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| PTSC.OB > SEC Filings for PTSC.OB > Form 10-Q on 9-Oct-2009 | All Recent SEC Filings |
9-Oct-2009
Quarterly Report
THE FOLLOWING DISCUSSION AND THE REST OF THIS REPORT ON FORM 10-Q INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS". SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2009.
Overview
In June 2005, we entered into a series of agreements with Technology Properties Limited ("TPL") and others to facilitate the pursuit of unlicensed users of our intellectual property. We intend to continue our joint venture with TPL to pursue license agreements with unlicensed users of our technology. We believe that utilizing the option of working through TPL, as compared to creating and using our own licensing team for those activities, avoids a competitive devaluation of our principal assets and is a prudent way to achieve the desired results as we seek to obtain fair value from users of our intellectual property.
With the proceeds generated by these licensing efforts, we are undertaking to make investments in technologies, and acquisitions of companies operating in the electronics technology market sector which may include i) selective expansion of our intellectual property portfolio, ii) pursuit of strategic minority investments in certain early-stage revenue or technology ventures that represent a technology or capability of interest to us, and iii) acquiring entire companies.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods. We believe the following critical accounting policies affect our most significant estimates and judgments used in the preparation of our consolidated financial statements.
1. Revenue Recognition
Historically we recognized revenue from the sale of our microprocessor chips upon shipment to the customer, at which time title transferred and we had no further obligations. We discontinued the sale of our microprocessor chips during the first fiscal quarter of 2009. Revenue from technology license agreements is recognized at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), and the customer is provided with the licensed technology, if applicable. Fees for maintenance or support are recorded on a straight-line basis over the underlying period of performance.
Our wholly-owned subsidiary Partiot Data Solutions Group, Inc. ("PDSG") sells software and services to end users primarily through relationships with systems integrators and prime contractors. PDSG recognizes revenue in accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, and all related amendments and interpretations. PDSG's revenue is derived primarily from the following sources: (i) software licensing, (ii) related professional services, and (iii) post contract customer support ("PCS") agreements. PCS agreements typically include software updates, on a when and if available basis, and telephone and Internet access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenue for support services is recognized on a straight-line basis over the support period.
When a sale involves multiple elements, PDSG allocates the entire fee from the arrangement to each respective element based on its Vendor Specific Objective Evidence ("VSOE") of fair value and recognizes revenue when each element's revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately. PDSG has not yet demonstrated VSOE for the professional services that are rendered in conjunction with its software license sales. Accordingly, we have combined their presentation on our consolidated statements of operations under the caption "License and service revenue."
The majority of PDSG's contracts with customers, including systems integrators and prime contractors, are multiple element arrangements which contain professional services that are considered essential to the functionality of the other elements of the arrangement. PDSG accounts for revenue on these arrangements according to the provisions of SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Under SOP 81-1, PDSG recognizes revenue based on progress towards contract completion measured by actual hours incurred in relation to the estimate of total expected hours. PDSG measures SOP 81-1 revenues by applying the contract-specific estimated percentage of completion to the total contract amount for software and professional services. PDSG routinely updates the estimates of future hours for agreements in process and reports any cumulative effects of such adjustments in current operations. PDSG immediately recognizes any loss expected on these contracts when it is projected that a loss is probable.
In certain situations where PDSG's customer contracts contain acceptance criteria or other conditions that are deemed adverse to the probability of collection, revenues recognized are limited to the amount of cash already collected.
Prior to its deconsolidation, Holocom, Inc. ("Holocom") recognized revenue upon shipment of its product or upon receipt of its product by the customer when shipped FOB destination and recognized revenue on its short-term installation contracts as time and materials costs were incurred.
2. Assessment of Contingent Liabilities
We are involved in various legal matters, disputes, and patent infringement claims which arise in the ordinary course of our business. We accrue for any estimated losses at the time when we can make a reliable estimate of such loss and it is probable that it has been incurred. By their very nature, contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the basis on which we have recorded our estimated exposure is appropriate.
3. Stock Options and Warrants
On June 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-Based Payment, which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period.
Stock-based compensation expense recognized during the period is based on the
grant date fair value of the portion of share-based payment awards ultimately
expected to vest during the period in accordance with the provisions of SFAS No.
123(R). As stock-based compensation expense recognized in the consolidated
statements of operations is based on awards ultimately expected to vest, it has
been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to
be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates. The estimated average
forfeiture rate for the three months ended August 31, 2009 and 2008 of
approximately 5% was based on historical forfeiture experience and estimated
future employee forfeitures. The estimated term of option grants for the
three months ended August 31, 2009 and 2008 was five years.
4. Income Taxes
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that a substantial majority of the deferred tax assets recorded on our balance sheet will ultimately be recovered. However, should there be a change in our ability to recover the deferred tax assets; the tax provision would increase in the period in which we determined that the recovery was not probable.
Additionally, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109, or FIN 48, on June 1, 2007, the first day of fiscal 2008. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Under FIN 48 we may only recognize tax positions that meet a "more likely than not" threshold.
5. Investments in Affiliated Companies
We have a 50% interest in Phoenix Digital Solutions, LLC ("PDS"). We account for our investment using the equity method of accounting since the investment provides us the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee's Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the investee and is recognized in the consolidated statements of operations in the caption "Equity in earnings (loss) of affiliated companies."
We have a 39.4% interest in Talis Data Systems, LLC ("Talis"). Prior to the
write down of our investment in Talis we were accounting for our investment
using the equity method of accounting pursuant to paragraph 8 of SOP 78-9,
Accounting for Investments in Real Estate Ventures (which has applicability to
non-real estate accounting matters as well). Under the equity method of
accounting, the investment, originally recorded at cost, was adjusted to
recognize our share of net earnings or losses of the investee and was recognized
in the consolidated statements of operations in the caption "Equity in earnings
(loss) of affiliated companies."
We own 37.1% of the preferred stock of Avot Media, Inc. ("Avot"). This investment is accounted for at cost since we do not have the ability to exercise significant influence over the operating and financial policies of Avot.
We own 100% of the preferred stock of Holocom. This investment has historically been accounted for at cost since we do not have the ability to exercise significant influence over the operating and financial policies of Holocom. Due to a re-consideration event on May 1, 2009, this investment is carried at cost plus the effects of deconsolidation of this variable interest entity on our August 31, 2009 condensed consolidated balance sheet.
We review our investments in these affiliated companies to determine whether
events or changes in circumstances indicate that the carrying amounts may not be
recoverable. The primary factors we consider in our determination are the
financial condition, operating performance and near term prospects of the
investees. If the decline in value is deemed to be other than temporary, we
would recognize an impairment loss.
The inability of Talis to meet its business plan and to raise capital and the
general economic environment were indicators of impairment on our investment;
accordingly at August 31, 2009, management obtained a third party valuation of
Talis from Vantage Point Advisors, Inc. Based on the results of the valuation,
it was determined that our investment in Talis was impaired by approximately
$680,000. We have recorded this as an impairment of investment in affiliated
company on our condensed consolidated statement of operations for the three
months ended August 31, 2009.
6. Business Combinations and Intangible Assets Including Goodwill
We account for business combinations using the purchase method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at their estimated fair values at the acquisition date. Goodwill represents the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Due to the time it takes to obtain pertinent information to finalize the acquired company's balance sheet, it may be several quarters before we are able to finalize the initial fair value estimates. Accordingly, it is not uncommon for the initial estimates to be subsequently revised. The results of operations of acquired businesses are included in our consolidated financial statements from the acquisition date.
Identifiable intangible assets with finite lives are amortized over their estimated useful lives on a straight line basis. Goodwill and intangible assets are tested for impairment on an annual basis, or sooner if an indicator of impairment occurs.
Results of Operations
Comparison of the Three Months Ended August 31, 2009 and Three Months Ended
August 31, 2008.
Consolidated:
Three Months Ended
August 31, 2009 August 31, 2008
Revenues:
Product sales and other $ - $ 1,358,646
License and service revenue 97,035 -
Total revenues 97,035 1,358,646
Cost of sales:
Product sales and other - 584,253
License and service revenue 31,983 -
Amortization of purchased intangibles 206,688 -
Total cost of sales 238,671 584,253
Gross profit (loss) $ (141,636 ) $ 774,393
Segment Results:
Three months ended
August 31, 2009 August 31, 2008
Holocom: Dollars % of Revenue Dollars % of Revenue
Revenues - Product sales and other $ - - $ 1,319,366 100.0%
Cost of sales - - 584,253 44.3%
Gross profit $ - - $ 735,113 55.7%
PDSG:
License and service revenue $ 97,035 100.0% $ - -
Cost of sales 31,983 33.0% - -
Amortization of purchased intangibles 206,688 - - -
Gross loss $ (141,636 ) - $ - -
PTSC:
Revenues - Product sales and other $ - - $ 39,280 100.0%
Cost of sales - - - -
Gross profit $ - - $ 39,280 100.0%
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Holocom
During the three months ended August 31, 2008, we recorded sales amounting to approximately $1,319,000 by our then consolidated variable interest entity, Holocom, with cost of sales amounting to approximately $584,000. Due to a re-consideration event we deconsolidated Holocom in May 2009.
PDSG
We acquired PDSG in a series of transactions in the second, third and fourth quarters of fiscal 2009. Revenue consists of software licenses and associated services relating to PDSG's CDX data agent product and the Sherlock™ software tool for medical facilities. Cost of sales includes the direct time of PDSG employees on each project as well as outside contractors. Included in cost of sales is approximately $206,700 of amortization expense on purchased intangible assets.
PTSC
During the three months ended August 31, 2008, we recognized maintenance fee revenues totaling $6,250 in connection with an agreement with AMD Corporation during the 2005 fiscal year. The agreement called for maintenance fees totaling $100,000 connected with a license agreement for our Ignite technology; the license fee revenue was being recognized as revenue evenly over the four year period of the license, which ended in February 2009.
In addition during the three months ended August 31, 2008, we recorded sales of approximately $33,000 from the sale of microprocessor chips that we no longer market. Inventory associated with the sales of these microprocessor chips is carried at zero value. Our final sales of microprocessor chips occurred during the quarter ended August 31, 2008.
Consolidated
Our revenues decreased from approximately $1,359,000 for the three months ended August 31, 2008 to approximately $97,000 for the three months ended August 31, 2009, primarily due to the deconsolidation of Holocom. Our revenue amounts do not include income of approximately $6,622,000 for the three months ended August 31, 2008 and loss of approximately $243,000 for the three months ended August 31, 2009 from our investment in PDS and losses of approximately $63,100 and $21,700, respectively, for the three months ended August 31, 2008 and 2009, respectively, from our investment in Talis.
Consolidated:
Three months ended
August 31, 2009 August 31, 2008
Research and development $ 314,197 $ -
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PDSG
Research and development costs consist of PDSG's payroll and related expenses
for software engineers as well as outside contractors retained to assist in the
development of PDSG's software product. For the three months ended August 31,
2009, approximately $1,200 of non-cash compensation was recorded in connection
with vesting of employee stock options in accordance with SFAS 123(R).
Consolidated:
Three months ended
August 31, 2009 August 31, 2008
Selling, general and administrative $ 1,927,795 $ 1,930,805
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Segment Results:
Three months ended
August 31, 2009 August 31, 2008
Holocom:
Selling, general and administrative $ - $ 617,660
PDSG:
Selling, general and administrative $ 1,010,348 $ -
PTSC:
Selling, general and administrative $ 917,447 $ 1,313,145
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Holocom
During the three months ended August 31, 2008, we recorded selling, general and administrative expenses amounting to approximately $618,000 by our then consolidated variable interest entity, Holocom. Due to a re-consideration event we deconsolidated Holocom in May 2009 (see Note 12).
PDSG
Selling, general and administrative expenses for the three months ended August 31, 2009 consist of approximately $670,000 of payroll and related expenses for the sales and administrative employees, approximately $43,000 of travel and related expenses for the sales employees, approximately $120,000 for consultants, and approximately $50,000 for rent expense. For the three months ended August 31, 2009, approximately $15,000 of non-cash compensation was recorded in connection with vesting of employee stock options in accordance with SFAS 123(R).
PTSC
Selling, general and administrative expenses decreased from approximately $1,313,000 for the three months ended August 31, 2008 to approximately $917,000 for the three months ended August 31, 2009, primarily due to the preparations for acquisition of PDSG in the prior year. The decrease consisted of approximately $190,000 in legal and accounting expense, approximately $90,000 in consulting expense and approximately $17,000 in public and investor relations expenses. These decreases were offset by increases in payroll and related expenses of approximately $27,000, and approximately $9,000 in travel and related expenses. For the three months ended August 31, 2009, approximately $22,000 of non-cash compensation was recorded in connection with vesting of employee stock options in accordance with SFAS 123(R) as compared to approximately $108,000 for the three months ended August 31, 2008.
Consolidated
Selling, general and administrative expenses decreased from approximately
$1,931,000 for the three months ended August 31, 2008 to approximately
$1,928,000 for the three months ended August 31, 2009.
Consolidated:
Three months ended
August 31,
2009 August 31, 2008
Other income (expense):
Interest and other income $ 42,928 $ 112,846
Impairment of investment in affiliated company (680,292 ) -
Interest expense (20,640 ) (4,622 )
Equity in earnings (loss) of affiliated companies (264,558 ) 6,558,770
Total other income (expense), net $ (922,562 ) $ 6,666,994
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Segment Results:
Three months ended
August 31,
2009 August 31, 2008
Holocom:
Interest and other income $ - $ 381
Interest expense - (9 )
Total other income (expense), net $ - $ 372
PDSG:
Interest and other income $ 9,336 $ -
Interest expense - -
Total other income (expense), net $ 9,336 $ -
PTSC:
Interest and other income $ 33,592 $ 112,465
Impairment of investment in affiliated company (680,292 ) -
Interest expense (20,640 ) (4,613 )
Equity in earnings (loss) of affiliated companies (264,558 ) 6,558,770
Total other income (expense), net $ (931,898 ) $ 6,666,622
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Consolidated
Our other income and expenses for the three months ended August 31, 2009 included equity in the loss of PDS consisting of net loss after expenses in the amount of approximately $243,000 and our share of loss in Talis consisting of approximately $22,000 after expenses. For the three months ended August 31, 2008, our other income and expenses included our share of income in PDS of approximately $6,622,000 and our share of loss in Talis of approximately $63,000. Our investments in PDS and Talis are accounted for in accordance with the equity method of accounting for investments. Total other income and expense for the three months ended August 31, 2009 amounted to net other expenses of approximately $932,000 compared with net other income of approximately $6,667,000 for the three months ended August 31, 2008. Interest income and other income decreased from approximately $112,000 for the three months ended August 31, 2008 to approximately $34,000 for the three months ended August 31, 2009 due to declines in interest rates for our cash, cash equivalents and long term investment accounts. For the three months ended August 31, 2009, we recorded an impairment of our investment in Talis of approximately $681,000.
During the three months ended August 31, 2009 we recorded a benefit for income taxes of approximately $1,321,000 and during the three months ended August 31, 2008, we recorded a provision for income taxes of approximately $2,380,000 related to federal and California taxes.
We recorded a net loss for the three months ended August 31, 2009 of $1,985,079 compared with net income of $3,209,513 for the three months ended August 31, 2008.
Liquidity and Capital Resources
Liquidity
Our cash and short-term investment balances increased from approximately $6,265,000 as of May 31, 2009 to approximately $8,224,000 as of August 31, 2009. We also have restricted cash balances amounting to approximately $52,000 as of May 31, 2009 and August 31, 2009. Total current assets increased from approximately $8,065,000 as of May 31, 2009 to approximately $9,835,000 as of August 31, 2009. Total current liabilities amounted to approximately $1,034,000 and approximately $797,000 as of May 31, 2009 and August 31, 2009, respectively. The change in our current position as of August 31, 2009 as compared with May 31, 2009 results in part from our receipt of approximately $3,667,000 in distributions from PDS.
During June 2008, we obtained a credit facility for as long as needed, which provides for financing up to 50% of the par value balance of our outstanding auction rate securities. The facility is collateralized by the full value of the outstanding auction rate securities, required no origination fee, and when drawn upon will bear interest at the federal funds rate plus 3%. On October 14, 2008, we borrowed $3,000,000 on the credit facility. The amount we can borrow against our collateral, currently $4,200,000, is limited by FINRA (see Note 13).
Current global economic conditions have resulted in increased volatility in the financial markets. The cost of accessing the credit markets has increased as . . .
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