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PTIX > SEC Filings for PTIX > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for PERFORMANCE TECHNOLOGIES INC \DE\

Form 10-Q for PERFORMANCE TECHNOLOGIES INC \DE\


13-Nov-2012

Quarterly Report


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.

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Critical Accounting Estimates and Assumptions

In preparing the financial statements in accordance with the accounting principles generally accepted in the United States (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 passed. 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

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, 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.

For arrangements with multiple deliverables, the arrangement consideration is allocated at the inception of an arrangement to all deliverables using the relative selling price method, using 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. 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, 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.

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, which is 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.

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.

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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 its 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, 2012, 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 $25 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 U.S. deferred tax assets.

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.

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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.

PT is a global supplier of advanced network communications solutions for telecommunication service providers, government communications, and OEM markets. PT's product portfolio includes IP-centric network elements and applications designed for high availability, scalability, and long life cycle deployments. PT's SEGway™ SS7 and Diameter Signaling Solutions provide affordable, high density signaling and advanced routing for next-generation LTE and IMS networks. These solutions enable IP migration, gateway capabilities, SIP bridging, and core-to-edge distributed intelligence, as well as features such as Number Portability and SMS Spam Defense. PT's Multi-Protocol and Communication Server (MPS) product portfolio enables LAN/WAN, radar and Smart-Grid networks to acquire, distribute and record critical data over IP Networks. PT's industry-leading Monterey MicroTCA and IPnexus® Platforms anchor a growing portfolio of the company's own solutions. Many other OEMs and application developers leverage PT's carrier-grade platforms and Linux® development environment (PT's NexusWare®).

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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:
telecommunications, and military, aerospace and government systems.

The telecommunications market, historically our largest vertical market, is fundamentally driven by capital expenditure investments in network infrastructure by carriers and service providers. Our integrated SEGway SS7 and Diameter signaling solutions, which are sold to carriers and service providers, enable straightforward evolution from today's SS7-based signaling networks to next-generation 4G LTE networks utilizing Diameter. Telecommunications market revenues derived from our Application-Ready Platforms, which are sold to OEMs, depend primarily on broad, multi-year deployments of next-generation telecommunications infrastructure. After experiencing a dramatic slowdown in telecommunications equipment revenue during the second quarter 2012, management surveyed our customer base to get an updated view of their going forward product requirements and had mixed results. Our service provider customers generally expect to make additional investments in their network infrastructure while our OEM customers were more reluctant to project requirements because of little or no visibility of demand from their end customers. Based upon the feedback received and ongoing global economic climate uncertainty, we have concluded that our overall revenues will likely not return to the first quarter 2012 level in the near term.

Sales into the military, aerospace and government systems market are typically to prime contractors and system integrators and reflect investment levels by various government agencies and military branches in specific programs and projects requiring enhanced communications capabilities. Management contacted various military, aerospace and government systems customers and generally was not able to obtain any specific schedule for projected purchasing requirements beyond January 1, 2013 due to the substantial pressure their government customers are under relative to the U.S government budget reductions that are scheduled to occur on January 1, 2013.

Strategy

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

During 2011, management shifted the Company's signaling sales and marketing strategy to become more heavily focused on working with large channel partners as our primary vehicle to expand our global and emerging market reach. In January 2011, GENBAND became a major signaling channel partner and during the third quarter 2011, Kapsch CarrierCom AG was added as a signaling channel partner. We also continue to work closely under our established relationship with Alcatel-Lucent as another major channel partner for our signaling products. The advantages of the channel partner strategy include the validation of our products by these large, credible resellers, access to their customer base including much larger service providers than we are generally able to engage with and significant expansion of the global reach for our products through their direct sales organizations. The notable disadvantages of this strategy are the lack of direct customer account control and reduced visibility on the timing of closing sales transactions.

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In May 2012, PT announced its Universal Diameter Router (UDR), broadening the Company's SEGway Signaling product portfolio. UDR provides essential functions of centralized core and edge routing for Diameter Protocol elements being deployed in the all-IP, service-oriented, IMS and Long Term Evolution (LTE) architecture networks.

Subsequent to September 30, 2012, the Company announced a program to restructure its operations, reduce its workforce, rationalize its product lines and refocus its resources on initiatives that are more closely aligned with the Company's near-term objectives and market potential. The program included the elimination of fourteen positions, which represents 10% of the Company's workforce, for which the Company expects to record a fourth quarter restructuring charge for severance costs in the amount of approximately $.5 million. Substantially all of this charge is expected to result in an outlay of cash in the fourth quarter 2012. Management suspended further development and selling activities relating to certain products, which will result in a fourth quarter impairment charge of approximately $.8 million against software development costs and purchased intangible assets. In addition, the Company sent letters to selected customers informing them of a last-time buy program related to the Company's IPnexus products. Many of these customers are ideal candidates to transition their applications to the Company's Monterey 8000TM platform. Management believes these initiatives will lead to a solid foundation for long-term growth.

There are identifiable risks associated with PT's strategy in the current economic climate. While management believes that its network communications market focus offers opportunities for growth in the long term, the level of network infrastructure investments by carriers is currently being impacted by challenging global economic conditions. The total available market for traditional SS7-based signaling products is declining and the market for Diameter-routing and SIP-based next-generation network products is at an early stage of growth. The Company's primary strength is its technological expertise.

Financial Overview

Revenue:

Revenue in the third quarter 2012 amounted to $4.7 million, compared to $9.0 million in the third quarter 2011. Revenue for the nine months ended September 30, 2012 was $18.0 million, compared to $27.1 million in the corresponding period in 2011. The decrease in revenue in the third quarter 2012 over the comparable prior year period was widespread across much of PT's customer base, with three customers accounting for $3.1 million of the decline. The decrease in revenue in the nine months ended September 30, 2012 over the comparable prior year period was primarily due to a $4.7 million decline in sales to the Company's traditionally largest customer, the non-recurrence of a 2011 shipment totaling $1.6 million to a government systems customer, as well as, general weakness in demand among PT's customer base. The Company had been expecting its largest customer to transition away from using PT's IPnexus platforms in some of their products during 2012 although this process occurred earlier and much more rapidly than was anticipated. Shipments to customers outside of the United States represented 47% and 53% in the third quarter of 2012 and 2011, respectively, and 47% and 48% in the nine months ended September 30, 2012 and 2011, respectively.

Net Income (Loss):

PT incurred a net loss in the third quarter 2012 in the amount of ($1.7 million), or ($.15) per basic share, including amortization of purchased intangible assets of $.03 per share and stock-based compensation expense of $.01 per share, based on 11.1 million shares outstanding. PT incurred a net loss in the third quarter 2011 in the amount of ($.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.

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PTincurred a net loss for the nine months ended September 30, 2012 amounting to ($3.1 million), or ($.28) per basic share, including amortization of purchased intangible assets of $.08 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, 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, 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.

Liquidity:

Cash, cash equivalents and investments amounted to $14.7 million and $15.8 million at September 30, 2012 and December 31, 2011, respectively. The Company had no long-term debt at either date. Accounts receivable at September 30, 2012 amounted to $4.2 million, compared to $5.6 million at the end of 2011. The lower level of accounts receivable is primarily related to the decline in third quarter sales.

Cash provided by operating activities amounted to $2.2 million in the nine months ended September 30, 2012, as compared to cash used by operating activities of $.5 million in the nine months ended September 30, 2011. The large swing in cash provided by operating activities was primarily due to a $1.5 million net decrease in accounts receivable in 2012, as compared with a net increase of $2.5 million in the prior year, and a $.2 million decrease in accounts payable and accrued expenses in 2012, as compared with a $2.6 million . . .

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