability to gauge order flows from customers, fluctuations in quarterly and annual results, the reliance on a limited number of third party suppliers, limitations of the Company's manufacturing capacity and arrangements, the protection of the Company's proprietary technology, errors or defects in our products, the effects of pending or threatened litigation, the dependence on key personnel, changes in critical accounting estimates, potential impairments related to investments, foreign regulations, possible loss or significant curtailment of significant government contracts or subcontracts, possible effects related to compliance with new conflict-free mineral regulations, and potential material weaknesses in internal control over financial reporting. In addition, during weak or uncertain economic periods, customers' visibility deteriorates causing delays in the placement of their 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.
Any of these factors could cause PT's actual results to differ materially from its anticipated results. For a more detailed discussion of these factors, see the "Risk Factors" discussion in Item 1A in the Annual Report on Form 10-K. The Company cautions readers to carefully consider such factors. Many of these factors are beyond the Company's control. Except as required by law, we undertake no obligation to publicly update these forward-looking statements, whether as a result of new information, future events or otherwise.
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