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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      September 30, 2011 
  OR   
        [   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF 
                THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from  to 
 
Commission File Number 0-27460 

 

 
PERFORMANCE TECHNOLOGIES,
  INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware 16-1158413
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
205 Indigo Creek Drive
Rochester, New York 14626

(Address of principal executive offices) (zip code)

(585) 256-0200

(Registrant's telephone number, including area code)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [ X ] No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company:  Large accelerated filer [   ] Accelerated filer [   ] Non-accelerated filer [   ] Smaller reporting company [ X ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [   ]   No [ X ]

The number of shares outstanding of the registrant's common stock was 11,116,397 as of October 31, 2011.


 
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
 
    Page 
PART I.  FINANCIAL INFORMATION   
Item 1.  Condensed Consolidated Financial Statements   
  Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010 (unaudited) 3
  Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)  4
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (unaudited) 5
  Notes to Consolidated Financial Statements (unaudited)  6
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3.  Quantitative and Qualitative Disclosures About Market Risk 28
Item 4.  Controls and Procedures 29
PART II.  OTHER INFORMATION   
Item 1. Legal Proceedings 29
Item 1A. Risk Factor 29
Item 6.  Exhibits  30
Signatures 31

 

 

 

 

 

 



 

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Table of contents

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(unaudited)

ASSETS
  September  30, December 31,
  2011 2010
Current assets:             
     Cash and cash equivalents  $ 9,483,000   $ 12,796,000  
     Investments    885,000     3,753,000  
     Accounts receivable, net    8,023,000     5,478,000  
     Inventories    6,106,000     7,787,000  
     Prepaid expenses and other assets    1,208,000     940,000  
     Prepaid income taxes    166,000     31,000  
     Fair value of foreign currency hedge contracts            17,000  
           Total current assets     25,871,000      30,802,000  
Investments    2,054,000     2,677,000  
Property, equipment and improvements, net    2,002,000     2,162,000  
Software development costs, net    4,220,000     3,995,000  
Purchased intangible assets, net    4,660,000      804,000  
           Total assets  $ 38,807,000   $ 40,440,000  
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:             
     Accounts payable  $ 1,115,000   $ 2,756,000  
     Other payable 992,000
     Deferred revenue 3,347,000 1,946,000
     Accrued expenses 1,962,000 2,919,000
     Fair value of foreign currency hedge contracts      115,000          
             Total current liabilities     7,531,000     7,621,000  
Deferred income taxes    82,000      51,000  
             Total liabilities     7,613,000      7,672,000  
 
Stockholders' equity:             
 Preferred stock - $.01 par value: 1,000,000 shares authorized; none issued            
 Common stock - $.01 par value: 50,000,000 shares authorized;             
     13,304,596 shares issued; 11,116,397 shares outstanding    133,000     133,000  
 Additional paid-in capital    17,276,000     17,042,000  
 Retained earnings    23,764,000     25,400,000  
 Accumulated other comprehensive (loss) income    (161,000   11,000  
 Treasury stock - at cost; 2,188,199 shares     (9,818,000    (9,818,000
           Total stockholders' equity     31,194,000      32,768,000  
           Total liabilities and stockholders' equity  $ 38,807,000   $ 40,440,000  

The accompanying notes are an integral part of these consolidated financial statements.

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Table of contents
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
  Three Months Ended Nine Months Ended
  September 30, September 30,
  2011   2010 2011 2010
 
Sales  $ 9,000,000   6,307,000 $ 27,125,000   $ 21,111,000
Cost of goods sold    4,454,000       3,801,000   14,419,000     11,428,000
           Gross profit    4,546,000       2,506,000   12,706,000     9,683,000
 
Operating expenses:                       
     Selling and marketing    1,585,000       1,976,000   4,966,000     6,383,000
     Research and development    1,593,000       1,827,000   5,342,000     5,709,000
     General and administrative    981,000       1,661,000   3,590,000     4,334,000
     Impairment charge - vendor software 400,000 400,000
     Restructuring charges     71,000        69,000   253,000      196,000
            Total operating expenses    4,630,000       5,533,000   14,551,000     16,622,000
Loss from operations    (84,000     (3,027,000 )   (1,845,000   (6,939,000 )
 
Other (expense) income, net    (4,000     65,000   86,000     170,000
Loss before income taxes    (88,000     (2,962,000 )   (1,759,000   (6,769,000 )
 
Income tax (benefit) provision    (2,000     (33,000 )   (123,000   20,000
            Net loss  $ (86,000   (2,929,000 ) $ (1,636,000 $ (6,789,000 )
 
 
Basic loss per share  $ (.01   (.26 ) $ (.15 $ (.61 )
 
Weighted average number of common shares used in                      
     basic loss per share     11,116,397     11,116,397     11,116,397       11,116,397 
 
The accompanying notes are an integral part of these consolidated financial statements.

 

 

 

 


 

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Table of contents
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
  Nine Months Ended
September 30,
 
  2011 2010
Cash flows from operating activities:             
 Net loss  $ (1,636,000 $ (6,789,000
 Non-cash adjustments:             
     Depreciation and amortization    2,027,000     2,096,000  
     Amortization of purchased intangible assets 812,000
     Impairment charge - vendor software 400,000
     Stock-based compensation expense    234,000     357,000  
     Loss on disposal of property, equipment and improvements 28,000
     Realized loss on sale of investment 17,000
     Non-cash interest expense 19,000
     Deferred income taxes    33,000     47,000  
 Changes in operating assets and liabilities:             
     Accounts receivable    (2,545,000   1,561,000  
     Inventories    1,759,000     (1,306,000
     Prepaid expenses and other assets    (268,000   (100,000
     Accounts payable and accrued expenses    (2,607,000   1,189,000  
     Deferred revenue 1,401,000 (200,000 )
     Income taxes payable and prepaid income taxes     (131,000    20,000  
           Net cash used by operating activities     (457,000    (3,125,000
 
Cash flows from investing activities:             
 Purchase of equipment, inventory and intangible assets (4,378,000 )
 Purchases of property, equipment and improvements    (227,000   (1,068,000
 Capitalized software development costs    (1,683,000   (1,891,000
 Proceeds from sales and maturities of investments  4,443,000 5,280,000
 Purchases of investments    (1,015,000   (4,449,000
 Proceeds from sales of property, equipment and improvements     4,000          
           Net cash used by investing activities     (2,856,000    (2,128,000
 
           Net decrease in cash and cash equivalents    (3,313,000   (5,253,000
Cash and cash equivalents at beginning of period      12,796,000       17,563,000  
Cash and cash equivalents at end of period $ 9,483,000   $ 12,310,000  

Supplemental Disclosure of Cash Flow Information:

     Other payable incurred for the purchase of assets

$ 973,000    

The accompanying notes are an integral part of these consolidated financial statements.

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PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited) 

 

Note A - Basis of Presentation and Changes in Significant Accounting Policies  

 

The interim unaudited Consolidated Financial Statements of Performance Technologies, Incorporated and Subsidiaries (collectively “PT,” “the Company," “we,” “us,” or “our”) have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information (“GAAP”) 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 full year.  The accompanying Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements of the Company as of December 31, 2010, as reported in its Annual Report on Form 10-K filed with the Securities and Exchange Commission.  Certain reclassifications have been made to the December 31, 2010 financial information in order to conform to the current period presentation.

 

Our preparation of the interim unaudited Consolidated Financial Statements’ of PT requires us to make estimates and assumptions that affect the amounts in those financial statements and accompanying notes.  Actual results could differ from these estimates.

 

Recent Accounting Pronouncements  

 

Revenue Recognition for Arrangements with Multiple Deliverables –

 

In September 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. As a result, these arrangements are accounted for in accordance with new, “non-software” guidance for arrangements with multiple deliverables.  The FASB also amended the accounting standards for revenue recognition for arrangements with multiple deliverables.  The new authoritative guidance for arrangements with multiple deliverables requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. It also establishes a selling price hierarchy 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. The new guidance eliminates the residual method of allocation for multiple-deliverable revenue arrangements which we used historically when we applied the software revenue recognition guidance to our multiple element arrangements.

 

We have adopted this guidance as of January 1, 2011. As most of our signaling products include both tangible products and software elements that function together to deliver the tangible product’s essential functionality, the existing software revenue recognition guidance no longer applies to these transactions.  The adoption of the new, non-software revenue recognition guidance did not have a material impact on the timing, pattern, or amount of revenue recognized in the first nine months or third quarter 2011.  Based on currently available information, we anticipate that the impact of adopting this guidance on revenue recognition in future periods will not be material.  However, this assessment may change because such impacts depend on terms and conditions of arrangements in effect in those future periods.

 

The new guidance does not generally change the units of accounting for our revenue transactions. For our multiple deliverable arrangements, our products and services qualify as separate units of accounting.  Our multiple deliverable arrangements generally include a combination of our 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. Our arrangements generally do not include any provisions for cancellation, termination, or refunds that would significantly impact recognized revenue.

 

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For substantially all of our multiple deliverable arrangements, we defer support and services revenue, and recognize 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, we recognize revenue based on the existing software revenue recognition guidance, which require 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 we are unable to establish VSOE for the delivered telecommunications products, we utilize the residual method to allocate revenue to each of the elements of an arrangement.  Under this method, we allocate 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).

 

For multiple deliverable arrangements entered into after January 1, 2011, we recognize revenue based on the new non-software revenue recognition guidance.  We allocate consideration to each deliverable in an arrangement based on its relative selling price. We follow a hierarchy to allocate the selling price of VSOE, then TPE and finally BESP. Because we rarely sell such products on a stand-alone basis or without support, we are not able to establish VSOE for these products. Additionally, we generally expect that we will not be able to establish TPE due to the nature of our products and the markets in which we compete. Accordingly, we expect the selling price of our proprietary hardware and software products to be based on our BESP. We have established VSOE for our support and services and, therefore, we utilize VSOE for these elements.

 

Since the adoption of the new guidance, 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.  We plan 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.

 

In June 2011, the FASB issued authoritative guidance on the presentation of comprehensive income that eliminates the option to present the components of other comprehensive income as part of the statement of equity and requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  This guidance is effective retrospectively for fiscal years (and interim periods within those years) beginning after December 15, 2011 (an effective date of January 1, 2012 for the Company).  The guidance requires changes in presentation only and will have no significant impact on the Company's consolidated financial statements.

 

In May 2011, the issued authoritative guidance that amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization.  This guidance is effective prospectively for interim and annual periods beginning after December 15, 2011 (an effective date of January 1, 2012 for the Company).  The Company does not expect that the adoption of this guidance will have a significant impact on its consolidated financial statements.

 

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Note B - Asset Purchase

 

In January 2011, the Company entered into an asset purchase agreement with GENBAND to acquire GENBAND's Universal Signaling Platform (“USP”) and SP2000 signaling technology which GENBAND acquired in its May 2010 acquisition of Nortel's Carrier VoIP and Application Solutions business.  In connection with this transaction, the Company acquired software, equipment, inventories, and intellectual property including a signaling-related patent, a license under GENBAND's signaling patent portfolio and an assignment of certain signaling technology conveyed to GENBAND under license from Nortel.  Certain of these licensed property rights are not transferable without GENBAND’s consent.  Furthermore, under certain circumstances, GENBAND has the right to terminate this licensing agreement. In addition to the acquisition of assets, the Company agreed to provide GENBAND with ongoing development, support and maintenance of signaling solutions, and solutions for stand-alone signaling applications as well as integrated signaling capabilities.

 

The total consideration for these assets amounted to $5,378,000, of which $4,000,000 was paid at closing in January 2011, $378,000 was paid for transaction-related expenses, and $1,000,000 is due in January 2012.  This payable, discounted at 3%, had a present value of $973,000 at the date of closing.  Including amortization of the discount, this payable amounts to $992,000 at September 30, 2011.

 

Approximately $613,000 of the total consideration for the GENBAND assets was allocated to property, plant and equipment, $78,000 to inventory, and the remainder was allocated to purchased intangible assets, including the estimated value of the support contract, which amounted to $986,000, and purchased developed technologies, which amounted to $3,710,000.

 

In addition to the software technologies acquired from GENBAND, the Company reclassified the technologies acquired in 2009 from Pactolus (with a cost of $835,000 and accumulated amortization of $31,000 at December 31, 2010) from software development costs, net, into purchased intangible assets.  Purchased intangible assets are being amortized over estimated useful lives of three to five years.

 

Purchased intangible assets consist of the following at September 30, 2011:

Purchased developed technologies $ 4,517,000  
Support contracts    986,000  
         Total 5,503,000  
 Less: accumulated amortization   (843,000
         Purchased intangible assets, net $ 4,660,000  

 

Amortization of purchased intangible assets totaled $280,000 in the third quarter 2011 and $812,000 in the nine months ended September 30, 2011.

 

Note C - Litigation 

 

In December 2009, the Company became aware that Tekelec, a California corporation headquartered in Morrisville, North Carolina, had filed but not served a complaint against the Company in the U.S. District Court for the Eastern District of North Carolina.  The complaint alleged that certain of the Company’s signaling systems products infringe three of Tekelec’s issued patents and sought a determination of infringement, a preliminary and permanent injunction from further infringement and an unspecified amount of damages.  On March 4, 2010, an amended complaint was served on the Company through its designated agent in North Carolina.  The amended complaint contained the same allegations as the original complaint but added two patents to the number of patents which Tekelec alleged the Company’s signaling systems products infringe. Subsequently, the complaint was further amended to add a sixth patent which Tekelec alleged the Company's signaling systems product infringe.

 

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In May 2011, PT and Tekelec agreed to voluntarily dismiss all of their claims and defenses against each other, without prejudice.  By Stipulation dated May 4, 2011, the litigation was dismissed without prejudice.

 

The Company is subject to various other legal proceedings and claims that arise in the ordinary course of business. 

 

Note D - Investments 

 

Investments are stated at fair value and consisted of the following:

 

 September 30,
December 31,
 

2011

2010
Corporate bonds $ 1,918,000   $ 3,190,000  
Certificates of deposit 521,000 1,240,000
Municipal bond 500,000
U.S. Government bond            2,000,000  
         Total investments  2,939,000   6,430,000  
 Less: current investments    (885,000   (3,753,000
         Non-current investments  $ 2,054,000   $ 2,677,000  
 

The Company’s bond investments have a cumulative par value of $2,353,000.  Non-current bonds with par values totaling $2,000,000 mature in 2012 through 2014, while the remaining bond matures in 2012 and is classified as a current asset.  As of December 31, 2010, the Company changed its classification of investments from held-to-maturity to available-for-sale because it determined that it is probable that at least some of its investments may be sold prior to maturity to fund operations.  As a result, any unrealized gains or losses are recorded in accumulated other comprehensive income.  At September 30, 2011, the cost basis of the Company’s investments exceeded their fair value by $46,000.  The Company recorded a realized loss of $13,000 upon the maturity of one bond in the third quarter 2011.

 

Note E - Inventories, net

 

Inventories consisted of the following:

September 30,

December 31,

  2011

2010

Purchased parts and components

$ 2,249,000   $ 3,318,000  

Work in process and purchased assemblies

2,424,000 3,361,000

Finished goods

   1,433,000    1,108,000  
         Net  $ 6,106,000   $ 7,787,000  

 

Note F - Software Development Costs

 

Software development costs consisted of the following:

September 30,

December 31,

  2011

2010

Capitalized software development costs  $ 21,801,000   $ 20,118,000  
Less: accumulated amortization     (17,581,000    (16,123,000
         Net  $ 4,220,000   $ 3,995,000  

Amortization of software development costs included in cost of goods sold was $441,000 and $541,000 in the third quarter 2011 and 2010, respectively.  Amortization of software development costs included in cost of goods sold was $1,459,000 and $1,492,000 for the nine months ended September 30, 2011 and 2010, respectively.  
 

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Note G - Warranty Obligations

 

Warranty obligations are incurred in connection with the sale of certain products.  The warranty period for PT’s products is generally one year from date of sale.  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 three and nine months ended September 30, 2011 and 2010 were as follows:

 

  2011 2010
Accrued warranty obligations, January 1  $ 156,000   $ 78,000  
Actual warranty experience    (62,000   (31,000
Warranty provision    45,000     31,000  
Accrued warranty obligations, March 31  139,000 78,000
Actual warranty experience  (22,000 ) (8,000
Warranty provision (reversal)   (23,000 )   108,000
Accrued warranty obligations, June 30 94,000   178,000  
Actual warranty experience  (21,000 ) 23,000
Warranty provision     23,000   (23,000 )
Accrued warranty obligations, September 30 $  96,000 $ 178,000

 

Note H - Loss Per Share

 

Basic earnings (loss) per share is computed by dividing net income or loss by the weighted average number of common shares outstanding for the period.  Diluted earnings per share calculations would reflect the assumed exercise and conversion of dilutive stock options, using the treasury stock method, if applicable.  Due to the net losses incurred, dilutive options were not considered for any period. The weighted average number of stock options that were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive were 1,691,000 and 1,800,000 shares for the third quarter 2011 and 2010 respectively, and 1,664,000 shares and 1,787,000 shares for the nine months ended September 30, 2011 and 2010, respectively.

 

Note I Comprehensive Loss

 

The components of comprehensive loss for the three and nine months ended September 30, 2011 and 2010, respectively, are as follows:

 

  Three Months Ended September 30, Nine Months Ended September 30,
  2011 2010 2011 2010
Net loss  $ (86,000 $ (2,929,000 ) $ (1,636,000 ) $ (6,789,000 )
Increase in unrealized loss on investments (19,000 ) (46,000 )
Unrealized net (loss) gain on foreign currency                        
   hedge contracts, net of tax    (125,000 )    19,000    (126,000 )    (108,000
     Comprehensive loss $ (230,000 $ (2,910,000 ) $ (1,808,000 ) $ (6,897,000 )

 

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NOTE J - Derivative Instruments – Foreign Currency Hedge Contracts

 

The Company is exposed to the impact of fluctuations in foreign currency exchange rates on the expenses incurred in its Canadian and United Kingdom operations.  PT’s risk management program is designed to reduce the exposure and volatility arising from fluctuations in foreign currency exchange rates.  At September 30, 2011, the Company had contracts in place to hedge approximately 60% of its estimated Canadian foreign currency risk through June 30, 2012.  PT’s derivative instruments are designated and qualify as cash flow hedges.  As such, any gains or losses resulting from changes in the fair value of these contracts are recorded in other comprehensive income or loss.  The Company will receive, or be required to disburse, cash payments upon the expiration of each contract depending on fluctuations in the underlying exchange rates.  Such payments will be recorded as reductions to, or increases in, expense as they are determined.

  

The fair value of the Company’s derivative instruments is estimated in accordance with the framework for measuring fair value contained in GAAP (Note K) and is recorded as either an asset or liability in the balance sheet based on changes in the current spot rate, as compared to the exchange rates specified in the contracts. For these instruments, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and is reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. The fair value measurement of the Company’s derivative instruments is estimated using Level 2 inputs, which are inputs other than quoted prices that are directly or indirectly observable for the asset or liability.  All of the Company’s derivative instruments are deemed to be fully effective at September 30, 2011, and the entire fair value of these instruments is expected to be reclassified to earnings during the remainder of 2011 and the first six months of 2012.

 

These hedge contracts are designed to fix in U.S. dollars a portion of the future cost of PT’s Canadian operation, which is denominated in Canadian dollars.  These contracts effectively fix the exchange rate on the first $200,000CDN of monthly expenses for October 2011 through June 2012 at exchange rates ranging from .98 to .985.  The fair value of these contracts is a liability of $115,000 at September 30, 2011.

 

At December 31, 2010, the Company had foreign currency hedge contracts in place to fix in U.S. dollars a portion of PT’s Canadian and U.K. operations for each of the months of January through March 2011.  These contracts have matured and have cash settled.

 

 

 

Balance

 

Fair value at

 

 

Sheet

 

September 30,

 

December 31,

 

 

Location

 

2011

 

2010

Derivatives designated as hedging instruments

 

Current assets

 

$            -

 

$17,000

Derivatives designated as hedging instruments

Current liabilities

$(115,000)

$         -   

 

The Company’s derivative instruments had the following effect on the statements of operations:

 

Amount of (loss) gain reclassified from
accumulated other
comprehensive income to the
statement of operations 
Location
of gain  Three Months Ended
  recognized in September 30,
 Derivatives in fair value hedging relationships  operations 2011   2010
Foreign exchange contracts  Operating expenses $ (2,000) $ 16,000

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Nine Months Ended 
September 30,
2011 2010
Foreign exchange contracts  Operating expenses $ 18,000  $ 227,000

The Company’s derivative instruments had the following effect on accumulated other comprehensive (loss) income:

 

Three Months Ended  Nine Months Ended
  September 30, September 30,
  2011 2010 2011 2010
Accumulated other comprehensive income, beginning $ 10,000   $ 1,000 $ 11,000 $ 128,000
Amount of gain recognized in statement of operations,
   net of tax   (2,000    (12,000    (18,000   (147,000 
Net change in fair value of derivative instruments    (123,000 )    31,000      (108,000 )    39,000  
Accumulated other comprehensive income (loss), ending     $ (115,000 )  $ 20,000 $ (115,000 ) $ 20,000

 

Note K Fair Value Measurements

 

GAAP defines fair value, establishes a framework for measuring fair value and requires certain disclosures about fair value measurements. In addition, GAAP establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value.  Level 1 inputs are quoted prices in active markets for identical assets or liabilities.  Level 2 inputs are inputs other than quoted prices included in Level 1 that are directly or indirectly observable for the asset or liability.  Such inputs include quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs derived principally from or corroborated by observable market data by correlation or other means.  Level 3 inputs are unobservable inputs for the asset or liability. Such inputs are used to measure fair value when observable inputs are not available.

 

The Company’s assets and liabilities measured at fair value on a recurring basis at September 30, 2011, were as follows:

 

  Level 1 Level 2  Level 3   
Assets:             

  Investments

$ 1,918,000 $ 1,021,000 $ -

     Total assets measured at fair value 

$ 1,918,000 $ 1,021,000 $  - 

Liabilities:

  Foreign currency hedge contracts

$ - $ (115,000 ) $
     Total liabilities measured at fair value  $ - $     (115,000 ) $ -  

 

 

 

 

 

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The Company’s assets measured at fair value on a recurring basis at December 31, 2010, were as follows:

 

  Level 1 Level 2  Level 3   
Assets:             

 Investments

$ 5,190,000 $ 1,240,000 $ -
 Foreign currency hedge contracts    -       17,000    -  
     Total assets measured at fair value  $ 5,190,000 $      1,257,000  $ -  

 

There were no transfers into or out of Level 1, Level 2 or Level 3 in the periods presented.

 

Note L Stock-Based Compensation

 

PT has stock options outstanding from two stock-based employee compensation plans: the 2001 Incentive Stock Option Plan and the 2003 Omnibus Incentive Plan.

PT recognizes compensation expense in the financial statements for stock option awards based on the grant date fair value of those awards, estimated using the Black-Scholes-Merton option pricing model.  The table below summarizes the impact of outstanding stock options on the results of operations for the three and nine month periods ended September 30, 2011 and 2010.

 Three Months Ended
Nine Months Ended
 

September 30,

 September 30,
  2011 2010 2011 2010
                     
Stock-based compensation expense – stock options  $ 66,000 $ 71,000   $ 234,000 $ 358,000   
Income tax benefit     -     -      -   -  
            Net increase in net loss  $ 66,000 $ 71,000   $ 234,000 $ 358,000  
                     
Per basic share increase in loss $ 0.01   $ 0.01   $ 0.02 $ 0.03  

 

The following table summarizes stock option activity for the nine months ended September 30, 2011:

Weighted 
        Average
  Number     Exercise
  of shares     Price 
Outstanding at January 1, 2011  1,662,933    $    4.42
Granted  391,000     2.17
Exercised  -     -
Expired  (363,050   5.10
Outstanding at September 30, 2011  1,690,883     3.75
 
Exercisable at September 30, 2011 961,063   $    4.69

 

The weighted average fair value of option grants was estimated using the Black-Scholes-Merton option pricing method.  At September 30, 2011, PT had approximately $332,000 of unrecognized stock compensation expense which will be recognized over a weighted average period of approximately 1.8 years.

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Note M Income Taxes

 

PT’s effective income tax rate is a combination of federal, state and foreign tax rates and differs from the U.S. statutory rate due to taxes on and credits against foreign income, permanent differences including tax-exempt interest, and the resolution of tax uncertainties, offset by a valuation allowance against  deferred income tax assets.

 

PT’s estimated effective annual tax rate was 7% for the nine months ended September 30, 2011 and does not include any material discrete items.  The estimated effective annual tax rate used for the nine months ended September 30, 2010 was -3% and included a provision item of $72,000 which offset the benefit credited to other comprehensive income associated with the decrease in unrealized gain on foreign currency hedge contracts that matured in the first quarter 2010.  In addition to this item, which was immaterial in 2011, the change in the effective annual tax rate is due to expected refundable Canadian provincial tax credits.

 

The Company had no balance in unrecognized tax benefits at either September 30, 2011 or December 31, 2010.  At September 30, 2011, the Company had gross deferred income tax assets totaling approximately $11,400,000, against substantially all of which the Company has recorded a valuation allowance.  At December 31, 2010, the Company had gross deferred income tax assets totaling approximately $10,200,000, against substantially all of which the Company has recorded a valuation allowance.

 

Note N Restructuring 

 

Restructuring expenses totaled $71,000 and $69,000 in the third quarter 2011 and 2010, respectively, and amounted to $253,000 and $196,000 in the nine months ended September 30, 2011 and 2010, respectively.

 

In December 2010, the Company announced an expense reduction action which was implemented primarily during the first half of 2011.  The program included the elimination of 21 positions, which represents 12% of the Company’s workforce.  In connection with this action, the Company’s San Luis Obispo, California engineering center was closed with those hardware engineering functions assumed by the Company’s engineering staff in Rochester.  Restructuring charges associated with this action totaled $71,000 in the third quarter 2011 and $245,000 in the nine months ended September 30, 2011.  This action is now complete at September 30, 2011.  The charges resulting from this action are employee severance and related costs, rental and lease termination expenses, moving costs and write-downs of equipment.

 

In December 2009, the Company announced its decision to outsource manufacturing of the printed circuit board assembly for the hardware elements of PT’s products.  This action was undertaken in order to reduce the Company’s future capital expenditure requirements and make product costs more predictable.  In connection with this decision, the Company reduced its Rochester workforce by fifteen employees.  Restructuring charges associated with this action consisted of severance charges amounting to zero and $69,000 in the third quarter 2011 and 2010, respectively, and $8,000 and $196,000 for the nine months ended September 30, 2011 and 2010, respectively.

 

 

 

 

 

 

 

 

 

 

 

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The following table sets forth the amounts recognized for restructuring expense and incurred during the quarters and nine month periods ended September 30, 2011 and 2010, respectively, and the balance of accrued restructuring at each quarter end:
 
  2011 2010
Accrued restructuring, January 1  924,000   -  
Restructuring expense - primarily employee-related costs   122,000     63,000  
Amount incurred in the period (all of which was cash)   (936,000 )   -  
Accrued restructuring, March 31  110,000 63,000
Restructuring expense - rent, employee-related costs and write-offs of equipment 60,000 64,000  
Amount incurred in the period (cash expenditures of $133,000 in 2011)   (154,000 )   (2,000 )
Accrued restructuring, June 30 16,000 125,000
Restructuring expense - rent and employee-related costs 71,000 69,000
Amount incurred in the period (all of which was cash)   (50,000 )   (20,000 )
Accrued restructuring, September 30 37,000   174,000  

 

 

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.  These estimates and assumptions are made during the closing process for the quarter, after the quarter end has past. 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

 

 

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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.

 

In September 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. As a result, these arrangements are accounted for in accordance with new, “non-software” guidance for arrangements with multiple deliverables.  The FASB also amended the accounting standards for revenue recognition for arrangements with multiple deliverables.  The new authoritative guidance for arrangements with multiple deliverables requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. It also establishes a selling price hierarchy 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. The new guidance eliminates the residual method of allocation for multiple-deliverable revenue arrangements which we used historically when we applied the software revenue recognition guidance to our multiple element arrangements.

 

We have adopted this guidance as of January 1, 2011. As most of our signaling products include both tangible products and software elements that function together to deliver the tangible product’s essential functionality, the existing software revenue recognition guidance no longer applies to these transactions.  The adoption of the new, non-software revenue recognition guidance did not have a material impact on the timing, pattern, or amount of revenue recognized in 2011.  Based on currently available information, we anticipate that the impact of adopting this guidance on revenue recognition in future periods will not be material.  However, this assessment may change because such impacts depend on terms and conditions of arrangements in effect in those future periods.

 

The new guidance does not generally change the units of accounting for our revenue transactions. For our multiple deliverable arrangements, our products and services qualify as separate units of accounting.  Our multiple deliverable arrangements generally include a combination of our 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. Our arrangements generally do not include any provisions for cancellation, termination, or refunds that would significantly impact recognized revenue.

 

For substantially all of our multiple deliverable arrangements, whereby equipment and software are combined with other elements, such as software and maintenance, we defer support and services revenue, and recognize 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.

 

 

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For multiple deliverable arrangements entered into prior to January 1, 2011 and not materially modified after that date, we recognize revenue based on the existing software revenue recognition guidance, which require 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 we are unable to establish VSOE for the delivered telecommunications products, we utilize the residual method to allocate revenue to each of the elements of an arrangement.  Under this method, we allocate 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).

 

For multiple deliverable arrangements entered into after January 1, 2011, we recognize revenue based on the new non-software revenue recognition guidance.  We allocate consideration to each deliverable in an arrangement based on its relative selling price. We follow a hierarchy to allocate the selling price of VSOE, then TPE and finally BESP. Because we rarely sell such products on a stand-alone basis or without support, we are not able to establish VSOE for these products. Additionally, we generally expect that we will not be able to establish TPE due to the nature of our products and the markets in which we compete. Accordingly, we expect the selling price of our proprietary hardware and software products to be based on our BESP. We have established VSOE for our support and services and, therefore, we utilize VSOE for these elements.

 

Since the adoption of the new guidance, 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.  We plan 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.

 

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 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.

 

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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, ranging from purchasing, to sales, to production, to 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 deferred tax asset in the future is 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.

 

PT operates within multiple taxing jurisdictions worldwide and is subject to audit in these jurisdictions. Such 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 of being 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, 2011, 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 of in excess of $11 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. 

 

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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.

 

Restructuring Costs: Restructuring costs may 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 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

 

The following discussion 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.

 

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PT is a global supplier of advanced network communications solutions to service provider, government, and OEM markets. PT’s portfolio includes IP-centric network elements and applications designed for high availability, scalability, and long life cycle deployments. The industry-leading Monterey MicroTCA and IPnexus Platforms anchor the company’s broad range of offerings on PT’s own IP-native, highly integrated platforms and element management systems. OEMs and application developers, including PT itself, leverage the robust carrier grade Linux development environment and rich suite of communications protocols (PT's NexusWare) of IPnexus Application-Ready Platforms as a cornerstone component of their end product value proposition. PT's SEGway Signaling Solutions provide affordable, high density signaling, advanced routing for LTE and IMS applications, IP migration, gateway capabilities, SIP bridging, and core-to-edge distributed intelligence, as well as features such as Number Portability and SMS Spam Defense. The company's Xpress NGN applications enable evolving Mobile 2.0, Multi-media, and IMS based revenue-generating services.

 

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.

 

PT’s business addresses one industry segment - Communications - and globally targets two primary vertical markets for its network communications products, namely telecommunications, and military, aerospace and government systems.  The telecommunications market, historically PT’s largest vertical market, is fundamentally driven by investments in network infrastructure by carriers and service providers.  Telecommunications market revenues derived from our Monterey and IPnexus Application-Ready platforms, which are sold to OEMs, depend primarily on broad, multi-year deployments of next-generation telecommunications infrastructure.  Telecommunications market revenues generated from service providers, purchasing our SEGway and Xpress product lines, result from investments necessary to support existing and evolving service demands such as text messaging and the transition to Internet-based communications networks. 

Sales into the military, aerospace and government systems market are typically to prime contractors and system integrators that reflect investment levels by various government agencies and military branches in specific programs and projects requiring enhanced communications capabilities.  Military, aerospace and government systems shipments are subject to project deployment schedules, which are often unpredictable.    Sales to the U.S. and foreign governments and their prime contractors carry certain inherent risks, as discussed further below in Part II, Item 1a.

Strategy

 

The Company’s strategy is to maximize the value proposition of its products by leveraging its field-proven systems, software and hardware technologies.  Management believes the tightly integrated combination of these technologies results in considerable benefits to its customers including a compelling return-on-investment proposition, significant development risk mitigation and a substantially accelerated time-to-market opportunity.

As we outlined in PART 1, ITEM 1, under the caption “Business” of PT’s Annual Report for the year ended December 31, 2010, as filed on Form 10-K with the Securities and Exchange Commission, management is continuing to concentrate on the four network communications-focused initiatives established at the beginning of 2010 to construct a solid foundation for long-term growth.  These initiatives include further strengthening our SEGway Signaling Systems product line, continued evolution and enhancement of our open-standards based Application-Ready Platforms for mission critical communications applications, intensifying our market diversification efforts in government systems markets, and identifying forward-looking network communications growth opportunities, such as our Xpress portfolio of SIP-based applications and enabling infrastructure, that we can pursue with our own end product solutions. In addition, our signaling product portfolio, which is targeted at the service provider market, has reached a scale in terms of features, functionality and cost-effectiveness that generates strong interest on a global basis and especially in many emerging markets.  As a result, beginning in 2011, the sales and marketing strategy for our signaling products shifted to being increasingly focused on working with strong channel partners as our primary vehicle to further expand our reach in the global and emerging markets.  To that end, we added GENBAND as a strong channel partner in January 2011, Kapsch CarrierCom AG in the third quarter 2011, and we continue to work closely under our established relationship with Alcatel-Lucent as another major channel partner. 

 

 

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There are identifiable risks associated with PT’s strategy in the current economic climate.  While management believes that its network communications market focus offers growth in the long term, current network infrastructure investments by carriers are very sluggish; the market for certain signaling products is declining and the market for SIP-based products is not growing rapidly enough to offset these declines.  The current economic environment remains very challenging and management believes that realizing meaningful profitability in the near term is likely to be very difficult. 

 

Financial Overview

 

Revenue

 

Revenue in the third quarter 2011 amounted to $9.0 million, compared to $6.3 million in the third quarter 2010.  Revenue for the nine months ended September 30, 2011 was $27.1 million, compared to $21.1 million in the corresponding period in 2010.   The increase in revenue in the third quarter 2011 over the comparable prior year period was primarily due to sales to GENBAND, Globacom (Ghana, Africa), Rockwell-Collins, Nologin Consulting S.L. and Kapsch CarrierCom AG (“Kapsch”), a new PT distributor, offset partially by the non-recurrence of revenue from Starcomm PLC during the third quarter of 2010.  The increase in revenue in the nine months ended September 30, 2011 over the prior year period was primarily due to a substantial first quarter 2011 sale to the FAA, sales to GENBAND, Kapsch, Globacom and Rockwell-Collins.  Shipments to customers outside of the United States represented 53% and 67% in the third quarter of 2011 and 2010, respectively, and 48% and 61% in the nine months ended September 30, 2011 and 2010, respectively.

 

Earnings

 

PT incurred a net loss in the third quarter 2011 in the amount of ($.1 million), or ($.01) per basic share, including an impairment charge recognized upon the termination of a value-added reseller agreement in the amount of $.04 per share, amortization of purchased intangible assets of $.03 per share, a restructuring charge of $.01 per share and stock-based compensation expense of $.01 per share, based on 11.1 million shares outstanding.  The Company incurred a net loss in the third quarter 2010 in the amount of ($2.9 million), or ($.26) per basic share, including other litigation expenses of $.05 per share, a restructuring charge of $.01 per share and stock-based compensation expense of $.01 per share, based on 11.1 million shares outstanding.

 

The Company incurred a net loss for the nine months ended September 30, 2011 amounting to ($1.6 million), or ($.15) per basic share, including an impairment charge recognized upon the termination of a value-added reseller agreement in the amount of $.04 per share, amortization of purchased intangible assets of $.07 per share, other litigation expenses of $.04 per share, a restructuring charge of $.02 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, 2010 amounting to ($6.8 million), or ($.61) per basic share, including other litigation expenses of $.08 per share, a restructuring charge of $.02 per share; stock-based compensation of $.03 per share; and a discrete income tax provision of $.01 per share, based on 11.1 million shares outstanding. 

 

Liquidity

 

Working capital amounted to $18.3 million at September 30, 2011 and $23.2 million at December 31, 2010.  PT’s primary sources of liquidity include cash, cash equivalents and long-term investments amounted to $12.4 million at September 30, 2011 and $19.2 million at December 31, 2010.  The Company had no long-term debt at either date.  For the nine months ended September 30, 2011, the decrease in cash, cash equivalents and long-term investments was due primarily to the Company’s operating loss, the payment of severance costs, and payments of $4.4 million to acquire equipment, inventory and intellectual property including signaling software products from GENBAND.

 

 

-21-

 

 

Accounts receivable at September 30, 2011 amounted to $8.0 million, compared to $5.5 million at December 31, 2010.  This increase was a result of increased sales in the final month of the third quarter 2011, compared to the final month of 2010.  Inventories decreased by $1.7 million, to $6.1 million at September 30, 2011, from December 31, 2010, as PT deliberately held purchasing of inventory below the level of inventory usage in second and third quarters

    

Cash used by operating activities amounted to ($.5 million) in the nine months ended September 30, 2011, compared to cash used by operating activities which amounted to ($3.1 million) in the nine months ended September 30, 2010.  This change was principally due to the $5.2 million lower loss from operations in 2011 (which, when the 2011 amortization of purchased intangible assets is added back, results in a cash flow improvement of $6.0 million over the prior year), partially offset by the net change in accounts receivable, inventories, accounts payable and accrued expenses, and deferred revenue, which amounted to a net use of cash of ($2.1 million) in the nine months ended September 30, 2011, compared to net cash provided of $1.2 million in the nine months ended September 30, 2010.

  

Key Performance Indicator:  

 

PT believes that a key indicator for its business is the trend for the volume of orders received from customers.  The telecommunications market, historically our largest vertical market, is fundamentally driven by investments in network infrastructure by carriers and service providers.  Telecommunications market revenues derived from our Monterey and IPnexus Application-Ready Platforms depend primarily on broad, multi-year deployments of next-generation telecommunications infrastructure.  The new norm in this OEM business is that OEM customers place orders for product only when they have orders in hand from their customers and they expect almost immediate delivery. Revenues from our OEM customers grew by 22% in the first nine months of 2011, compared to the corresponding period in 2010.   Telecommunications market revenues generated from service providers result from investments necessary to support existing and evolving service demands such as text messaging and the transition to Internet-based communications networks.  Primarily as a result of channel sales and the Globacom order, revenues from service providers grew by 44% year-over-year during the first nine months of 2011.  Of note, during the first quarter 2011, PT received an order amounting to nearly $3 million to supply SEGway Signaling solutions to be deployed in Nigeria and Ghana (Globacom).  Revenues totaling $.9 million from this order were recognized in the third quarter 2011 and the remainder of this order is expected to be recognized upon completion of installation and acceptance during the fourth quarter 2011 and first quarter 2012.  The economy appears to be recovering unevenly around the world and current business conditions continue to remain quite challenging in the telecommunications equipment market.

 

Sales into the military, aerospace and government systems market are typically to prime contractors and system integrators that reflect investment levels by various government agencies and military branches in specific programs and projects requiring enhanced communications capabilities.  The timing of government-funded network infrastructure and military related expenditures remains for the most part unpredictable. See Part II, Item 1A for additional information about this risk factor.  Sales into the military, aerospace and government systems market during the first nine months of 2011 grew significantly primarily due to a shipment to the FAA amounting to $1.6 million during the first quarter 2011 and shipments throughout the year to Rockwell-Collins and Nologin Consulting S.L., our new European distributor. Our sales efforts for our Xpress product line have generated interest from both telecommunications and government customers but meaningful orders have yet to occur. 

 

During the first nine months 2011, the challenging economic climate continued to cause customers to limit and/or delay investments in their network infrastructure.  However, PT is gaining market traction despite this climate.  Sales to customers amounted to $9.0 million in the third quarter 2011, compared to $6.3 million in the third quarter 2010.  For the nine months ended September 30, 2011, revenue increased to $27.1 million, from $21.1 million during the corresponding period in 2010.  During weak economic periods, customers’ ability to forecast their requirements deteriorates causing delays in the placement of orders.   Forward-looking visibility on customer orders continues to be at low levels. 

 

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.

 

-22-

 

 

 

Results of Operations

Three and Nine Months Ended September 30, 2011, Compared with the

Three and Nine Months Ended September 30, 2010

 

The following table presents the percentage of sales represented by each item in the Company’s consolidated statements of operations for the periods indicated:  

 

  Three Months Ended  Nine Months Ended
  September 30, September 30,
  2011 2010 2011 2010
Sales  100.0 100.0 100.0 100.0
Cost of goods sold  49.5   60.3   53.2   54.1  
Gross profit  50.5   39.7   46.8   45.9  
 
Operating expenses:                 
     Selling and marketing  17.6   31.3   18.3   30.3  
     Research and development  17.7   29.0   19.7   27.0  
     General and administrative  10.9   26.3   13.3   20.5  
     Impairment charge - vendor software 4.4 1.4
     Restructuring charges  .8    1.1   .9   .9 
           Total operating expenses  51.4   87.7   53.6   78.7  
Loss from operations  (.9 (48.0 (6.8 (32.8
 
Other income, net  (.1 )  1.0   .3 .8  
Loss before income taxes  (1.0 (47.0 (6.5 (32.0 )
Income tax (benefit) provision      (.5 (.5 .1  
            Net loss  (1.0 )%  (46.5 )% (6.0 )%  (32.1 )% 

 

Sales.  Total revenue for the third quarter 2011 amounted to $9.0 million, compared to $6.3 million for the corresponding quarter in 2010.  The sales increase in the third quarter is primarily attributable to sales through the Company’s new alliance with GENBAND, sales through two European distributors, Kapsch CarrierCom AG and Nologin Consulting S.L., revenue from Globacom (Ghana, Africa), and sales to Rockwell-Collins,  offset by the non-recurrence of the shipment to Starcomm PLC in the third quarter of 2010.   During the third quarter 2011 and 2010, one customer, Metaswitch Networks, accounted for 14% and 22% of sales, respectively.  In the third quarter 2011, two additional customers accounted for 14% and 10% of sales, respectively, while PT’s four largest customers represented 47% of sales, compared to 40% of sales in the third quarter 2010.  The Company’s four largest customers comprised 43% and 41% of sales in the nine months ended September 30, 2011 and 2010, respectively.

 

Shipments to customers outside of the United States represented 53% and 67% of PT’s sales during the third quarter of 2011 and 2010, respectively.  Shipments to customers outside of the United States represented 48% and 61% of the Company’s sales for the nine months ended September 30, 2011 and 2010, respectively.  Total shipments to customers in the United Kingdom represented 15% of sales in the third quarter 2011, compared to 22% of sales in the third quarter 2010.  One U.K. customer, Metaswitch Networks, represented 14% and 22% of sales in the third quarter 2011 and 2010, respectively.  Total shipments to customers in the United Kingdom represented 23% and 28% of sales in the nine months ended September 30, 2011 and 2010, respectively.

 

 

 

-23-

 

 

Management is focused on selling PT’s products into two primary vertical markets within one segment - Communications.  Revenue from each vertical market is expressed as a percentage of sales for the periods indicated:

 

  Three Months Ended Nine Months Ended
  September 30, September 30,
  2011 2010 2011 2010
Telecommunications  77 79 74 80
Military, aerospace and government systems 23 21 26 20
  100 100 100 100

Telecommunications market:

 

Revenue from the telecommunications market amounted to $6.9 million and $4.9 million in the third quarters of 2011 and 2010, respectively.  This increase was due to sales through PT’s new alliance with GENBAND, revenue from Globacom (Ghana, Africa), and sales through Kapsch, a new distributor in Europe, offset by the non-recurrence of the shipment to Starcomm PLC in the third quarter of 2010
 
Revenue from the telecommunications market amounted to $20.1 million and $16.9 million for the nine months ended September 30, 2011 and 2010, respectively.  This increase of $3.2 million, or 19%, was due to a $.6 million increase in shipments to Metaswitch Networks, sales through GENBAND and Kapsch, and revenue from Globacom.

 

Military, Aerospace and Government Systems market:

 

Our government systems group continues to work with numerous prime contractors including Raytheon, Lockheed Martin, EADS, Rockwell-Collins and General Dynamics to incorporate PT’s COTS-based, Application-Ready Platforms into specific programs and projects requiring enhanced communications capabilities.  Our recently introduced Xpress product line is generating interest from our government systems customers and based on such interest, we presently expect to begin our first Xpress product engagement for a government customer during the fourth quarter 2011 or first quarter next year.   

Military, aerospace and government systems products revenue amounted to $2.1 million and $1.3 million in the third quarter 2011 and 2010, respectively. This increase of $.8 million, or 62%, was primarily attributable to increased shipments to Rockwell-Collins, Aeroflex and a European distributor, Nologin.

Military, aerospace and government systems products revenue amounted to $7.1 million and $4.2 million in the nine months ended September 30, 2011 and 2010, respectively. This increase of $2.9 million, or 69%, was primarily attributable to a $.6 million increase in shipments to the U.S. Government FAA (through Raytheon in 2010) plus increases in shipments to Rockwell-Collins, Aeroflex, and Nologin, offset partially by the non-recurrence of the 2010 sales to EADS.

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 profit and gross margin percentage amounted to $4.5 million and 50.5% of sales in the third quarter 2011, compared to $2.5 million and 39.7% of sales for the third quarter 2010.  The increase in gross profit was primarily attributable to the higher sales volume and improved sales mix (due primarily to an increase in sales of higher-margin signaling products), partially offset by a $.2 increase in amortization of software and purchased developed technology.

 

Gross profit and gross margin amounted to $12.7 million and 46.8% of sales for the nine months ended September 30, 2011, compared to $9.7 million and 45.9% of sales in the comparable 2010 period.  The increase in gross margin percentage primarily reflects the higher sales volumes and slightly more favorable sales mix, partially offset by a $.8 million increase in amortization of capitalized software and purchased developed technology. In addition, the continued contraction of the Company's manufacturing organization following the transition to an outside contract manufacturer of printed circuit board assemblies contributed to the improved gross margin.

 

-24-

 

 

Total Operating Expenses.  Total operating expenses amounted to $4.6 million and $5.5 million in the third quarter 2011 and 2010, respectively.  Total operating expenses amounted to $14.6 million and $16.6 million in the nine months ended September 30, 2011 and 2010, respectively.

 

Selling and marketing expenses were $1.6 million and $2.0 million for the third quarter 2011 and 2010, respectively.  For the nine months ended September 30, 2011 and 2010, selling and marketing expenses were $5.0 million and $6.4 million, respectively.  The decreases in 2011 over the comparable 2010 periods primarily relate to a reduction in sales and marketing staff (partially as a result of the December 2010 restructuring action) and planned lower trade show expenditures offset by higher commissions associated with the increased sales.

  

Research and development expenses were $1.6 million and $1.8 million in the third quarter 2011 and 2010, respectively.  The Company capitalizes 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 third quarter 2011 and 2010, respectively.  Research and development expenses were $5.3 million and $5.7 million for the nine months ended September 30, 2011 and 2010, respectively.  Amounts capitalized to software development costs amounted to $1.7 million and $1.9 million in the nine months ended September 30, 2011 and 2010, respectively.  The decreases in research and development expenses in 2011 over the comparable 2010 periods are primarily the result of a net decrease in the number of engineers in research and development due to the Company’s restructuring actions, partially offset by the addition of software engineers to support the Company’s new sales alliance with GENBAND.

 

General and administrative expenses were $1.0 million and $1.7 million in the third quarter 2011 and 2010, respectively.  General and administrative expenses were $3.6 million and $4.3 million in the nine months ended September 30, 2011 and 2010, respectively.  The third quarter 2011 decrease was the result of a reduction in litigation-related legal expenses associated with the Tekelec matter, lower stock compensation costs, and a reduction in administrative headcount.  In May 2011, PT and Tekelec agreed to voluntarily dismiss all of their claims and defenses against each other, without prejudice.    

 

In the third quarter 2011, PT recorded a $.4 million charge to impair certain assets in conjunction with the Company’s termination of a value-added resellers agreement with a vendor.

 

Restructuring expenses were $.07 million in the third quarter of both 2011 and 2010, and $.3 million and $.2 million in the nine months ended September 30, 2011 and 2010, respectively.  In December 2010, the Company announced an expense reduction action which was completed in the third quarter 2011.  The program included the elimination of 21 positions, which represented 12% of the Company’s workforce.  In connection with this action, the Company’s San Luis Obispo, California engineering center was closed with those hardware engineering functions being assumed by the Company’s engineering staff in Rochester.  Restructuring charges associated with this action totaled $.9 million in the fourth quarter 2010 and $.3 million in the first three quarters of 2011.  Most of the charges resulting from this action are employee severance and related costs and nearly all have been incurred as cash expenditures.  No cash was expended in connection with this action in 2010, while $1.1 million was expended during the nine months ended September 30, 2011.

 

Other Income (expense), net. Other income consists primarily of interest income, and is presented net of other expense.  During the third quarter 2011, PT’s funds were invested in high-quality corporate bonds, certificates of deposit and money market funds.  Other expense for the third quarter 2011 consisted of a realized loss on the maturity of an investment security and foreign currency transaction losses, which exceeded the amount of other income in the quarter.

 

 

-25-

 

 

Income taxes. The Company’s effective income tax rate for the third quarter 2011 differs from the statutory rate primarily due to a full valuation allowance provided against its U.S. deferred tax assets, the taxes on foreign income that differ from the U.S. tax rate, and permanent tax differences including Canadian research activities, and tax-exempt interest.     

 

PT’s income tax benefit for the third quarter 2011 amounted to $.002 million, compared to a benefit of $.03 million for the third quarter 2010.  The Company recorded an income tax benefit of $.1 million and a provision of $.02 million for the nine months ended September 30, 2011 and 2010, respectively.  For the third quarter 2011, PT’s annual estimated effective income tax rate is 7%, and reflects refundable credits the Company expects to receive relating to its Canadian research operations.  A discrete income tax provision of $.1 million was recorded in the nine months ended September 30, 2010 due to the income tax benefit which resulted from the decrease in unrealized gain on foreign currency hedge contracts.

 

Liquidity and Capital Resources

 

The Company had working capital of $18.3 million and $23.2 million at September 30, 2011 and December 31, 2010, respectively.  PT’s primary sources of liquidity are cash, cash equivalents and long-term investments, which totaled $12.4 million at September 30, 2011 and $19.2 million at December 31, 2010. 

 

For the nine months ended September 30, 2011, cash used by operating activities amounted to $.5 million.  This amount reflects the net loss of ($1.6 million) offset by non-cash items including depreciation and amortization charges of $2.8 million, the impairment charge – vendor software of $.4 million and stock-based compensation expense of $.2 million.  Cash used in operations due to changes in operating assets and liabilities included a decrease in cash associated with a $2.5 million increase in accounts receivable and a $2.6 million decrease in accounts payable and accrued expenses, partially offset by a $1.8 million decrease in inventories and a $1.4 million increase in deferred revenues.  The decrease in inventories was a result of PT’s decision to hold the level of inventory purchasing below the level of inventory usage in second and third quartersThe increase in deferred revenue resulted from significant deposits received in 2011 for sales not yet recognized in revenue, and the decrease in accounts payable resulted from lower production activity at the Company’s printed circuit board manufacturer at the end of the third quarter 2011.  The increase in accounts receivable resulted from a significant increase in sales in the final month of the third quarter 2011, compared to the final month of 2010.

  

Cash used by investing activities during the nine months ended September 30, 2011 totaled $2.9 million, including the purchase of assets from GENBAND which amounted to $4.4 million (including acquisition-related costs of $.4 million), capitalized software development costs amounting to $1.7 million and capital expenditures of $.2 million, offset by net proceeds from the sale and maturities of investments of $3.4 million.

 

Off-Balance Sheet Arrangements:

 

The Company did not enter into any off-balance sheet arrangements during the third quarter 2011.  

 

Contractual Obligations:

 

The Company did not enter into any other significant contractual obligations during the third quarter 2011.

Current Position:

 

Assuming there is no significant change in the business, 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.  It is likely that if the world’s economy falls into another recession, PT’s current cash position will be impacted.  As noted in Note D to the interim financial statements, PT’s investments are classified as available-for-sale and could be liquidated in order to meet short-term cash flow requirements.

 

-26-

 

The lease for PT’s Rochester, New York headquarters building expires in April 2012.  PT is actively investigating alternatives in an effort to secure space more appropriate to the Company’s size and which will accommodate the Company’s current and projected needs.
 

As previously reported, in December 2009, Tekelec commenced litigation against PT in the U.S. District Court for the Eastern District of North Carolina alleging that certain of PT's signaling products infringed certain of Tekelec's issued patents.  In May 2011, PT and Tekelec agreed to voluntarily dismiss all of their claims and defenses against each other, without prejudice.  By Stipulation dated May 4, 2011, the litigation has now been dismissed without prejudice.

 

Recent Accounting Pronouncements

 

In October 2009, the FASB issued authoritative guidance on revenue recognition that became effective for the Company on January 1, 2011. Under this new guidance on arrangements that include software elements, tangible products that have software components (referred to as “software-enabled devices”) that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition.

 

The adoption of the new, non-software revenue recognition guidance did not have a material impact on the timing, pattern, or amount of revenue recognized in 2011.  Based on currently available information, we anticipate that the impact of adopting this guidance on revenue recognition in future periods will not be material.  However, this assessment may change because such impacts depend on terms and conditions of arrangements in effect in those future periods.

 

In June 2011, the FASB issued authoritative guidance on the presentation of comprehensive income that eliminates the option to present the components of other comprehensive income as part of the statement of equity and requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  This guidance is effective retrospectively for fiscal years (and interim periods within those years) beginning after December 15, 2011 (an effective date of January 1, 2012 for the Company).  The guidance requires changes in presentation only and will have no significant impact on the Company's consolidated financial statements.

 

In May 2011, the FASB issued authoritative guidance that amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization.  This guidance is effective prospectively for interim and annual periods beginning after December 15, 2011 (an effective date of January 1, 2012 for the Company).  The Company does not expect that the adoption of this guidance will have a significant impact on its consolidated financial statements.

 

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

 

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 management of Performance Technologies, Incorporated and its subsidiaries (collectively “PT”) 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. 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 of December 31, 2010, as contained in the Company's Annual Report on Form 10-K, and other documents filed with the Securities and Exchange Commission.

 

-27-

 

 

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, 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, 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.

 

 

ITEM 3.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company is exposed to various market risks in the normal course of business, primarily interest rate risk and changes in the market value of investments and management believes PT’s exposure to such risk is minimal.  PT’s investments are made in accordance with PT’s investment policy and primarily consist of money market funds, highly-rated corporate and quasi-government bonds, certificates of deposit and bank guaranteed contracts.  The Company is also subject to foreign currency exchange risks related to its operations in Kanata, Ontario, Canada, and in the United Kingdom. The Company believes that its balance sheet exposure to foreign currency exchange risks is minimal, as generally all revenues and accounts receivable are denominated in U.S. dollars.  However, PT’s expenses at these locations are denominated in the local currency and PT’s results of operations are influenced by changes in the exchange rates between the United States and Canada and the United Kingdom.  The Canadian dollar and British Pound continued to strengthen against the U.S. dollar during the first nine months of 2011, resulting in higher levels of expense denominated in U.S. dollars.  The Company has entered into forward hedge contracts to lock in a spot rate of approximately .98 for the first $200,000 (CDN) of monthly Canadian expenses incurred during the remainder of 2011 and the first half of 2012 (see Note J to the condensed consolidated financial statements).

 

 

 

 

 

 

 

 

 

 

 

-28-

 

ITEM 4.        CONTROLS AND PROCEDURES

 

A.    Evaluation of Disclosure Controls and Procedures

 

PT’s Chief Executive Officer and its Chief Financial Officer have evaluated PT’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that PT’s disclosure controls and procedures were effective as of such date.

 

B.    Changes in Internal Control Over Financial Reporting

 

There has been no change in PT’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, PT’s internal controls over financial reporting.

 

 

PART II. OTHER INFORMATION

 

ITEM 1.         LEGAL PROCEEDINGS

                         

In December 2009, the Company became aware that Tekelec, a California corporation headquartered in Morrisville, North Carolina, had filed but not served a complaint against the Company in the U.S. District Court for the Eastern District of North Carolina.  The complaint alleged that certain of the Company’s signaling systems products infringe three of Tekelec’s issued patents and sought a determination of infringement, a preliminary and permanent injunction from further infringement and an unspecified amount of damages.  On March 4, 2010, an amended complaint was served on the Company through its designated agent in North Carolina.  The amended complaint contained the same allegations as the original complaint but added two patents to the number of patents which Tekelec alleged the Company’s signaling systems products infringe.  Subsequently, the complaint was further amended to add a sixth patent which Tekelec alleged the Company’s signaling systems product infringe. 

 

In May 2011, PT and Tekelec agreed to voluntarily dismiss all of their claims and defenses against each other, without prejudice.  By Stipulation dated May 4, 2011, the litigation has now been dismissed without prejudice.

 

The Company is subject to various other legal proceedings and claims that arise in the ordinary course of business. 

 

ITEM 1A      RISK FACTOR

 

The Company discloses in its Annual Report on Form 10-K those risk factors which we believe to be significant to our business, and we are required to update and modify those risk factors and disclose new risk factors in our quarterly filings on Form 10-Q as events and circumstances may indicate the need to do so.  In light of ongoing budgetary, credit and political conditions pertaining to the United States Federal Government and other foreign governments, the following risk factor should be considered:

 

Our revenue includes sales to federal and foreign government entities, generally under subcontracts with prime contractors.  A loss of such contracts or an interruption in government funding for such contracts, could have a material adverse effect on our business.

 

 

-29-

 

 

We derived approximately 16% and 23% of our revenue for the three and nine months ended September 30, 2011 from contracts with agencies of the United States Federal Government or subcontracts with prime contractors or subcontractors of the Federal Government, or contracts with foreign governments.  The loss or significant curtailment of any of these government contracts or subcontracts, whether due to PT’s performance or due to interruptions of or changes in governmental funding for such contracts or subcontracts, could have a material adverse effect on our business, results of operations and financial condition. Among the factors that could impact federal government spending and which would reduce our federal government contracting and subcontracting business are: a significant decline in, or reapportioning of, spending by the Federal Government; changes, delays or cancellations of Federal Government programs or requirements; the adoption of new laws or regulations that affect companies that provide services to the Federal Government; Federal Government shutdowns or other delays in the government appropriations process; changes in the political climate, including with regard to the funding of the products we provide; and general economic conditions.

 

ITEM 6.        EXHIBITS

 

31.1                  Certification of Chief Executive Officer

 

31.2                  Certification of Chief Financial Officer

 

32.1                  Section 1350 Certification

 

100.INS*           XBRL Taxonomy Instance Document

 

100.PRE*          XBRL Taxonomy Extension Presentation Linkbase

 

100.SCH*          XBRL Taxonomy Schema Linkbase

 

100.LAB*          XBRL Taxonomy Label Linkbase

 

 

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement of prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-30-

 

 

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

                                                                                                             

 

November 10, 2011                                                        By: /s/  John M. Slusser        

                                                                                         John M. Slusser

                                                                                         President and

                                                                                         Chief Executive Officer

 

 

November 10, 2011                                                        By: /s/  Dorrance W. Lamb   

                                                                                         Dorrance W. Lamb

                                                                                         Senior Vice President and Chief Financial Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-31-

 

 

Exhibit 31.1

 

Certification of Chief Executive Officer

 

I, John M. Slusser, 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: November 10, 2011                                                                        By:/s/   John M. Slusser   

                                                                                                                   John M. Slusser

                                                                                                                   Chief Executive Officer

 

 

 

 

 

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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: November 10, 2011                                                                        By:/s/  Dorrance W. Lamb  

                                                                                                                   Dorrance W. Lamb

                                                                                                                   Chief Financial Officer

 

 

 

 

 

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                                                                                                            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”), John M. Slusser 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 September 30, 2011 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:  November 10, 2011                                                           By:/s/   John M. Slusser            

                                                                                                       John M. Slusser

                                                                                                       President and Chief Executive Officer

 

Date:  November 10, 2011                                                           By:/s/   Dorrance W. Lamb        

                                                                                                       Dorrance W. Lamb

                                                                                                       Senior Vice President and Chief Financial Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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