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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
------------------
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 March 31, 2006
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 (I.R.S. Employer
of incorporation) Identification No.)
205 Indigo Creek Drive, Rochester, New York 14626
(Address of principal executive offices) (Zip Code)
------------------
Registrant's telephone number, including area code: (585) 256-0200
------------------
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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer: Large accelerated filer
[ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock was
13,175,425 as of April 28, 2006.
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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 March 31, 2006 and
December 31, 2005 (unaudited) 3
Consolidated Statements of Income for the Three Months
Ended March 31, 2006 and 2005 (unaudited) 4
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2006 and 2005 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 21
Item 4. Controls and Procedures 21
PART II. OTHER INFORMATION
Item 6. Exhibits 22
Signatures 22
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
ASSETS
March 31, December 31,
2006 2005
---------------- ----------------
Current assets:
Cash and cash equivalents $11,670,000 $11,803,000
Investments 21,275,000 21,150,000
Accounts receivable, net 9,076,000 9,523,000
Inventories 7,745,000 7,148,000
Prepaid expenses and other assets 457,000 470,000
Deferred taxes 3,445,000 3,272,000
---------------- ----------------
Total current assets 53,668,000 53,366,000
Property, equipment and improvements, net 2,201,000 2,004,000
Software development costs, net 3,300,000 3,182,000
Investment in unconsolidated company 248,000 248,000
Goodwill 4,143,000 4,143,000
---------------- ----------------
Total assets $63,560,000 $62,943,000
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,268,000 $ 1,836,000
Income taxes payable 385,000 244,000
Accrued expenses 4,379,000 4,438,000
---------------- ----------------
Total current liabilities 6,032,000 6,518,000
Deferred taxes 1,184,000 1,138,000
---------------- ----------------
Total liabilities 7,216,000 7,656,000
---------------- ----------------
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 14,252,000 13,903,000
Retained earnings 42,694,000 42,601,000
Treasury stock - at cost; 125,118 and
171,757 shares held at March 31, 2006 and
December 31, 2005, respectively (735,000) (1,350,000)
---------------- ----------------
Total stockholders' equity 56,344,000 55,287,000
---------------- ----------------
Total liabilities and stockholders'
equity $63,560,000 $62,943,000
================ ================
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
March 31,
2006 2005
---------------- ----------------
Sales $12,168,000 $13,157,000
Cost of goods sold 5,957,000 6,462,000
---------------- ----------------
Gross profit 6,211,000 6,695,000
---------------- ----------------
Operating expenses:
Selling and marketing 1,370,000 1,477,000
Research and development 2,800,000 2,545,000
General and administrative 1,284,000 1,433,000
Restructuring charges 435,000 57,000
---------------- ----------------
Total operating expenses 5,889,000 5,512,000
---------------- ----------------
Income from operations 322,000 1,183,000
Other income, net 334,000 295,000
---------------- ----------------
Income before income taxes 656,000 1,478,000
Income tax provision 110,000 429,000
---------------- ----------------
Net income $ 546,000 $ 1,049,000
================ ================
Basic earnings per share $ .04 $ .08
================ ================
Diluted earnings per share $ .04 $ .08
================ ================
Weighted average number of common
shares used in basic earnings per
share 13,098,469 12,809,320
Potential common shares 230,830 406,540
Weighted average number of common
shares used in diluted earnings per ---------------- ----------------
share 13,329,299 13,215,860
================ ================
The accompanying notes are an integral part of these
consolidated financial statements.
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended
March 31,
2006 2005
---------------- ----------------
Cash flows from operating activities:
Net income $ 546,000 $ 1,049,000
Non-cash adjustments:
Depreciation and amortization 565,000 572,000
Tax benefit from stock option exercises 227,000 143,000
Stock-based compensation expense 121,000 6,000
Deferred income taxes (127,000) 1,000
Other 9,000
Changes in operating assets and liabilities:
Accounts receivable 447,000 (1,043,000)
Inventories (597,000) 354,000
Prepaid expenses and other assets 13,000 521,000
Accounts payable and accrued expenses (627,000) 422,000
Income taxes payable 141,000
---------------- ----------------
Net cash provided by operating
activities 709,000 2,034,000
---------------- ----------------
Cash flows from investing activities:
Purchases of property, equipment and
improvements (384,000) (77,000)
Capitalized software development costs (493,000) (616,000)
Purchases of investments (17,375,000) (7,225,000)
Proceeds from sales of investments 17,250,000 9,075,000
---------------- ----------------
Net cash (used) provided by
investing activities (1,002,000) 1,157,000
---------------- ----------------
Cash flows from financing activities:
Exercise of stock options 160,000 310,000
---------------- ----------------
Net cash provided by financing
activities 160,000 310,000
---------------- ----------------
Net (decrease) increase in cash and
cash equivalents (133,000) 3,501,000
Cash and cash equivalents at beginning of
period 11,803,000 10,361,000
---------------- ----------------
Cash and cash equivalents at end of period $ 11,670,000 $ 13,862,000
================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Non-cash financing activity:
Exercise of stock options using 21,484
shares of common stock $ 156,000
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, 2005, 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
-----------------------------------------------
The Company has stock options outstanding from three stock-based employee
compensation plans, the Amended and Restated 1986 Incentive Stock Option Plan,
the 2001 Incentive Stock Option Plan, and the 2003 Omnibus Incentive Plan.
Effective January 1, 2006, the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123 (revised 2004), "Share-Based Payment", and related
interpretations, were adopted to account for stock-based compensation using the
modified prospective transition method and therefore, prior period results were
not restated. SFAS No. 123(R) supersedes Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees", and revises guidance
of SFAS No. 123, "Accounting for Stock-Based Compensation". Among other things,
SFAS No. 123(R) requires that compensation expense be recognized in the
financial statements for share-based awards based on the grant-date fair value
of those awards. The modified prospective transition method applies to (a) stock
options granted prior to December 31, 2005 which had unrecognized compensation
expense at January 1, 2006, calculated under SFAS No. 123, and (b) any new
share-based awards granted subsequent to December 31, 2005, based on the
grant-date fair value estimated in accordance with the provisions of SFAS No.
123(R). Additionally, stock-based compensation expense includes an estimate for
pre-vesting forfeitures and is recognized over the requisite service periods of
the awards on a straight-line basis, which is generally commensurate with the
vesting term. Stock-based compensation expense of $115,000 was recorded during
the first quarter of 2006 as a result of the adoption of SFAS No. 123(R). Of
this amount, $105,000 related to stock options that were granted prior to
December 31, 2005.
Prior to January 1, 2006, stock-based compensation plans were accounted for in
accordance with APB No. 25 and related interpretations. Stock options may be
granted to any officer or employee at not less than the fair market value at the
date of grant (not less than 110% of the fair market value in the case of
holders of more than 10% of the Company's common stock). Options granted under
the plans generally expire between five and ten years from the date of grant and
vest in periods ranging from one to six years. Prior to the adoption of SFAS No.
123(R), as required under the disclosure provisions of SFAS No. 123, as amended,
pro forma net income (loss) and earnings (loss) per common share were provided
for each period as if the fair value method were applied to measure stock-based
compensation expense.
The table below summarizes the impact of outstanding stock options and
restricted stock on the results of operations for the three months ended
March 31, 2006 under the provisions of SFAS No. 123(R):
Three Months
Ended March 31,
2006
-------------------
Stock based compensation expense:
Stock options $ 115,000
Restricted stock 6,000
Income tax benefit (41,000)
-------------------
Net decrease in net income $ 80,000
===================
Decrease in earnings per share:
Basic $ .01
===================
Diluted $ .01
===================
The following table illustrates the effect on net income and earnings per common
share for the three months ended March 31, 2005 as if the provisions of SFAS No.
123 were applied using the fair value method to measure stock-based
compensation:
Three Months
Ended March
31, 2005
----------------
Net income, as reported $ 1,049,000
Add: Restricted stock compensation
expense, net of tax 4,000
Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects (2,137,000)
----------------
Pro forma net loss $(1,084,000)
================
Earnings (loss) per share:
Basic - as reported $ .08
================
Basic - pro forma $ (.08)
================
Diluted - as reported $ .08
================
Diluted - pro forma $ (.08)
================
The Black-Scholes-Merton option pricing model was used to estimate the fair
value of share-based awards under SFAS No. 123(R) as well as for pro forma
disclosures under SFAS No. 123. The Black-Scholes-Merton option pricing model
incorporates various and highly subjective assumptions, including expected term
and expected volatility. For valuation purposes, stock option awards were
categorized into two groups, stock option grants to employees and stock option
grants to members of the Board of Directors.
The expected term of options granted prior to January 1, 2006 equaled the
vesting period. The expected term of options granted in 2006 was the average of
the vesting term and the contractual life. The expected volatility at the
grant date is estimated using historical stock prices based upon the expected
term of the options granted. The risk-free interest rate assumption is
determined using the rates for U.S. Treasury zero-coupon bonds with maturities
similar to those of the expected term of the award being valued. Cash dividends
have never been paid and are not anticipated to be paid in the foreseeable
future. Therefore, the assumed expected dividend yield is zero.
SFAS No. 123(R) requires pre-vesting option forfeitures at the time of grant be
estimated and periodically revised in subsequent periods if actual forfeitures
differ from those estimates. Stock-based compensation expense is recorded only
for those awards expected to vest using an estimated forfeiture rate based on
historical pre-vesting forfeiture data. Previously, forfeitures were accounted
for as they occurred under the pro forma disclosure provisions of SFAS No. 123
for periods prior to 2006.
No stock options were granted during the three months ended March 31, 2005. The
following table shows the detailed assumptions used to compute the fair value of
stock options granted during the three months ended March 31, 2006:
Three Months
Ended March 31,
2006
-------------------
Expected term (years) 6.5
Volatility 66%
Risk free interest rate 4.6% - 4.8%
The weighted average grant date fair value of options granted during the three
months ended March 31, 2006 was $4.42 per option. Unrecognized stock-based
compensation expense was approximately $1,901,000 as of March 31, 2006, relating
to a total of 605,000 unvested stock options under the Company's stock options
plans. This stock-based compensation expense is expected to be recognized over a
weighted average period of approximately five years.
The following table summarizes stock option activity for the three months ended
March 31, 2006:
Weighted
Number Average Exercise Price
of Shares Exercise Price Range
------------- -------------- --------------
Outstanding at December 31, 2005 2,118,164 $9.71 $3.40 - $18.13
Granted 185,000 $6.73 $6.64 - $7.50
Exercised (68,123) $4.65 $3.40 - $7.25
Expired (105,684) $13.67 $3.80 - $18.13
-------------
Outstanding at March 31, 2006 2,129,357 $9.42 $3.40 - $18.13
The following table summarizes stock option information at March 31, 2006:
Options outstanding Options exercisable
---------------------------------------------------
Weighted Weighted Weighted
average average average
Range of remaining exercise exercise
exercise price Shares life (yrs) price Shares price
--------------------------------------------------------------------------------
$3.40 to $5.94 579,264 2.93 $4.61 398,330 $4.32
$5.95 to $8.60 827,155 5.51 $7.74 288,491 $8.25
$8.61 to $11.40 65,500 2.93 $10.26 65,165 $10.27
$11.41 to $14.24 294,013 .81 $13.74 290,313 $13.74
$14.25 to $18.13 363,425 2.73 $17.50 363,425 $17.50
--------------------------------------------------------------------------------
2,129,357 3.60 $9.46 1,405,724 $10.76
The total intrinsic value of all outstanding options and all exerciseable
options at March 31, 2006, whose exercise price was less than the Company's
closing stock price at March 31, 2006, was $1,890,000 and $1,294,000
respectively. The total intrinsic value, determined as of the date of exercise,
of options exercised in the first quarter of 2006 and 2005 was $175,000 and
$391,000, respectively. Cash received from option exercises for the three months
ended March 31, 2006 and 2005, amounted to $160,000 and $310,000, respectively.
The total fair value of options that vested during the first quarter 2006 was
$11,000.
During 2005 and 2006, a total of 225,000 and 185,000 options, respectively, were
granted that are subject to accelerated vesting based upon the achievement of
certain milestones, as defined in the option agreements.
During 2003, 17,720 shares of restricted stock were granted at prices ranging
from $6.89 to $12.54. During 2003, 1,740 shares of restricted stock were
forfeited, without vesting. In January 2004, 10,524 shares vested and were
issued. The remaining shares vest in November 2006. The value of restricted
stock is charged to compensation expense over the vesting period of the grant.
Unrecognized compensation expense totaled approximately $14,000 at March 31,
2006, related to restricted stock.
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 and conversion of dilutive
stock options and unvested restricted stock, applying the treasury stock method.
Diluted earnings per share calculations exclude the effect of approximately
1,264,000 and 958,000 options for the three months ended March 31, 2006 and
2005, respectively, since such options have an exercise price in excess of the
average market price of the Company's common stock.
Note C - Inventories, net
----------------
Inventories consisted of the following:
March 31, December 31,
2006 2005
------------------ ------------------
Purchased parts and components $ 3,134,000 $ 2,884,000
Work in process 3,235,000 3,378,000
Finished goods 1,376,000 886,000
------------------ ------------------
Net $ 7,745,000 $ 7,148,000
================== ==================
Note D - Investments
-----------
At March 31, 2006 and December 31, 2005, investments consisted of high grade,
auction rate municipal securities which were classified as available-for-sale.
The contractual maturities of the available-for-sale securities at March 31,
2006 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, these securities historically had the ability to be
quickly liquidated. All income generated from these investments was recorded as
interest income.
Note E - Warranty Obligations
--------------------
Warranty obligations are incurred in connection with the sale of certain
products. The warranty period 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
product-based historical performance rates and related costs to repair. Changes
in accrued warranty obligations for the first quarter 2006 and 2005 were as
follows:
2006 2005
---------------- ----------------
Accrued warranty obligations, January 1, $310,000 $288,000
Actual warranty experience (19,000) (25,000)
Warranty provisions (25,000) 32,000
---------------- ----------------
Accrued warranty obligations, March 31, $266,000 $295,000
================ ================
Note F - Stock Repurchase Program
------------------------
On July 11, 2005, a plan to repurchase shares of common stock for an aggregate
amount not to exceed $10,000,000 was authorized by the Board of Directors. Under
this program, shares of common stock may be repurchased through open market or
private transactions, including block purchases, through July 11, 2006.
Repurchased shares will be used for the stock option plan, potential acquisition
initiatives and general corporate purposes. To date, there have been no
repurchases of shares under this program.
Note G - 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 international operations, research activities,
tax exempt interest and foreign sales. For the first quarter 2006, the effective
tax rate was 17%. This rate was a combination of an expected annual effective
tax rate of 27%, reduced by the recording of a discrete tax benefit of $60,000
which related to a previously unused tax credit. The effective tax rate was 29%
for the first quarter 2005.
Note H - Restructuring Costs
-------------------
Restructuring charges amounted to $435,000 and $57,000 in the first quarter 2006
and 2005, respectively. Restructuring charges in the first quarter 2006 are
primarily related to severance expenses incurred and estimated for the closing
of the Company's Norwood, Massachusetts engineering center. Restructuring
charges in the first quarter 2005 relate primarily to severance payments
associated with the Company's efforts to centralize operations.
Note I - Recent Accounting Pronouncements
--------------------------------
On January 1, 2006, the Company adopted 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. This adoption did not
have a material impact on the Company's 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. 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, 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. Estimates are generally not made
until preliminary results for a financial quarter are known and analyzed. It is
believed that given the current facts and circumstances that 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. The critical accounting policies, judgments and estimates
that we believe have the most significant effect on our 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
o Stock-Based Compensation
o Restructuring Costs
Revenue Recognition: Revenue is recognized from product sales in accordance with
the SEC Staff Accounting Bulletin No. 104, "Revenue Recognition." Product sales
represent the majority of our revenue and include 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
collectability is reasonably assured. Additionally, products are sold 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. If these conditions are not met, revenue
recognition is deferred until such time that 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, revenue
recognition is deferred and revenue will be recognized when all obligations
under the arrangement are fulfilled. 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. Certain products are sold 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
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 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 lifecycles
and estimated inventory levels. 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 further information
on foreign regulations) 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 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, 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: Income taxes are accounted for 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. A valuation
allowance is recorded to reduce deferred tax assets to the amount that is more
likely than not to be realized. 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 deferred tax asset 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 deferred tax asset in the future
is 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: Warranty obligations are incurred in connection with the sale
of certain 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.
Carrying Value of Goodwill: Tests for impairments of goodwill are conducted
annually, at year end, or more frequently if circumstances indicate that the
asset might be impaired. The accounting estimate related to impairment of
goodwill is considered a "critical accounting estimate" because these impairment
tests include 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 the goodwill's
carrying amount exceeds its fair value.
Stock-Based Compensation: Stock options are granted to purchase our common
stock. Under the provisions of SFAS No. 123(R), stock compensation expense is
recorded based upon the 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.
Restructuring Costs: Restructuring costs, which primarily consist of
employee-related severance benefits, are estimated and recorded pro-rata over
the period of each planned restructuring activity. 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 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.
Overview
The following contains forward-looking statements within the meaning of the
Securities Act of 1933 and Securities Exchange Act of 1934 and these
forward-looking statements are subject to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995.
The Company is a leading developer of communications platforms and systems for
the communications market. We target three vertical markets: telecommunications,
defense and homeland security, and commercial. Of the three vertical markets
served, telecommunications is the largest and represents approximately 80% of
our business. An approximate breakdown of the telecommunications applications
that utilize our products is as follows: Voice-over-IP (VoIP) represents 40%,
wireless infrastructure represents 40%, and the remaining 20% is spread across
IP multimedia systems and other applications.
Our products are marketed through a direct worldwide sales force under a variety
of brand names including IPnexus(TM), SEGway(TM), NexusWare(TM) and Advanced
Managed Platforms. These products are based on open standards and are sold as
fully integrated, purpose built, application ready platforms, or as individual
blade components for the embedded communications marketplace. When sold as
platforms, known as our Advanced Managed Platform products, our customers can
quickly move to the enhanced value steps of their products while realizing
distinct cost advantages, increased overall system reliability and performance,
and improved time-to-market. Since its introduction in 2003, our Advanced
Managed Platform product line has realized more than 32 new design wins. If
successfully implemented by our customers, each is expected to generate greater
than $0.5 million of annualized revenue when reaching production volumes. In
addition, we have realized more than 34 new design wins for components solutions
in this same time period. Design wins are subject to risks and uncertainties and
therefore not all design wins are expected to result in production orders.
A company-wide transformation began in early 2006 which will establish the
foundation upon which the Company can reach its aggressive growth goals. This
transformation will move the Company from its traditional engineering and
technology focus to a new emphasis on sales and marketing.
We believe the key elements of this plan are focusing on Tier 1 customers and
increasing the number of sales people calling on customers. We believe the
company has the products and technologies to support much higher revenue levels.
By focusing our sales efforts on Tier 1 customers, we should be able to
replicate the sales successes we have with our largest customers. In addition,
almost all of the targeted Tier 1 suppliers to the telecommunications market are
currently our customers, so we believe we have the basis on which to increase
our sales.
In the current period, which is showing no growth, we recognize the need to
balance investments in sales and marketing, with expense reductions in other
areas of the business. Several actions have been instituted on both sides of
this equation, with more actions to be taken.
Since the beginning of the year, we hired several new sales and marketing
professionals to bolster our sales organization. A number of the new sales
people hired will exclusively sell our signaling products, which have our
highest margins and was our fastest growing product line in 2005. At the same
time, a number of expense reductions have been initiated including the closing
of the Norwood engineering facility. Restructuring costs totaled $.4 million in
the first quarter 2006. Since the closing of the Norwood facility began in the
first quarter 2006, only part of the expense savings was realized during the
first quarter. Savings from these actions are expected to be realized in the
third quarter 2006 since closure of that operation is expected to be completed
in the second quarter. Restructuring costs in the second quarter 2006 are
expected to be in the range of $.3 million to $.6 million. In addition, we are
focusing on obtaining greater savings in our manufacturing and supply chain
operations through sourcing opportunities in China.
The Company's wireless infrastructure business is reliant upon carrier spending
to upgrade networks to next-generation equipment. During the first quarter 2006,
telecommunications carriers and equipment suppliers experienced a wave of merger
announcements, notably the AT&T-BellSouth merger and the Alcatel-Lucent merger.
Furthermore, investments by U.S. wireless carriers in third generation mobile
networks were selective, rather than broadly-based, during the first quarter and
some network carriers trimmed their capital budgets. These industry conditions
resulted in lower than expected sales of our products in the first quarter of
2006, compared to the first quarter of 2005. We are currently evaluating the
long term impact of these events on the Company's operations.
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.
Through acquisitions and internal investments since 2002, we believe the Company
has moved from a position of addressing approximately 20% of the available
market, to a position currently of addressing over 60% of the available market
served.
Beginning in 2003, a new product strategy was adopted. This strategy
repositioned the Company to deliver fully managed, system-level platform
solutions to the embedded communications marketplace. This line of platform
solutions specifically addresses equipment manufacturers' requirements for an
increased level of system integration and services from suppliers, thus allowing
them to focus on their value-added stages of product development, which in most
cases is application software. Our strategy also enables our customers to
replace proprietary or legacy platforms with the latest generation of fully
managed system functionality.
Our goal is to drive sustained and profitable revenue growth. We expect to
achieve this objective through a combination of organic growth and acquisitions.
A company-wide transformation began in early 2006 which will establish the
foundation upon which we expect to reach our aggressive growth goals. This
transformation will move our Company from our traditional engineering and
technology focus, to a new emphasis on sales and marketing. We are highly
focused on these objectives.
There are identifiable risks associated with carrying out our growth strategy in
the current uncertain economic climate. Many of our end markets are forecasted
to show only modest growth in the near term. In order to realize growth in this
environment, we will have to gain market share from our competitors, many of
which are larger, more established companies with greater resources than ours.
We believe that our strategy to increase our emphasis on sales and marketing
while continuing to invest in new product development will enable us to compete
in this economic environment.
Financial Information
Revenue:
-------
Revenue in the first quarter 2006 amounted to $12.2 million, compared to $13.2
million in the corresponding quarter a year earlier.
Earnings:
--------
Net income for the first quarter 2006 totaled $.5 million, or $.04 per diluted
share based on 13.3 million shares outstanding and included restructuring
charges of $.4 million, or $.02 per diluted share, primarily related to the
closing of our Norwood engineering center. Net income for the first quarter 2005
amounted to $1.0 million, or $.08 per diluted share based on 13.2 million shares
outstanding and included restructuring charges of $.1 million, or $.00 per
diluted share.
On January 1, 2006, we adopted the provisions of SFAS No. 123(R). Under this
accounting standard, compensation expense is recognized and recorded related to
the granting of stock options. As a result, stock-based compensation expense was
recorded in the amount of $.1 million, or $.01 per diluted share in the first
quarter 2006.
Liquidity:
---------
Cash, cash equivalents and investments amounted to $32.9 million and $33.0
million at March 31, 2006 and December 31, 2005, respectively. We had no
long-term debt at either date.
Centralization of Functions:
---------------------------
On January 4, 2006, a plan was announced to close our engineering center in
Norwood, Massachusetts and transfer product development and customer support for
the voice technology products to our other engineering centers. During the three
months ended March 31, 2006, restructuring charges amounted to $.4 million, or
$.02 per diluted share, primarily related to these efforts.
We are currently investigating relocating our San Luis Obispo engineering group
to more cost-effective space in the San Luis Obispo area and our Ottawa
operations to Kanata, a high-tech district in the Ottawa area.
Forward Looking Guidance for the Second Quarter 2006 (published April 27, 2006):
The following contains forward-looking statements within the meaning of the
Securities Act of 1933 and Securities Exchange Act of 1934 and are subject to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995.
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 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.
Guidance is only provided on earnings per share expected in the next quarter.
Diluted earnings per share in the second quarter 2006 is expected to be $.05 to
$.08. This earnings per share guidance excludes restructuring charges and any
impact of the Restriction of Certain Hazardous Substances Directive ("RoHS")
issued by the European Union which becomes effective on July 1, 2006. There is a
possibility of non-compliant inventory being written off as a result of this
legislation (see LIQUIDITY AND CAPITAL RESOURCES for further discussion).
Any additional information provided, such as revenue forecasts, is provided as
supplementary information to the earnings per share guidance. Based upon the
current business mix, the current backlog and review of sales forecasts, revenue
is expected to be in the range of $12.0 million to $13.0 million in the second
quarter 2006. Gross margin is expected to be approximately 51.0% to 52.5% and
the effective corporate income tax rate for the second quarter 2006 is expected
to be 27%.
In the second quarter 2006, we expect to hire additional sales, marketing and
engineering staff as we work towards the goals of our strategy. In addition, we
expect to complete the second phase of the Norwood transition plan by closing
our Norwood engineering center at the end of June 2006.
Key Performance Indicators:
Our communications platforms and systems are incorporated into current and
next-generation embedded systems infrastructure. Traditionally, "design wins"
have been an important metric for us to judge our product acceptance in our
marketplace. Design wins, if successfully implemented by our customers, 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.
During the first quarter 2006, we were notified of three design wins. These new
design wins were for our Advanced Managed Platform (with multiple products) (2)
and SEGway products (1). During the first quarter 2005, we were notified of five
design wins for our products. These new design wins were for our Advanced
Managed Platform (with multiple products) (2), individual component design wins
for IPnexus access (1) and SEGway products (2). Each design win is expected to
generate at least $0.5 million of annualized revenue when reaching production
volumes. Not all design wins are expected to result in production orders.
Beginning in 2006, our sales organization is focusing on realizing larger, high
revenue potential design wins and therefore, we expect to report fewer design
wins.
We believe that another key indicator for our business is the volume of orders
received from our 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 first quarter 2006 amounted to $12.2 million, compared to $13.2
million in the first quarter 2005. We believe revenue in the first quarter 2006
was impacted by selective investments by U.S. wireless carriers in third
generation mobile networks, rather than broadly-based infrastructure
investments. In addition, some network carriers trimmed their capital budgets.
More in-depth discussions of our strategy and financial performance can be found
in our Annual Report on Form 10-K and other filings with the Securities and
Exchange Commission.
Quarter Ended March 31, 2006, Compared with
the Quarter Ended March 31, 2005
The following table presents the percentage of sales represented by each item in
our consolidated statements of income for the periods indicated.
Three Months Ended
March 31,
2006 2005
------------ ------------
Sales 100.0% 100.0%
Cost of goods sold 49.0 49.1
------------ ------------
Gross profit 51.0 50.9
------------ ------------
Operating expenses:
Selling and marketing 11.3 11.2
Research and development 23.0 19.4
General and administrative 10.6 10.9
Restructuring charges 3.5 .4
------------ ------------
Total operating expenses 48.4 41.9
------------ ------------
Income from operations 2.6 9.0
Other income, net 2.8 2.2
------------ ------------
Income before income taxes 5.4 11.2
Income tax provision .9 3.2
------------ ------------
Net income 4.5% 8.0%
============ ============
Sales. Total revenue for the first quarter 2006 amounted to $12.2 million,
compared to $13.2 million for the corresponding quarter in 2005. In the first
quarter 2006, one customer represented 22% of our sales. Our four largest
customers represented 40% of sales. In the first quarter 2005, the Company had
two customers that each represented greater than 10% of sales, and the four
largest customers represented 47% of sales.
Shipments to customers outside of the United States represented 41% and 33% of
our sales during the first quarter 2006 and 2005, respectively. Total shipments
to a single foreign country did not exceed 10% of revenue during the three
months ended March 31, 2006 or March 31, 2005.
Beginning in 2006, our products are grouped into three distinct categories in
one market segment: Communications (network access, signaling and voice)
products, Computing products and Switching products. Revenue from each product
category is expressed as a percentage of sales for the periods indicated:
Three Months Ended
March 31,
2006 2005
------------ ------------
Communications 48% 49%
Computing 20% 20%
Switching 32% 30%
Other 1%
------------ ------------
Total 100% 100%
============ ============
Communications products:
Communications products are comprised of network access, SEGway signaling and
Voice Technology products. Network access products provide a connection between
a variety of voice, data and signaling networks and embedded systems platforms
that are used to control the network and/or process information being
transported over networks. This family includes a complete line of
communications protocols. Many of our signaling products provide a signaling
bridge between traditional telephone networks and the growing IP packet-switched
network, and enable the transport of signaling messages over IP networks. Voice
Technology products enable voice, data and fax processing for communications
applications.
Revenue from Communications products amounted to $5.9 million and $6.4 million
in the first quarter of 2006 and 2005, respectively. This decrease of $.5
million, or 8%, was primarily a result of one customer in the first quarter of
2005, which did not purchase product in the first quarter of 2006, due to
decreases in demand from its customer.
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 $2.4 million in the first quarter 2006,
compared to $2.7 million in the first quarter 2005. The decline in revenue of
$.3 million, or 11%, was attributable to a general decline in customer demand in
the comparative quarters.
Switching products:
Our Ethernet switch components operate as the "nexus" of the IP packet switching
functionality of the Advanced Managed Platforms. Revenue from switching products
amounted to $3.9 million in both the first quarter 2006 and 2005.
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 51.0% and 50.9% of sales for the
first quarter 2006 and 2005, respectively. Gross margin for the comparative
periods was positively impacted by our expense reductions resulting from our
centralization efforts that took place in 2005. This positive impact was offset
by lower production volumes in 2006 resulting in fixed manufacturing costs being
spread over fewer units which negatively impacted the gross margin improvements.
Included in cost of goods sold is the amortization of software development costs
which totaled $.4 million in both the first quarters of 2006 and 2005.
Total Operating Expenses. Total operating expenses in the first quarter 2006
amounted to $5.9 million, compared to $5.5 million in the same period of 2005.
Operating expenses in 2006 and 2005 include restructuring expenses of $.4
million and $.1 million, respectively. The restructuring costs in 2006 are
primarily related to the closing of our Norwood, Massachusetts engineering
center. The costs in 2005 are related to the centralization of our
multi-location operations and the streamlining of our organization. Operating
expenses in the first quarter 2006 also included $.1 million related to our
adoption of SFAS 123(R) on January 1, 2006.
Selling and marketing expenses were $1.4 million and $1.5 million for the first
quarter 2006 and 2005, respectively. This decrease is related to staff
reductions in 2005 that were partially offset by additional sales hires in the
first quarter 2006.
Research and development expenses were $2.8 million and $2.5 million in the
first quarter 2006 and 2005, respectively. We capitalize certain software
development costs, which reduces the amount of software development charged to
operating expenses. Amounts capitalized were $.5 million and $.6 million during
the first quarter 2006 and 2005, respectively. The increase in gross
expenditures for the comparative periods is a result of increased salaries and
personnel costs.
General and administrative expenses were $1.3 million in the first quarter 2006,
compared to $1.4 million in the first quarter 2005. The decrease in expenses is
related to higher corporate governance costs in the first quarter 2005, compared
to the current quarter. This decrease was partially offset by the recording of
stock based compensation expense in the first quarter amounting to $.1 million.
Restructuring charges amounted to $.4 million in the first quarter 2006,
compared to $.1 million during the first quarter 2005. Restructuring charges in
the first quarter 2006 are primarily related to severance expenses incurred and
estimated for the closing of our Norwood, Massachusetts engineering center.
Restructuring charges in the first quarter 2005 relate primarily to severance
expenses associated with our efforts to centralize our operations.
Other Income, net. Other income consists primarily of interest income. Our 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 2006 resulted in an increase in interest income. Interest income in 2005 also
included interest income from a note receivable from an unconsolidated company.
Income taxes. The 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 our international operations, research
activities, tax exempt interest and foreign sales. For the first quarter 2006,
the effective tax rate was 17%. This rate was a combination of an expected
annual effective tax rate of 27%, reduced by the recording of a discrete tax
benefit of $.1 million which related to a previously unused tax credit. The
effective tax rate was 29% for the first quarter 2005. The expected annual
effective tax rate in first quarter 2006 was less than the same period in 2005
due to expected increased tax benefits attributable to our investments.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity are cash, cash equivalents and investments,
which together totaled $32.9 million at March 31, 2006. The Company had working
capital of $47.6 million and $46.8 million at March 31, 2006 and December 31,
2005, respectively.
Cash provided by operating activities amounted to $.7 million for the three
months ended March 31, 2006. This amount included net income of $.5 million and
a depreciation and amortization charge of $.6 million. Cash provided by
operations due to changes in operating assets and liabilities included a
decrease in cash associated with an increase in inventory of $.6 million and a
decrease in accounts payable and accrued expenses of $.6 million. The increase
in inventory is primarily related to the acquisition of inventory associated
with foreign regulations discussed below. The decrease in accounts payable and
accrued expenses is related to the timing of payments. These decreases in cash
were offset by an increase in cash of $.4 million related to a reduction in
accounts receivable. The reduction in accounts receivable is due to improved
collections and a decrease in sales in the first quarter of 2006, compared to
the fourth quarter of 2005.
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 that exceed very low
maximum concentration values of certain substances, including lead. It is
expected that we 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. As of the end of March 2006, the majority of our inventory contains
substances prohibited by the RoHS directive. Upon effectiveness of the RoHS
legislation, a portion of our inventory may become obsolete and, as a result,
may have to be written off. In addition, prior to the effectiveness, our overall
inventory balances have increased as we build RoHS compliant product prior to
the effective date. We are working closely with our customers and suppliers to
minimize this impact. However, there can be no assurance that we will be
successful in fully reducing our non-compliant inventory prior to the effective
date and, in the future, we may incur inventory obsolescence charges related to
unsaleable non-compliant products. In addition, we are not certain what effect
potentially higher costs of new materials will have on our gross margins and
inventory levels or when the cost of RoHS compliant materials will stabilize
from the initial high costs.
Cash used by investing activities during the first three months of 2006 totaled
$1.0 million. This utilization was primarily the result of capital asset
purchases of $.4 million and the capitalization of software development costs
amounting to $.5 million.
Cash provided by financing activities for the first three months of 2006
amounted to $.2 million, resulting from the exercise of stock options. On July
11, 2005, our Board of Directors authorized the Company to repurchase shares of
our common stock for an aggregate amount not to exceed $10.0 million. Under this
program, shares of our common stock may be repurchased through open market or
private transactions, including block purchases, through July 11, 2006.
Repurchased shares will be used for our stock option plans, potential
acquisition initiatives and general corporate purposes. To date, there have been
no repurchases of shares under this program.
Off-Balance Sheet Arrangements:
We did not enter into any off-balance sheet arrangements during the first
quarter 2006.
Contractual Obligations:
We did not enter into any other significant contractual obligations during the
first quarter 2006.
Current Position:
Assuming there is no significant change in our business, we believe that our
current cash, cash equivalents and investments, together with cash generated
from operations and a line of credit available on a bank credit facility, should
be sufficient to meet our anticipated cash requirements, including working
capital and capital expenditure requirements, for at least the next twelve
months. However, we are continuing our strategic acquisition program to further
accelerate our growth and market penetration efforts. These strategic
acquisition efforts could have an impact on our working capital, liquidity or
capital resources and we may raise additional capital to facilitate these
efforts.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2006, the Company adopted 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. This adoption did not
have a material impact on the Company's 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 our 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.
Our 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 our 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 and obtaining orders as a result, fluctuations in
quarterly and annual results, the reliance on a limited number of third party
suppliers, limitations of our manufacturing capacity and arrangements, the
protection of our proprietary technology, the dependence on key personnel,
changes in critical accounting estimates, potential impairments related to
goodwill and 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, 2005, 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
We are exposed to various market risks in the normal course of business,
primarily interest rate risk and changes in the market value of our investments
and believes our exposure to such risk is minimal. Our investments are made in
accordance with our investment policy and primarily consist of auction rate
municipal securities. We are also subject to foreign exchange risk related to
our operations in Ottawa, Canada. We believe that our exposure to foreign
currency risk is minimal. We do 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
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. Management has
concluded that the Company's disclosure controls and procedures were
not effective due to a material weakness related to the Company's
internal control surrounding the accounting for restructuring costs.
Specifically, the control deficiency relates to the accounting for
certain severance benefits. To address this material weakness, the
Company performed additional analysis in order to prepare the
unaudited quarterly consolidated financial statements in accordance
with generally accepted accounting principles in the United States,
which resulted in an adjustment to the unaudited interim financial
statements for the first quarter 2006. Accordingly, management
believes that the accompanying financial statements for the first
quarter 2006 are presented fairly and that the material weakness has
been remediated as of May 10, 2006, the date of this filing.
B. Changes in Internal Control Over Financial Reporting
Except as noted above, there has been no change in the Company's
internal control over financial reporting that occurred during the
fiscal quarter covered by this report that has materially affected,
or is reasonably likely to materially affect, the Company's internal
controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
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
May 10, 2006 By:/s/ Michael P. Skarzynski
------------------------------
Michael P. Skarzynski
President and
Chief Executive Officer
May 10, 2006 By:/s/ Dorrance W. Lamb
------------------------------
Dorrance W. Lamb
Chief Financial Officer and
Senior Vice President of Finance
Exhibit 31.1
Certification of Chief Executive Officer
I, Michael P. Skarzynski, 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
fourth fiscal quarter in the case of an annual report) 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: May 10, 2006 By:/s/ Michael P. Skarzynski
-----------------------------
Michael P. Skarzynski
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
fourth fiscal quarter in the case of an annual report) 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: May 10, 2006 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"), Michael P. Skarzynski 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 March 31, 2006 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: May 10, 2006 By:/s/ Michael P. Skarzynski
------------------------------
Michael P. Skarzynski
President and
Chief Executive Officer
Date: May 10, 2006 By:/s/ Dorrance W. Lamb
------------------------------
Dorrance W. Lamb
Chief Financial Officer and
Senior Vice President of Finance