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| PIII > SEC Filings for PIII > Form 10-Q on 14-Aug-2009 | All Recent SEC Filings |
14-Aug-2009
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 completed its purchase of Alltel and Embarq has merged with Century Telecom. During the third quarter of 2009, AT&T is expected to acquire Centennial Wireless. 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, and 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 2008 and analysts have projected further growth in 2009. In the event that capital spending does not grow in 2009, we believe we are positioned to take market share based on our industry leading responsiveness capability.
In 2009, we believe the merger and acquisition activity noted above has resulted in a slowing of 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 2009 year-to-date revenues for this product have increased 40.1%. The QuantumÔ Power System, introduced to the market in 2008, 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 QuickLoadÔ 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-ViewÔ faceplate indicators that report rectifier current and load-sharing status.
In addition to introducing the Quantum system, we also completed the design of a new cabinet for powering wireless base stations. The SC1172 battery cabinet occupies the same footprint as the previous vintage, but with nearly twice the battery capacity. The improved system density lowers operating expenses for the wireless carriers by reducing the requirements for site leases at cell towers.
With the introduction of our small power products, we have an exciting opportunity to grow our business in a space in which we have not competed in to date. By leveraging our industry leading responsiveness capability with this new technology platform provides our customers with another reason to rely on PECO II for its power requirements.
Our services group focused on hardening our solution portfolio to meet the power needs of our Tier I customer base. The revenue growth in 2009 was primarily driven by a major customer contract that was awarded to us in late 2008.
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.
In the second quarter of 2009, we were awarded a nationwide maintenance contract for the DC power component of a Tier II Wireline service provider's network. Additionally, we had six new account wins, most of which are with our new small power platform. Further, we had wins at three existing accounts deploying new cabinet solutions.
Lastly, in July 2009, PECO II received USDA (United States Department of Agriculture) Rural Utilities Services (RUS) acceptance for certain models of our power products. The USDA, through the RUS process, provides programs to finance rural America's telecommunications infrastructure.
Results of Operations
Our second quarter 2009 financial performance reflects the impact of the slowing economy, offset by our improved operational performance. Our net sales decreased to $9.9 million and $17.4 million for the three and six months ended June 30, 2009, respectively, a decrease of $1.1 million and $2.7 million, or 10.2% and 13.2%, respectively, compared to the corresponding prior year periods.
Product net sales were $6.4 million for the second quarter of 2009, a decrease of $2.1 million, or 24.4%, compared to the second quarter of 2008. Product net sales were $11.9 million for the six months ending June 30, 2009, a decrease of $3.9 million, or 24.9%, compared to the corresponding period in 2008. We attributed this reduction in product revenues to the impact of both the slowing economy and merger and acquisition activity among our customers, which resulted in a slowdown in orders during 2009.
Services net sales were $3.5 million for the second quarter of 2009, an increase of $0.9 million, or 36.8%, compared to the second quarter of 2008. Services net sales were $5.5 million for the six months ending June 30, 2009, an increase of $1.3 million, or 30.0%, compared to the corresponding period in 2008. This growth was primarily attributed to a contract with a major service provider that was awarded to PECO II in the fourth quarter of 2008 for engineering and installation services.
As of June 30, 2009, our sales backlog, which represents total dollar volume of firm sales orders not yet recognized as revenue, was $7.2 million, a $1.0 million, or 15.8%, increase from the comparable prior year period, a $4.7 million, or 183.0%, increase from December 31, 2008, and a $2.2 million, or 43.1% increase, from March 31, 2009. Product backlog of $3.4 million as of June 30, 2009 represented a 15.9% decline over the $4.0 million product backlog recorded as of June 30, 2008 and was a $0.4 million, or a 13.7% increase from March 31, 2009. The services backlog was $3.8 million as of June 30, 2009, which represented a 73.8% increase over the $2.2 million services backlog recorded as of June 30, 2008 and was a $1.8 million, or a 85.8% increase from March 31, 2009. Given the telecom seasonality, the second quarter is normally our highest quarter for sales orders in a given year. We expect that to be the case this year. Second quarter 2009 bookings were 3.2% less than second quarter 2008 due to decreases in the product segment. This growth in backlog was totally attributable to our services business segment.
Gross margin dollars were $2.4 million and $3.4 million, respectively, for the three and six months ended June 30, 2009, as compared to $1.8 million and $3.3 million, respectively, for the three and six months ended June 30, 2008. Gross margin as a percentage of net sales was 24.0% and 19.7% for the three and six months ended June 30, 2009, compared to 16.3% for both of the comparable prior year periods. This improvement was primarily driven by increased services margins of $0.5 million with growth in the engineering and installation business volume related to the contract award noted above.
For the quarter ended June 30, 2009, product gross margin was $1.5 million, or 22.7% of net product sales, as compared to $1.3 million, or 15.7% of net product sales for the corresponding period in 2008, notwithstanding the revenue decline of $2.1 million. The product margin improvement was primarily attributable to a number of price increases and product enhancements that have been implemented which have resulted in a reduction in product support costs and reduced obsolescence charges combined with a favorable sales volume mix.
The services gross margin was $925 thousand for the second quarter of 2009, or 26.5% of net services sales, as compared to $468 thousand, or 18.3% of net services sales for the second quarter of 2008, or a services gross margin increase of 8.2%. The services gross margin improvement was driven by the increased volume of engineering and installation business combined with the successful completion of a number of projects significantly ahead of budget. We do not expect to maintain the 26.5% gross margin level moving forward.
Second quarter 2009 operating expenses of $2.6 million remained flat when compared to the first quarter of 2009 and are $0.5 million less than of the second quarter of 2008. The reduced level of operating expenses versus 2008 was directly attributable to cost reduction actions implemented to address the current economic climate.
Research, development and engineering expense incurred was $413 thousand and $934 thousand respectively, for the three and six months ended June 30, 2009, down from $666 thousand and $1.3 million, respectively for the three and six months ended June 30, 2008. As a percentage of net product sales, research, development and engineering expense was 6.4% for the quarter ended June 30, 2009, which was a decrease of 1.4% from the second quarter of 2008. With the enhancements that have been implemented in our product portfolio over the past two years, current level of expenditures are believed to be adequate to fund the ongoing product development work that is required to respond to our customer requirements.
Selling, general and administrative expense was $1.8 million and $3.6 million for the three and six months ended June 30, 2009, as compared to $2.0 million and $3.9 million respectively, for the comparable prior year period. As a percentage of net sales, selling, general and administrative increased slightly to 18.5% for the quarter ended June 30, 2009, compared to 18.4% in the comparable prior year period. As a percentage of net sales, we expect selling general and administrative expenses to decline in the near term as we grow services business segment revenues.
Net loss was $0.2 million and $1.9 million for the three and six months ended June 30, 2009, as compared to $1.2 million and $2.6 million, respectively, for the comparable prior year period. The $1.0 million reduction in net loss compared to the second quarter of 2008 was driven primarily by improved services gross margins of $0.5 million resulting from strong revenue growth, attributed to a significant service provider contract that was awarded to PECO II in the fourth quarter of 2008, combined with a $0.4 million reduction in operating expenses noted above.
Liquidity and Capital Resources
As of June 30, 2009, available cash and cash equivalents approximated $5.0 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 June 30, 2009 was $11.3 million, which represented a working capital ratio of 2.3 to 1, compared to $12.4 million at December 31, 2008, which represented a working capital ratio of 2.5 to 1. Capital expenditures for the six months ended June 30, 2009, totaled $119 thousand. We continue our efforts to conserve cash.
Cash flows provided by operating activities for the six months ended June 30, 2009, was $287 thousand. While this included a net loss, it was offset by non-cash charges and reductions in working capital. There was $98 thousand of cash used for investing activities which was primarily from capital expenditures offset by the sale of equipment sold as a result of outsourcing. Cash used for financing activities was $993 thousand from the net decrease in bank overdraft.
Cash flows used for operating activities for the six months ended June 30, 2008, was $82 thousand. This was primarily from the net loss, offset by reductions in working capital and other non-cash charges. There was $175 thousand of cash used for investing activities which was primarily from the issuance of a note, offset by the sale of equipment sold as a result of outsourcing. Cash provided by financing activities was $8 thousand.
Contractual Obligations
We have 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, the Company maintains a deposit account with the bank. As of June 30, 2009, the balance on the line of credit was $0.9 million. As such, $0.9 million of the deposit account is reflected as restricted cash.
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, 2008. 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 second quarter of 2009, except for the recently adopted accounting pronouncements as discussed below.
Recently Adopted and Issued Accounting Pronouncements
As permitted, management elected to defer adoption of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, until 2009 for nonfinancial assets and liabilities measured at fair value on a nonrecurring basis. Accordingly, beginning January 1, 2009, management will apply the provisions of SFAS 157 to nonfinancial assets and liabilities as the nonrecurring fair value measurements are required. During 2009, there have been no fair value measurements on a nonrecurring basis of the Company's nonfinancial assets and liabilities that require further consideration or disclosure.
Effective January 1, 2009, we adopted SFAS 141(R), Business Combinations, and SFAS 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements. These new standards significantly change the financial accounting and reporting of business combination transactions and noncontrolling (or minority) interests in consolidated financial statements. We have not entered into any business combination transactions during 2009; and therefore, the effect of implementing these standards will be dependent upon the nature and extent of future business combination transactions.
Effective January 1, 2009, we adopted the Financial Accounting Standards Board's Staff Position on EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities ("FSP EITF 03-6-1"). Under the guidance of FSP EITF 03-6-1, unvested share-based awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share pursuant to the two-class method described in SFAS 128, Earnings per Share. Before adoption, the Company already treated unvested share-based awards granted in share-based payment transactions as participating securities. As such, the adoption of FSP EITF 03-6-1 did not have any effect on the computation of earnings per share.
Effective for the quarterly period ended June 30, 2009, we adopted SFAS 165, Subsequent Events. The new standard provides guidance for the accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. It also requires us to disclose the date through which subsequent events were evaluated and whether that date represents the date the financial statements were issued or were available to be issued. The adoption of this standard did not have a material effect on our consolidated results of operations, financial position, or cash flows.
Effective for the quarterly period ended June 30, 2009, we adopted the FASB's Staff Position on FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. The FSP amends SFAS 107 and APB 28 to require disclosures about the fair value of financial instruments for interim reporting periods in addition to annual financial statements. The adoption of this standard does not have a material effect on our consolidated results of operations, financial position, or cash flows.
In June 2009, the FASB issued SFAS 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. The FASB Accounting Standards Codification (the Codification) will become the single source of authoritative U.S. generally accepted accounting principles (GAAP) to be applied by nongovernmental entities. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification is considered non-authoritative. The Codification will be effective for our quarterly reporting period ended September 30, 2009 and will not have a material effect on our consolidated results of operations, financial position, or cash flows.
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 2009 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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