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| PIII > SEC Filings for PIII > Form 10-Q on 14-Nov-2008 | All Recent SEC Filings |
14-Nov-2008
Quarterly Report
References to "we," "us," "our," "the Company," or "PECO II" refer to PECO II, Inc. unless the context indicates otherwise.
Overview
PECO II, Inc. was organized in 1988 for the purpose of acquiring the assets of ITT's communications power product business. Today, we provide solutions to our telecommunications customers through a variety of products and services in order to meet their cost, quality, productivity and capacity challenges. As part of this process, we design and manufacture communications specific power products. We also provide on-site E&I, systems integration, installation, maintenance, and monitor service to our customers. Our power systems provide a primary supply of power to support the infrastructure of communications service providers, including local exchange carriers, long distance carriers, wireless service providers, internet service providers and broadband access providers. Our power distribution equipment directs this power to specific customer communications equipment. Our systems integration business provides complete built-to-order communications systems assembled and installed pursuant to customer specifications and incorporating other manufacturers' products.
Market conditions remain uncertain and difficult. In the recent past, several of our customers have engaged in mergers, acquisitions and divestitures, such as SBC acquiring AT&T, AT&T acquiring Bell South and Cingular, Alltel acquiring Western Wireless, and Sprint acquiring NEXTEL. Also, both Sprint Nextel and Alltel spun off their local wireline businesses to focus on their core wireless businesses. Recently Verizon has announced its intention to purchase Alltel, AT&T has announced its intention to acquire Centennial, and CenturyTel is planning to merge with Embarq. Currently, major wireline companies are focusing their capital expenditure spending on FTTC (fiber to the curb) and FTTN (fiber to the node) for both broadband and video services distribution, while wireless companies are focusing their capital expenditure spending on migration of acquired systems to the standards of the acquiring carrier, integrating networks, improving area coverage, deploying 3G data services and have begun to announce plans to deploy WIMAX and LTE networks.
While the telecommunications market is extremely volatile, capital expenditure spending expanded by the mid single digits in 2007 and analysts have projected further growth in 2008. The current economic environment is causing many companies to forecast a downturn in spending in the near future. Notwithstanding this possible slowdown, we believe that our capabilities combined with our market position will afford us the opportunity to take market share even in a slowing economy.
In 2008, we are targeting the capital expenditure growth in the wireless market. We have successfully ramped the midsized power products, which serve the wireless base station market, including both cabinet and hut applications. The midsized product platforms are standardized at 3 wireless operators.
The acquisition of Delta Products' U.S. and Canadian Telecom Power business in 2006 added more cell site power solutions to our portfolio. The HDS3000 product provides customers with either +24V or -48V operation using a horizontal distribution architecture. Customer preferences for distribution architecture vary by region, so the HDS3000 offers a true complement to the vertical style used by PECO II plants.
Our R&D investment extends beyond traditional cell site applications. In 2007, the Company modified its 827E inverter system to address a specific application at a major wireline carrier and 2008 year-to-date revenues for this product have increased 26%. In June, we introduced our new small power platform at the NXTcomm08 trade show in Las Vegas. The Quantum™ Power System positions us as a player in the shelf power market segment and the fast growing outside plant broadband market. According to industry analyst Skyline Marketing, the size of this power market segment in the United States is estimated to be $269 million in 2008, reaching $450 million by 2011.
The Quantum platform is a 48-volt DC power system that combines high-density rectifiers, distribution and control in a sleek, low-profile shelf for optimized value to telecom carriers deploying fiber-to-the-node and traditional wireline architectures. Designed for the harsh outside plant environment, the Quantum system's small footprint makes it ideal for cabinets where rack space is at a premium.
The Quantum Power System has several distinctive features that optimize the user experience. Our innovative QuickLoad™ feature enables the technician to rapidly configure the system. The system controller features a technician-friendly input control device and a display that can easily be read in difficult outdoor conditions. The rectifiers include our unique I-View™ faceplate indicators that report rectifier current and load-sharing status.
During the third quarter, we continued to develop features for the Quantum Power System. New developments included additional distribution options and configurations that enabled the product to be deployed in more diverse applications. First orders and subsequent installations for the Quantum Power System were received from a major wireline carrier. The Quantum system will be deployed in two applications to power different network elements. Additionally, systems were quoted to 10 other customers during the third quarter. Lastly, we augmented our field sales team by adding a seasoned veteran in the Tier 2 and nontraditional service provider markets resulting in a marked increase in quoting opportunities over the last four weeks of the third quarter with the trend continuing into the first half of the fourth quarter.
We also introduced the high-capacity 5069HC BDFB (battery distribution fuse bay) in September 2008. The 5069HC is a modular power distribution solution offering 66 percent improvement in current capacity. The 5069HC features an industry-leading 1000 Amps per panel, enabling telecom power engineers to significantly lower the cost of powering and cabling new high-power network elements such as routers, optical equipment and broadband delivery systems. The 5069HC also achieved NEBS certification during the quarter.
During the third quarter 2008, we achieved TL9000 recertification. The certification process included evaluation of our core business processes based on TL9000 Quality Management System Requirements Release 4.0, an upgrade over previous assessments. The TL9000 standard defines the telecommunications quality system requirements for the design development, production, delivery, installation and maintenance of products and services.
Our services group focused on hardening our solution portfolio to meet the power needs of our Tier I customer base. The revenue decline in 2008 was driven by reduced spending at two of our major customers.
Our services division continues to provide multi-vendor engineering and installation services for all major power product brands. This capability is both respected and valued in the marketplace. Our strong power E&I services reputation has provided many opportunities for introducing new power products as well as a real user feedback channel on deployed products. This feedback continues to aid us with designing and improving products to meet the industry evolving needs.
Looking forward, we will continue to focus our efforts on delivering the service solutions our customers have come to expect from working with PECO II. This dedication has enabled us to minimize customer turn-over. We will continue to expand our services footprint on those opportunities that make the best utilization of our current available resources, and/or those that position us for success as our industry matures to the next level.
Results of Operations
The third quarter financial performance reflects solid in-year revenue growth for both products and services. Revenues for the quarter were the highest quarterly revenues recorded since the third quarter of 2006. Our net sales increased to $12.0 million and $32.0 million for the three and nine months ended September 30, 2008, respectively, an increase of $1.2 million and $2.7 million, or 11.7% and 9.1%, respectively, compared to the corresponding prior year periods.
Product net sales were $8.8 million for the third quarter of 2008, an increase of $0.9 million, or 12.2%, compared to the third quarter of 2007. Product net sales were $24.6 million for the nine months ending September 30, 2008, an increase of $3.6 million, or 17.2%, compared to the corresponding period in 2007. Product market share gains were realized among both our large Tier I customers as well as our general markets customers.
Services net sales were $3.1 million for the third quarter of 2008, an increase of $0.3 million, or 10.1%, as compared to the third quarter of 2007. Services net sales were $7.4 million for the nine months ending September 30, 2008, a decrease of $0.9 million, or 11.2%, compared to the corresponding period in 2007. The decrease in sales year to date in the services segment was attributable primarily to reduced spending by two customers during the first six months of 2008. During the third quarter, spending recovered to expected levels at one of these two customers.
As of September 30, 2008, our sales backlog, which represents total dollar volume of firm sales orders not yet recognized as revenue, was $5.7 million, a $0.2 million, or 3.8%, increase from the comparable prior year period, and was a 25.1% increase of $1.1 million from December 31, 2007 and an 8.9% decrease of $0.6 million from June 30, 2008. Product backlog of $3.9 million was a $0.1 thousand, or 0.4% decrease from December 31, 2007 and was a $0.1 million, or a 3.3% decrease from June 30, 2008, while services backlog was $1.8 million, a $1.2 million, or 184%, increase from December 31, 2007 and was a $0.4 million, or a 19.2% decrease from June 30, 2008. Due to the seasonality of the telecom industry, we generally receive the greatest number of sales orders during the second quarter. Thus, backlogs at the end of the third quarter are generally expected to decrease from the backlogs at the end of the second quarter. The increase in period-over-period backlogs was primarily due to growth in the wireless midsized power portion of the product business segment. Third quarter 2008 bookings were 16.7% better than third quarter 2007.
Gross margin dollars were $1.5 million and $4.3 million, respectively, for the three and nine months ended September 30, 2008, as compared to $1.8 million and $4.5 million, respectively, for the three and nine months ended September 30, 2007. Gross margin as a percentage of net sales was 12.8% and 13.3% for the three and nine months ended September 30, 2008, compared to 17.1% and 15.2%, respectively, for the comparable prior year periods. Third quarter gross margins were negatively impacted by the write-off of inventory totaling $0.4 million. We are currently performing a detailed review of product life cycles and we anticipate that we will discontinue a number of older products in the fourth quarter of 2008. Depending on customer needs, this elimination of certain product lines could lead to an additional inventory write-off of materials that will no longer be of use. We will take these charges to operating earnings once determined and the impact could be significant.
For the quarter ended September 30, 2008, product gross margin was $1.0 million, or 10.8% of net product sales, as compared to $1.3 million, or 17.0% of net product sales for the corresponding period in 2007. The $1.0 million of product gross margin includes the inventory write-down of $0.4 million noted above. We continue to target product gross margin for improvement with the pricing actions we have taken and the rollout of our new small power product line, although any improvement may be offset by inventory obsolesence charges in the fourth quarter.
Services gross margin was $0.6 million for the third quarter of 2008, or 18.2% of net services sales, as compared to $0.5 million, or 17.7% of net services sales for the third quarter of 2007, or a services gross margin increase of 0.5%. The services gross margin increase was primarily driven by revenue growth in the quarter.
Third quarter 2008 operating expenses of $2.8 million are $0.3 million greater than third quarter of 2007 operating expenses. On a year to date basis, operating expenses include $1.0 million of costs related to the development and rollout of our new small power product platform. We expect our engineering expenses to decline somewhat in the fourth quarter of the year as we roll out our small power to market. We also anticipate that our selling expenses will increase in the fourth quarter as we invest in our go-to-market strategy for small power.
Research, development and engineering expense incurred was $0.6 million and $1.9 million respectively, for the three and nine months ended September 30, 2008, up slightly from $0.5 million and $1.8 million, respectively for the three and nine months ended September 30, 2007. As a percentage of net product sales, research, development and engineering expense was 7.0% for the quarter ended September 30, 2008, which was an increase of 0.8% from the third quarter of 2007. During the nine months ending September 30, 2008, we have spent $1.0 million in developing our new small power platforms, which is currently being introduced to the market. Our new product introduction cycles include, at times, significant out-of-pocket costs to bring new products to the market and as such, research, development and engineering expenses will likely continue to move up and down, period to period, as we introduce new products.
Selling, general and administrative expense was $2.1 million and $6.3 million for the three and nine months ended September 30, 2008, as compared to $2.0 million and $6.5 million, respectively, for the comparable prior year period. As a percentages of net sales, selling, general and administrative decreased to 17.9% for the quarter ended September 30, 2008, as compared to 18.2% in the comparable prior year period. We expect selling expenses to grow in the near term as we ramp our revenues from our new power platforms.
The third quarter 2008 net loss of $1.2 million is in line with the net loss from the second quarter of 2008 and was primarily attributed to the sequential revenue growth, offset by increased inventory obsolescence charges of $0.4 million. The increased net loss, when compared to the third quarter of 2007 loss of $0.5 million was driven primarily by reductions in product gross margins of $0.4 million that was attributable to the inventory obsolescence charge noted above.
Liquidity and Capital Resources
As of September 30, 2008, available cash and cash equivalents approximated $6.0 million. We believe that cash and cash equivalents, anticipated cash flow from operations, and our credit facilities will be sufficient to fund our working capital and capital expenditure requirements for the next 12 months. Working capital at September 30, 2008 was $13.8 million, which represented a working capital ratio of 2.7 to 1, compared to $16.5 million at December 31, 2007, which represented a working capital ratio of 3.2 to 1. Capital expenditures for the nine months ended September 30, 2008, totaled $60 thousand. We continue our efforts to conserve cash.
Cash flows used for operating activities for the nine months ended September 30, 2008, was $1.8 million. This was primarily from the net loss and increase in accounts receivable, offset by reductions in inventory and other non-cash charges. There was $138 thousand of cash used for investing activities, which was primarily from the issuance of the note receivable, offset by the sale of equipment sold as a result of outsourcing. Cash provided by financing activities was $8 thousand.
Cash flows provided by operating activities for the nine months ended September 30, 2007, was $1.4 million. This was primarily from reductions in accounts receivable and inventory offset by a net loss and decreases in accounts payable and other current liabilities. There was $624 thousand of cash provided by investing activities, which was primarily from the sale of equipment sold as a result of outsourcing. Cash provided by financing activities was $1.2 million, which included the pay off of our credit line and the transfer of our restricted cash to cash available.
Contractual Obligations
We have signed an agreement with National City Bank to provide all banking services and a $3.5 million line of credit. As collateral for the line of credit, we established a $3.5 million deposit account with the bank to cover any outstanding balance of the line of credit. As of September 30, 2008, the balance on the line of credit was $0.6 million. As such, $0.6 million of the deposit account is reflected as restricted cash.
We do not currently plan to pay dividends.
Critical Accounting Policies and Estimates
In preparing the accompanying unaudited condensed consolidated financial statements and accounting for the underlying transactions and balances, we applied the accounting policies disclosed in the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2007. For a detailed discussion of the critical accounting policies and estimates, see the Management Discussion and Analysis included in our Annual Report. There were no significant changes in these critical accounting policies and estimates in the third quarter of 2008, except for the recently adopted accounting pronouncements as discussed below.
Recently Adopted Accounting Pronouncements
Effective January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 157, Fair Value Measurements (SFAS 157). SFAS 157 applies to most current accounting pronouncements that require or permit fair value measurements. SFAS 157 provides a framework for measuring fair value and requires expanded disclosures about fair value methods and inputs by establishing a hierarchy for ranking the quality and reliability of the information used by management to measure and report amounts at fair value.
The Company has only partially applied the provisions of SFAS 157 as management has elected the deferral provisions of FASB Staff Position (FSP) SFAS 157-2 as it applies to nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The major categories of assets and liabilities that are recognized or disclosed at fair value on a nonrecurring basis include certain amounts of property and equipment and goodwill reported at fair value as a result of impairment testing, and certain other assets, liabilities and equity instruments recognized as a result of prior business combinations.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 provides guidance on various methods used to measure fair value including market, income and cost approaches. These approaches require the Company to utilize certain assumptions that market participants would use in pricing assets and liabilities, including assumptions about risk. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company attempts to utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the inputs used in the valuation techniques, SFAS 157 requires the Company to classify the inputs under a fair value hierarchy that ranks the inputs based on their quality and reliability. Financial instruments carried at fair value will be classified and disclosed in one of the following three categories:
• Level 1 - Quoted market prices in active markets for identical assets or liabilities.
• Level 2 - Observable market based inputs or unobservable inputs that are corroborated by market data.
• Level 3 - Unobservable inputs that are not corroborated by market data.
The estimated fair values of the Company's short-term financial instruments, including cash and cash equivalents, receivables and payables arising in the ordinary course of business, and current portions of debt, approximate their individual carrying amounts due to the relatively short period of time between their origination and expected realization. The Company does not have any other financial instruments measured at fair value on a recurring basis that require further disclosure.
The Company does not have any financial instruments that required a cumulative-effect adjustment to beginning accumulated deficit upon adoption. There was no material impact to the Company's consolidated financial position, results of operations, or cash flows as a result of the adoption of SFAS 157.
Effective January 1, 2008, the Company adopted FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits the Company to voluntarily choose, at specified election dates, to measure specified financial assets and liabilities and other items at fair value that are not currently required to be measured at fair value. Subsequent changes in fair value would then be required to be reported in earnings each reporting period. At the date of adoption, the Company did not elect the fair value option for eligible items that existed at January 1, 2008. Therefore, the adoption of SFAS 159 did not have any effect on the Company's consolidated financial position, results of operations, or cash flows. Any future effect will be dependent upon the nature and amount of eligible items that the Company elects to account for using the fair value option.
Forward-Looking Statements
Certain of the Company's statements in this Quarterly Report on Form 10-Q and the foregoing Management's Discussion and Analysis of Financial Condition and Results of Operation are not purely historical, and as such are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but may not be limited to, all statements regarding the Company's and management's intent, beliefs, expectations, and plans, such as statements concerning the Company's future profitability, industry trends, operating results, and product development strategy. These forward-looking statements include numerous risks and uncertainties, including, without limitation: a general economic recession; a downturn in our principal customers' businesses; current and future mergers of key customers; the volatility in the communications industry; the demand for communications equipment generally and in particular for the products and services offered by the Company; the Company's ability to generate sales orders during fiscal 2008 and thereafter; the ability to develop and market new products and product enhancements; the potential environmental issues in regards to an aging manufacturing facility; the ability to attract and retain customers; competition and technological change; and successful implementation of the Company's business strategy. One or more of these factors have affected, and in the future could affect, the Company's business and financial results in future periods and could cause actual results to differ materially from plans and projections.
There can be no assurances that the forward-looking statements included herein will prove to be accurate, and issuance of such forward-looking statements should not be regarded as a representation of the Company, or any other person, that the objectives and plans of the Company will be achieved. In addition, this Quarterly Report on Form 10-Q contains time-sensitive information that reflects management's best analysis only as of the date of this report. PECO II does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of this release. Further information concerning issues that could materially affect financial performance related to forward-looking statements can be found in the Company's periodic filings with the Securities and Exchange Commission.
Results for the interim period are not necessarily indicative of the results that may be expected for the entire year.
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