SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
quarterly period ended March 31, 2006
[
]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
transition period from.................to...................
Commission
file number 1-8191
PORTA
SYSTEMS CORP.
(Exact
name of registrant as specified in its charter)
Delaware
|
11-2203988
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
incorporation
or organization)
|
Identification
No.)
|
6851
Jericho Turnpike, Suite 170, Syosset, New York
(Address
of principal executive offices)
11791
(Zip
Code)
516-364-9300
(Company’s
telephone number, including area code)
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be
filed by
Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding
12
months
(or for such shorter period that the registrant was required to file such
reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes
X
No
__
Indicate
by a check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, see definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of Exchange Act. Check
one:
Large
accelerated filer [ ]
|
Accelerated
filer [ ]
|
Non-accelerated
filer [x]
|
Indicate
by a check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes _ No X
Indicate
the number of shares outstanding of each of the issuer’s classes of common stock
as of the latest
practicable date:
Common
stock (par value $0.01) 10,075,561 shares as of May 02,
2006
PART
I. FINANCIAL INFORMATION
Item
1- Financial
Statements
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Consolidated
Balance Sheets
(In
thousands, except shares and par value)
|
|
|
March
31,
|
|
|
December
31,
|
|
Assets |
|
|
2006
|
|
|
|
|
Current
assets:
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,033
|
|
$
|
1,254
|
|
Accounts
receivable - trade, less allowance for doubtful
|
|
|
|
|
|
|
|
accounts
of $256 in 2006 and $256 in 2005
|
|
|
4,602
|
|
|
3,655
|
|
Inventories
|
|
|
4,464
|
|
|
4,851
|
|
Prepaid
expenses and other current assets
|
|
|
496
|
|
|
481
|
|
Total
current assets
|
|
|
10,595
|
|
|
10,241
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
1,413
|
|
|
1,409
|
|
Goodwill
|
|
|
2,961
|
|
|
2,961
|
|
Other
assets
|
|
|
52
|
|
|
50
|
|
Total
assets
|
|
$
|
15,021
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Deficit
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior
debt, including accrued interest
|
|
$
|
24,404
|
|
$
|
24,675
|
|
Subordinated
notes
|
|
|
6,144
|
|
|
6,144
|
|
6%
Convertible subordinated debentures
|
|
|
385
|
|
|
385
|
|
Accounts
payable
|
|
|
4,984
|
|
|
4,614
|
|
Accrued
expenses and other
|
|
|
2,460
|
|
|
3,021
|
|
Other
accrued interest payable
|
|
|
5,417
|
|
|
5,180
|
|
Total
current liabilities
|
|
|
43,794
|
|
|
44,019
|
|
|
|
|
|
|
|
|
|
Deferred
compensation
|
|
|
810
|
|
|
827
|
|
Total
long-term liabilities
|
|
|
810
|
|
|
827
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
44,604
|
|
|
44,846
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
deficit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred
stock, no par value; authorized 1,000,000 shares, none
issued
|
|
|
-
|
|
|
-
|
|
Common
stock, par value $.01; authorized 20,000,000 shares,
|
|
|
|
|
|
|
|
issued
10,084,577 shares in 2006 and 10,084,577 in 2005
|
|
|
101
|
|
|
101
|
|
Additional
paid-in capital
|
|
|
76,124
|
|
|
76,124
|
|
Accumulated
deficit
|
|
|
(99,000
|
)
|
|
(99,895
|
)
|
Accumulated
other comprehensive loss:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
(4,869
|
)
|
|
(4,577
|
)
|
|
|
|
(27,645
|
)
|
|
(28,247
|
)
|
Treasury
stock, at cost, 30,940 shares
|
|
|
(1,938
|
)
|
|
(1,938
|
)
|
Total
stockholders’ deficit
|
|
|
(29,583
|
)
|
|
(30,185
|
)
|
Total
liabilities and stockholders’ deficit
|
|
$
|
15,021
|
|
$
|
14,661
|
|
See
accompanying notes to consolidated financial statements
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Operations and Comprehensive Income
(In
thousands, except per share amounts)
|
|
|
Three
Months Ended
|
|
|
|
|
March
31,
|
|
|
March
31,
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
8,043
|
|
$
|
7,615
|
|
Cost
of sales
|
|
|
5,308
|
|
|
4,472
|
|
Gross
profit
|
|
|
2,735
|
|
|
3,143
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
1,364
|
|
|
1,177
|
|
Research
and development expenses
|
|
|
447
|
|
|
421
|
|
Total
expenses
|
|
|
1,811
|
|
|
1,598
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
924
|
|
|
1,545
|
|
|
|
|
|
|
|
|
|
Interest
expense, net of interest income
|
|
|
(296
|
)
|
|
(325
|
)
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
628
|
|
|
1,220
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(23
|
)
|
|
(17
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
605
|
|
$
|
1,203
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
(293
|
)
|
|
(62
|
)
|
|
|
|
|
|
|
|
|
Comprehensive
income
|
|
$
|
312
|
|
$
|
1,141
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per
share data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share of common stock
|
|
$
|
0.06
|
|
$
|
0.12
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
9,972
|
|
|
|
|
|
|
|
|
|
Diluted
per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share of common stock
|
|
$
|
0.06
|
|
$
|
0.12
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,106
|
|
|
10,005
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Cash Flows
(In
thousands)
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
March
31,
|
|
|
|
2006
|
|
2005
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
605
|
|
$
|
1,203
|
|
Adjustments
to reconcile net income to net cash
|
|
|
|
|
|
|
|
Provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
99
|
|
|
101 |
|
|
|
|
|
|
|
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(947
|
)
|
|
(495
|
)
|
Inventories
|
|
|
387
|
|
|
(338
|
)
|
Prepaid
expenses and other current assets
|
|
|
(15
|
)
|
|
(359
|
)
|
Other
assets
|
|
|
(2
|
)
|
|
(1
|
)
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
(37
|
)
|
|
(305
|
)
|
Net
cash provided by (used in) operating activities
|
|
|
90
|
|
|
(194
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures, net
|
|
|
(102
|
)
|
|
(169
|
)
|
Net
cash used in investing activities
|
|
|
(102
|
)
|
|
(169
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Increase
in senior debt
|
|
|
67
|
|
|
91
|
|
Repayments
of senior debt
|
|
|
(338
|
)
|
|
(150
|
)
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(271
|
)
|
|
(59
|
)
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash
|
|
|
62
|
|
|
(58 |
)
|
|
|
|
|
|
|
|
|
Decrease
in cash and cash equivalents
|
|
|
(221
|
)
|
|
(480
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - beginning of the year
|
|
|
1,254
|
|
|
2,040
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - end of the period
|
|
$
|
1,033
|
|
$
|
1,560 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
cash flow disclosure:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for interest expense
|
|
$
|
66
|
|
$ |
151 |
|
|
|
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
23
|
|
$ |
30 |
|
|
|
|
|
|
|
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note
1: Management’s Responsibility For Interim Financial Statements
Including All
Adjustments
Necessary For Fair Presentation
Management
acknowledges its responsibility for the preparation of the accompanying interim
consolidated financial statements which reflect all adjustments, consisting
of
normal recurring adjustments, considered necessary in its opinion for a fair
statement of its consolidated financial position and the results of its
operations for the interim period presented. These consolidated financial
statements should be read in conjunction with the summary of significant
accounting policies and notes to consolidated financial statements included
in
the Company’s Form 10-K annual report for the year ended December 31, 2005.
These financial statements have been prepared assuming that the Company will
continue as a going concern and, accordingly, do not include any adjustments
that might result from the outcome of the uncertainties described within. The
audit opinion included in the December 31, 2005 Form 10-K annual report
contained an explanatory paragraph regarding the Company’s ability to continue
as a going concern. The factors which resulted in the explanatory paragraph
are
continuing. Results for the first three months of 2006 are not necessarily
indicative of results for the year.
Note
2: Inventories
Inventories
are stated at the lower of cost (on the average or first-in, first-out methods)
or market.
The
composition of inventories at the end of the respective periods is as follows
(net of reserves of $2,576,000 for 2006 and $2,583,000 for 2005):
|
|
|
March
31, 2006
|
|
|
December
31, 2005
|
|
|
|
|
(in
thousands)
|
|
Parts
and components
|
|
$
|
3,046
|
|
$
|
3,196
|
|
Work-in-process
|
|
|
325
|
|
|
460
|
|
Finished
goods
|
|
|
1,093
|
|
|
1,195
|
|
|
|
$
|
4,464
|
|
$
|
4,851
|
|
Note
3: Senior and Subordinated Debt
On
March
31, 2006, the Company’s liability to the holder of its senior debt was
$24,404,000.
During
the fourth quarter of 2004, SHF IX LLC, an affiliate of Stonehill Financial,
LLC, purchased the Company’s senior debt of approximately $25,000,000 from Wells
Fargo Foothill, Inc. The Company has made payments totaling $2,260,000 as
required by amendments and extensions of the loan agreement, of which $864,000
was applied to interest and $1,396,000 was applied to principal. The most recent
extension, which extended the maturity date, subject to the Company attaining
certain milestones, from May 1, 2006 to September 30, 2006, requires the Company
to continue to make monthly payments of $112,500. The most recent extension
also
includes a number of milestones to the continuation of efforts towards a
restructure of the Company in a manner which would enable the holder of the
senior debt to receive significant payments on account of the senior debt.
The
loan becomes due and payable on September 30, 2006 or earlier if the Company
fails to achieve any of the milestones and the holder of the senior debt
declares a default. If the holder of the senior debt demands payment of all
or a
significant portion of the loan when due, the Company will not be able to
continue in business and it is likely that the Company will seek protection
under the Bankruptcy Code.
As
of
March 31, 2006, the Company’s short-term debt also included $6,144,000 of
subordinated debt that became due on July 3, 2001 and $385,000 of 6% debentures
which became due on July 2, 2002. Accrued interest on the subordinated notes
was
approximately $5,284,000, which represents interest from July 2000 through
March
31, 2006, and accrued interest on the 6% debentures was $133,000. We are
precluded by the holder of our senior debt from paying any principal or interest
on the subordinated debt.
Note
4: Accounting for Stock Based Compensation
Incentive
awards are provided to employees under the terms of our 1998 Non-Qualified
Stock
Option Plan and our 1999 Incentive and Non-Qualified Stock Option Plan (the
"1998 Plan" and “1999 Plan”, respectively). Options
under the 1998 Plan may be granted to key employees, including officers and
directors of the Company and its subsidiaries. The exercise prices for all
options granted under the 1998 Plan are equal to the fair market value at the
date of grant and vest as determined by the board of directors. Options
under the 1999 Plan may be granted to key employees, including officers and
directors of the Company and its subsidiaries, except that members
and alternate members of the stock option committee are not eligible for options
under the 1999 Plan. The exercise prices for all options granted are equal
to
the fair market value at the date of grant and vest as determined by the board
of directors, which is historically determined as six months. In addition,
the
1999 Plan provides for the automatic grant to non-management directors of
non-qualified options to purchase 5,000 shares on May 1st of each year
commencing May 1, 1999, based upon the average closing price of the last ten
trading days of April of each year. Options under both the 1998 and 1999 Plans
have expiration terms between 5 and 10 years.
Effective
January 1, 2006, the Company adopted the provisions of FAS No. 123(R),
"Share-Based Payment" ("FAS123(R)"). Under FAS123(R), share-based compensation
cost is measured at the grant date, based on the estimated fair value of the
award, and is recognized as expense over the requisite service period. The
Company adopted the provisions of FAS123(R) using a modified prospective
application. Under this method, compensation cost is recognized for all
share-based payments granted, modified or settled after the date of adoption,
as
well as for any unvested awards that were granted prior to the date of adoption.
Prior periods are not revised for comparative purposes. Because all of the
Company’s outstanding options are fully vested, there is no stock-based
compensation expense for the period ended March 31, 2006.
Stock
option activity through the three months ended March 31, 2006 is as
follows:
|
|
|
|
|
|
Weighted
Average
Exercise
Price
Per
Share
|
|
|
Weighted
Average
Remaining
Term
|
|
|
Aggregate
Intrinsic Value
|
|
Outstanding
at January 1, 2006
|
|
|
337,780
|
|
$
|
1.39
|
|
|
2.73
|
|
$ |
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
- |
|
Forfeited
|
|
|
(28,500
|
)
|
|
3.31
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
and Exercisable at March 31, 2006
|
|
|
309,280
|
|
$
|
1.22
|
|
|
2.71
|
|
$
|
3,240
|
|
Prior
to
the beginning of fiscal 2006, the Company did not record compensation expense
for its stock based compensation plans, as such treatment was permitted under
the provisions of Accounting Principles Board (“APB”) Opinion No. 25 “Accounting
for Stock Issued to Employees,” related interpretations, and SFAS 123,
“Accounting for Stock-Based Compensation.” The Company provided the requisite
pro forma disclosures and complied with provisions of SFAS 148, “Accounting for
Stock-Based Compensation—Transition and Disclosures.” For the three months ended
March 31, 2005, there was no pro-forma disclosure as there were no unvested
options.
Note
5: Segment Data
The
Company has three reportable segments: Line Connection and Protection Equipment
(“Line”) whose products interconnect copper telephone lines to switching
equipment and provide fuse elements that protect telephone equipment and
personnel from electrical surges; Signal Processing (“Signal”) whose products
are used in data communication devices that employ high frequency transformer
technology, and Operating Support Systems (“OSS”) whose products automate the
testing, provisioning, maintenance and administration of communication networks
and the management of support personnel and equipment.
Because
of continuing losses in the OSS division, combined with difficulties in
marketing OSS products in view of our financial condition, we limit our OSS
activities to the performance of maintenance and warranty services. For the
three months ended March 31, 2006, OSS sales were $105,000, which was
approximately 1.3% of the Company’s revenue and the OSS operations generated a
loss of approximately $82,000. For the three months ended March 31, 2005, OSS
sales were $208,000, which was approximately 2.7% of the Company’s revenue and
the OSS operations generated a loss of approximately $273,000. The Company
anticipates that the OSS revenue will represent an increasingly smaller portion
of our revenue.
The
factors used to determine the above segments focused primarily on the types
of
products and services provided, and the type of customer served. Each of these
segments is managed separately from the others, and management evaluates segment
performance based on operating income.
There
has
been no significant change from December 31, 2005 in the basis of measurement
of
segment revenues and profit or loss, and no significant change in the Company’s
assets.
|
|
Three
Months Ended
|
|
|
|
March
31, 2006
|
|
March
31, 2005
|
|
Sales:
|
|
|
|
|
|
|
|
Line
|
|
$
|
6,488,000
|
|
$
|
5,707,000
|
|
Signal
|
|
|
1,412,000
|
|
|
1,656,000
|
|
OSS
|
|
|
105,000
|
|
|
208,000
|
|
|
|
$
|
8,005,000
|
|
$
|
7,571,000
|
|
|
|
|
|
|
|
|
|
Segment
profit (loss):
|
|
|
|
|
|
|
|
Line
|
|
$
|
1,204,000
|
|
$
|
1,573,000
|
|
Signal
|
|
|
384,000
|
|
|
698,000
|
|
OSS
|
|
|
(82,000
|
)
|
|
(273,000
|
)
|
|
|
$
|
1,506,000
|
|
$
|
1,998,000
|
|
The
following table reconciles segment totals to consolidated totals:
|
|
|
Three
Months Ended
|
|
|
|
|
March
31, 2006
|
|
|
March
31, 2005
|
|
Sales:
|
|
|
|
|
|
|
|
Total
revenue for reportable segments
|
|
$
|
8,005,000
|
|
$
|
7,571,000
|
|
Other
revenue
|
|
|
38,000
|
|
|
44,000
|
|
Consolidated
total revenue
|
|
$
|
8,043,000
|
|
$
|
7,615,000
|
|
|
|
|
|
|
|
|
|
Operating
Income:
|
|
|
|
|
|
|
|
Total
segment income for
|
|
|
|
|
|
|
|
reportable
segments
|
|
$
|
1,506,000
|
|
$
|
1,998,000
|
|
Corporate
and unallocated
|
|
|
(582,000
|
)
|
|
(453,000
|
)
|
Consolidated
total operating income
|
|
$
|
924,000
|
|
$
|
1,545,000
|
|
Item
1 A. Risk
Factors
In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2005, which could materially
affect our business, financial condition or future results. The risks described
in our Annual Report on Form 10-K are not the only risks facing our Company.
Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and/or operating results.
Item
2. Management’s
Discussion and Analysis of Financial Condition and Results
of Operations
The
Company’s consolidated statements of operations for the periods indicated below,
shown as a percentage of sales, are as follows:
|
|
|
Three
Months Ended
|
|
|
|
|
March
31,
|
|
|
|
|
2006
|
|
|
2005
|
|
Sales
|
|
|
100
|
%
|
|
100
|
%
|
Cost
of Sales
|
|
|
66
|
%
|
|
59
|
%
|
Gross
Profit
|
|
|
34
|
%
|
|
41
|
%
|
Selling,
general and administrative expenses
|
|
|
17
|
%
|
|
15
|
%
|
Research
and development expenses
|
|
|
6
|
%
|
|
6
|
%
|
Operating
income
|
|
|
11
|
%
|
|
20
|
%
|
Interest
expense - net
|
|
|
(4
|
%)
|
|
(4
|
%)
|
Net
income
|
|
|
8
|
%
|
|
16
|
%
|
The
Company’s sales by product line for the periods ended March 31, 2006 and 2005
are as follows:
|
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
connection/protection equipment
|
|
$
|
6,488
|
|
|
81
|
%
|
$
|
5,707
|
|
|
75
|
%
|
Signal
Processing
|
|
|
1,412
|
|
|
18
|
%
|
|
1,656
|
|
|
22
|
%
|
OSS
equipment
|
|
|
105
|
|
|
1
|
%
|
|
208
|
|
|
3
|
%
|
Other
|
|
|
38
|
|
|
0
|
%
|
|
44
|
|
|
1
|
%
|
|
|
$
|
8,043
|
|
|
100
|
%
|
$
|
7,615
|
|
|
100
|
%
|
Overview
We
operate in the telecommunications industry, and our customer base consists
largely of government-owned and privately-owned telecommunications companies.
Our line connection and protection equipment (“Line”) interconnects copper
telephone lines to switching equipment and provides fuse elements that protect
telephone equipment and personnel from electrical surges. Our signal processing
(“Signal”) equipment is used in data communication devices that employ high
frequency transformer technology. Our Operating Support Systems (“OSS”), which
are becoming an increasingly less important part of our business, automate
the
testing, provisioning, maintenance and administration of communication networks
and the management of support personnel and equipment.
Because
of continuing losses in the OSS division, combined with difficulties in
marketing OSS products in view of our financial condition, we limit our OSS
activities to the performance of maintenance and warranty services. In addition,
we are trying to sell our remaining OSS inventory although we did not generate
any sales of OSS inventory in the first quarter of 2006 as well as for the
year
ended 2005. We expect our OSS business to continue to decline in future years,
and we do not anticipate that we will enter into new maintenance contracts
when
our warranty obligations terminate or renew existing maintenance contracts
when
they expire.
Our
Line
equipment is designed to connect copper-wired telecommunications networks and
to
protect telecommunications equipment from voltage surges. We market this
equipment to telephone operating companies in the United States and foreign
countries. Our Line division operated at a profit for the three months ended
March 31, 2006 and March 31, 2005. We market Signal equipment principally
for use in defense and aerospace applications. The Signal division generated
operating profit for the three months ended March 31, 2006 and the comparable
period of 2005. We recognize revenue from Line and Signal products when the
product is shipped.
On
March
31, 2006, our liability to the holder of our senior debt was $24,404,000. The
most recent extension, which extended the maturity date, subject to our
attaining certain milestones, from May 1, 2006 to September 30, 2006, requires
us to continue to make monthly payments of $112,500. The most recent extension
also includes a number of milestones to the
continuation of efforts towards a restructure in a manner which would enable
the
holder of the senior debt to receive significant payments on account of the
senior debt. The loan becomes due and payable on September 30, 2006 or earlier
if we fail to achieve any of the milestones and the holder of the senior debt
declares a default. If the holder of the senior debt demands payment of all
or a
significant portion of the loan when due, we will not be able to continue in
business and it is likely that we will seek protection under the Bankruptcy
Code.
Results
of Operations
Our
sales
for the quarter ended March 31, 2006 were $8,043,000, representing an increase
of $428,000 (5%) compared to the quarter ended March 31, 2005 of $7,615,000.
The
increased sales level resulted
from increased sales of Line products, with our increase in Line products being
partially offset by decreased sales by Signal and OSS.
Line
equipment sales increased by $781,000 (14%) from $5,707,000 for the March 2005
quarter to $6,488,000 for the March 2006 quarter, primarily as a result of
an
increase in sales to British Telecommunications as a result of British
Telecommunications’ continuing rollout of DSL lines, and its implementation of
the local loop unbundling program, demanded by regulators in the United Kingdom
to enable third party providers of the telephone service to gain access to
British Telecommunications’ systems.
Signal
processing revenue for the quarter ended March 31, 2006 compared to 2005
decreased by $244,000 (15%) from $1,656,000 to $1,412,000. The decline in Signal
Processing revenue from the first quarter of 2005 resulted from a level of
sales
in the 2005 quarter which included products for which shipments had been delayed
from the fourth quarter of 2004 because of our cash difficulties which affected
our ability to ship products in 2004.
OSS
sales
decreased by $103,000 (50%) from $208,000 for the quarter ended March 31, 2005
to $105,000 for the quarter ended March 31, 2006. The decreased sales, all
of
which were generated from maintenance agreements, resulted from the reduction
in
the scope of our OSS operations.
Gross
margin for the March 2006 quarter was 34% compared to 41% for the March 2005
quarter. This
decrease is primarily related to a change in products sold to British
Telecommunications in the quarter ended March 31, 2006, from the higher gross
margin DSL products to the lower margin local loop unbundling products from
our
Line segment, and additional freight costs associated with on time deliveries
to
customers. Also, our Signal segment gross margin slightly decreased during the
quarter due to a minor shift to lower margin deliveries to
customers.
Selling,
general and administrative expenses increased by $187,000 (16%) from $1,177,000
in the March 2005 quarter to $1,364,000 in the March 2006 quarter. This increase
relates primarily to increased expenses in our Signal segment for salaries,
commissions and advertising as our marketing activities for Signal were
increased during the first quarter of 2006. Selling and marketing salaries
increased in our Line segment as well as increased administrative salaries
which
were partially offset by a decrease in general and administrative expenses
relating to the OSS division as we continue to wind down that
operation.
Research
and development expenses increased by $26,000 (6%) from $421,000 in the March
2005 quarter to $447,000 in the March 2006 quarter. This resulted from our
increased spending by our line connection/protection division of approximately
$100,000 to enhance our existing Line products and develop new products. This
increased spending was partially offset by reduced spending of approximately
$75,000 in our OSS division as we continue to wind down that operation. There
is
an insignificant amount spent for OSS related to warranty and maintenance
contracts.
As
a
result of the foregoing, we had an operating income of $924,000 for the March
2006 quarter, as compared to an operating income of $1,545,000 for the March
2005 quarter.
We
continue to accrue interest on obligations to the holder of $2,225,000 of our
senior debt, which represents interest on senior debt that we incurred
subsequent to March 2002. In
addition, there is outstanding an old term loan, in the principal amount of
approximately $23,000,000, that accrues no interest commencing March 1, 2002,
until such time as the holder of the debt, in its sole discretion, notifies
us
that interest, at a rate of 12%, or a default rate of 14%, shall be payable.
The
holder of the senior debt has not required us to pay interest on this
amount.
Income
tax expense for the quarter ended March 31, 2006 as well as March 31, 2005
relates to state and foreign taxes. No federal income tax expense has been
provided due to the availability of net operating loss carry
forwards.
As
the
result of the foregoing, we generated net income of $605,000, $.06
per
share (basic and diluted), for the March 2006 quarter versus net income of
$1,203,000, $0.12 per share (basic and diluted), for the March 2005
quarter.
Liquidity
and Capital Resources
At
March
31, 2006, we had cash and cash equivalents of $1,033,000 compared with
$1,254,000 at December 31, 2005. Our working capital deficit at March 31, 2006
was $33,199,000, compared to a working capital deficit of $33,778,000 at
December 31, 2005, a reduction of $579,000 in our working capital deficit.
This
improvement is primarily the result of our increased accounts receivable. During
the first quarter, we continued making payments to the holder of our senior
debt, with payment of $338,000, of which
approximately $66,000 was applied to interest and the remaining $272,000 was
applied to principal.
As
of
March 31, 2006, our debt includes $24,404,000 of senior debt which matures
on
September 30, 2006 or earlier if we fail to meet required milestones and the
holder of the senior debt calls a default, $6,144,000 of principal and
$5,284,000 of accrued interest on our subordinated debt that became due on
July
3, 2001, and $385,000 of principal and $133,000 of accrued interest on our
6%
debentures that became due on July 2, 2002. We are prohibited by the holder
of
our senior debt from paying principal or interest on any of the subordinated
debt. We have been notified by the trustee of 6% debentures that the non-payment
of the principal and interest caused an event of default. At March 31, 2006,
we
did not have sufficient resources to pay either the senior lender or the
subordinated lenders; it is unlikely that we can generate such cash from our
operations, and our senior lender has precluded us from making any payments
on
the subordinated debt.
We
have
sought
to
address our need for liquidity by exploring alternatives, including the possible
sale of one or more of our divisions. During 2004 and 2005, we were engaged
in
discussions with respect to the possible sale of our divisions; however, those
negotiations were terminated without an agreement having been reached, and
we
may not be able to sell those divisions on acceptable, if any, terms.
Furthermore, if we sell a division, we anticipate that a substantial
portion,
if not
all,
of the
net proceeds will be paid to the holder of our senior debt, and we will not
receive any significant amount of working capital from such a sale. We continue
our efforts to reduce costs while we seek additional business from new and
existing customers. The significant reduction in the operations of our OSS
division will impair our ability to sell that division, and such reduction,
and
the dependence of our copper business on several significant customers, are
major factors which may impair our ability to sell the copper division or our
business as a whole. Further, if we sell one of our two divisions, we may be
unable to operate the remaining division at a profit.
Forward
Looking Statements
Statements
contained in this Form 10-Q include forward-looking statements that are subject
to risks and uncertainties. In particular, statements in this Form 10-Q that
state our intentions, beliefs, expectations, strategies, predictions or any
other statements relating to our future activities or other future events or
conditions are “forward-looking statements.” Forward-looking statements are
subject to risks, uncertainties and other factors, including, but not limited
to, those identified under “Risk Factors,” in our Form 10-K for the year ended
December 31, 2005 and those described in “Management's Discussion and Analysis
of Financial Conditions and Results of Operations” in our Form 10-K and this
Form 10-Q, and those described in any other filings by us with the Securities
and Exchange Commission, as well as general economic conditions and economic
conditions affecting the telecommunications industry, any one or more of which
could cause actual results to differ materially from those stated in such
statements. Such
statements could be affected by risks and uncertainties related to our financial
conditions, our relationship with the holder of our senior and subordinated
debt, including the willingness or unwillingness of the holder of the senior
debt to extend the maturity date of the senior debt and the amount and timing
of
any payments which the holder of the senior debt may require, our ability to
sell any or all of our divisions or effect a restructure of our business and
our
debt and equity structure on terms acceptable to the holder of the senior debt,
our relationship with British Telecommunications including its continued
requirements for our products, factors which affect the telecommunications
industry, market and customer acceptance, our access to current technology,
competition, domestic and foreign government regulations and requirements and
pricing, as well as general industry and market conditions and growth rates,
and
general economic conditions. Any forward-looking statements speak only as of
the
date on which they are made, and we do not undertake any obligation to update
any forward-looking statement to reflect events or circumstances after the
date
of this Form 10-Q.
Item
3.
Quantitative
and Qualitative Disclosure About Market Risk.
We
conduct certain operations outside the United States. A substantial portion
of
our revenue and expenses from our United Kingdom operations are denominated
in
Sterling. Any Sterling-denominated receipts are promptly converted into United
States dollars. We do not engage in any hedging or other currency
transactions.
Item
4.
Controls
and Procedures
Disclosure
Controls and Procedures
As
of the
end of the period covered by this report, our Chief Executive Officer and Chief
Financial Officer evaluated the effectiveness of our disclosure controls and
procedures. Based on his evaluation, the Chief Executive Officer and Chief
Financial Officer has concluded that our disclosure controls and procedures
are effective.
Internal
Control Over Financial Reporting
There
has
been no change in our internal control over financial reporting that occurred
during the fiscal quarter covered by this quarterly report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART
II - OTHER INFORMATION
Item
3. Defaults Upon Senior Securities.
See
Note
3 of Notes to Unaudited Consolidated Financial Statements and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources” for information concerning defaults on our
subordinated debt.
Item
6. Exhibits
|
31.1
|
Certificate
of Chief Executive Officer and Chief Financial Officer pursuant to
Section
302 of the Sarbanes-Oxley Act of 2002.
|
|
32.1
|
Certificate
of Chief Executive Officer and Chief Financial Officer pursuant to
Section
906 of the Sarbanes-Oxley Act of
2002.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
PORTA
SYSTEMS CORP.
|
|
|
|
|
Dated:
May 12, 2006
|
By
/s/ Edward B. Kornfeld
|
|
Edward
B. Kornfeld
|
|
Chief
Executive Officer
|
|
and
Chief Financial Officer
|