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 June 30, 2006
o 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
o
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 o
Accelerated filer o
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 o
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) 10,053,617 shares as of July 18, 2006.
PART
I.-
FINANCIAL INFORMATION
Item
1- Financial
Statements
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Consolidated
Balance Sheets
(In
thousands, except shares and par value)
|
|
June
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
Assets
|
|
(Unaudited)
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,539
|
|
$
|
1,254
|
|
Accounts
receivable - trade, less allowance for doubtful accounts
|
|
|
|
|
|
|
|
of
$256 in 2006 and $256 in 2005
|
|
|
4,931
|
|
|
3,471
|
|
Inventories
|
|
|
3,862
|
|
|
4,541
|
|
Prepaid
expenses and other current assets
|
|
|
759
|
|
|
446
|
|
Assets
of discontinued operations
|
|
|
455
|
|
|
588
|
|
Total
current assets
|
|
|
11,546
|
|
|
10,300
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
1,491
|
|
|
1,351
|
|
Goodwill,
net
|
|
|
2,961
|
|
|
2,961
|
|
Other
assets
|
|
|
49
|
|
|
49
|
|
Total
assets
|
|
$
|
16,047
|
|
$
|
14,661
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Deficit
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Senior
debt
|
|
$
|
24,124
|
|
$
|
24,675
|
|
Subordinated
notes
|
|
|
6,144
|
|
|
6,144
|
|
6%
convertible subordinated debentures
|
|
|
385
|
|
|
385
|
|
Accounts
payable
|
|
|
4,937
|
|
|
4,035
|
|
Accrued
expenses and other
|
|
|
2,264
|
|
|
1,567
|
|
Other
accrued interest payable
|
|
|
5,653
|
|
|
5,180
|
|
Liabilities
of discontinued operations
|
|
|
575
|
|
|
2,033
|
|
Total
current liabilities
|
|
|
44,082
|
|
|
44,019
|
|
Deferred
compensation
|
|
|
794
|
|
|
827
|
|
Total
long-term liabilities
|
|
|
794
|
|
|
827
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
44,876
|
|
|
44,846
|
|
|
|
|
|
|
|
|
|
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 shares in 2005
|
|
|
101
|
|
|
101
|
|
Additional
paid-in capital
|
|
|
76,124
|
|
|
76,124
|
|
Accumulated
deficit
|
|
|
(98,413
|
)
|
|
(99,895
|
)
|
Accumulated
other comprehensive loss:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
(4,703
|
)
|
|
(4,577
|
)
|
|
|
|
(26,891
|
)
|
|
(28,247
|
)
|
Treasury
stock, at cost, 30,940 shares
|
|
|
(1,938
|
)
|
|
(
1,938
|
)
|
Total
stockholders’ deficit
|
|
|
(28,829
|
)
|
|
(30,185
|
)
|
Total
liabilities and stockholders’ deficit
|
|
$
|
16,047
|
|
$
|
14,661
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Operations and Comprehensive Income
(In
thousands, except per share amounts)
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Sales
|
|
$
|
16,021
|
|
$
|
15,631
|
|
Cost
of sales
|
|
|
10,556
|
|
|
9,197
|
|
Gross
profit
|
|
|
5,465
|
|
|
6,434
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
2,704
|
|
|
2,488
|
|
Research
and development expenses
|
|
|
756
|
|
|
651
|
|
Total
expenses
|
|
|
3,460
|
|
|
3,139
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
2,005
|
|
|
3,295
|
|
|
|
|
|
|
|
|
|
Interest
expense, net of interest income
|
|
|
(587
|
)
|
|
(646
|
)
|
Other
income, net
|
|
|
2
|
|
|
1
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes
|
|
|
1,420
|
|
|
2,650
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(70
|
)
|
|
(23
|
)
|
|
|
|
|
|
|
|
|
Income
from continuing operations before discontinued operations
|
|
|
1,350
|
|
|
2,627
|
|
|
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Loss
from discontinued operations (net of taxes of zero)
|
|
|
(159
|
)
|
|
(536
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,191
|
|
$
|
2,091
|
|
|
|
|
|
|
|
|
|
Other
comprehensive loss:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
(126
|
)
|
|
(108
|
)
|
|
|
|
|
|
|
|
|
Comprehensive
income
|
|
$
|
1,065
|
|
$
|
1,983
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per common share:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
0.13
|
|
$
|
0.26
|
|
Discontinued
operations
|
|
|
(0.01
|
)
|
|
(0.05
|
)
|
|
|
$
|
0.12
|
|
|
0.21
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
10,005
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per common share:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
0.13
|
|
$
|
0.26
|
|
Discontinued
operations
|
|
$
|
(0.01
|
)
|
$
|
(0.05
|
)
|
|
|
$
|
0.12
|
|
$
|
0.21
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,105
|
|
|
10,036
|
|
See
accompanying notes to unaudited 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
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Sales
|
|
$
|
8,084
|
|
$
|
8,223
|
|
Cost
of sales
|
|
|
5,332
|
|
|
4,948
|
|
Gross
profit
|
|
|
2,752
|
|
|
3,275
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
1,406
|
|
|
1,457
|
|
Research
and development expenses
|
|
|
346
|
|
|
340
|
|
Total
expenses
|
|
|
1,752
|
|
|
1,797
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
999
|
|
|
1,478
|
|
|
|
|
|
|
|
|
|
Interest
expense, net of interest income
|
|
|
(289
|
)
|
|
(321
|
)
|
Other
income, net
|
|
|
---
|
|
|
1
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before income taxes
|
|
|
710
|
|
|
1,158
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(47
|
)
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
Income
from continuing operations before discontinued operations
|
|
|
663
|
|
|
1,151
|
|
|
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Loss
from discontinued operations (net of taxes of zero)
|
|
|
(76
|
)
|
|
(264
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
587
|
|
$
|
887
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
167
|
|
|
(46
|
)
|
|
|
|
|
|
|
|
|
Comprehensive
income
|
|
$
|
754
|
|
$
|
841
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per common share:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
0.07
|
|
$
|
0.12
|
|
Discontinued
operations
|
|
|
(0.01
|
)
|
|
(0.03
|
)
|
|
|
$
|
0.06
|
|
$
|
0.09
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
10,038
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per common share
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
0.07
|
|
$
|
0.12
|
|
Discontinued
operations
|
|
|
(0.01
|
)
|
|
(0.03
|
)
|
|
|
$
|
0.06
|
|
$
|
0.09
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,098
|
|
|
10,067
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Cash Flows
(In
thousands)
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2006
|
|
2005
|
|
Cash
flows from operating activities of continuing operations:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,191
|
|
$
|
2,091
|
|
Loss
from discontinued operations
|
|
|
159
|
|
|
536
|
|
Adjustments
to reconcile net income to net cash
|
|
|
|
|
|
|
|
provided
by operating activities of continuing operations:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
175
|
|
|
171
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(1,459
|
)
|
|
(356
|
)
|
Inventories
|
|
|
679
|
|
|
(140
|
)
|
Prepaid
expenses and other current assets
|
|
|
(312
|
)
|
|
(221
|
)
|
Other
assets
|
|
|
--
|
|
|
--
|
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
2,161
|
|
|
(14
|
)
|
Net
cash provided by continuing operations
|
|
|
2,594
|
|
|
2,067
|
|
|
|
|
|
|
|
|
|
Net
cash used in operations of discontinued operations
|
|
|
(1,480
|
)
|
|
(525
|
)
|
|
|
|
|
|
|
|
|
Net
cash from operations
|
|
|
1,114
|
|
|
1,542
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures, net
|
|
|
(292
|
)
|
|
(351
|
)
|
Net
cash used in investing activities
|
|
|
(292
|
)
|
|
(351
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Repayments
of senior debt
|
|
|
(675
|
)
|
|
(375
|
)
|
Net
cash used in financing activities
|
|
|
(675
|
)
|
|
(375
|
)
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash
|
|
|
138
|
|
|
(96
|
)
|
|
|
|
|
|
|
|
|
Increase
in cash and cash equivalents
|
|
|
285
|
|
|
720
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - beginning of the year
|
|
|
1,254
|
|
|
2,040
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - end of the period
|
|
$
|
1,539
|
|
$
|
2,760
|
|
|
|
|
|
|
|
|
|
Supplemental
cash flow disclosure:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for interest expense
|
|
$
|
678
|
|
$
|
375
|
|
|
|
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
52
|
|
$
|
73
|
|
|
|
|
|
|
|
|
|
Common
stock issued for accrued director fees
|
|
$
|
---
|
|
$
|
66
|
|
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 second quarter or the first six months of 2006
are
not necessarily indicative of results for the year.
Inventories,
from continuing operations, are stated at the lower of cost (on the average
or
first-in, first-out method) or market. The composition of inventories at the
end
of the respective periods is as follows (net of reserve of $2,173,000 for 2006
and $2,101,000 for 2005):
|
|
June
30, 2006
|
|
December
31, 2005
|
|
|
|
(in
thousands)
|
|
Parts
and components
|
|
$
|
2,668
|
|
$
|
3,192
|
|
Work-in-process
|
|
|
773
|
|
|
459
|
|
Finished
goods
|
|
|
421
|
|
|
890
|
|
|
|
$
|
3,862
|
|
$
|
4,541
|
|
Note
3: |
Senior
and Subordinated Debt
|
On
June
30, 2006, the Company’s liability to the holder of its senior debt was
$24,124,000. 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
through June 30, 2006 totaling $2,597,500 as required by amendments and
extensions of the loan agreement, of which $926,000 was applied to interest
and
$1,671,500 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
June 30, 2006, the Company’s short-term debt also included $6,144,000 of
subordinated debt, which 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 $5,515,000 as of June 30, 2006, which
represents interest from July 2000 through June 30, 2006, and accrued interest
on the 6% debentures was $139,000. The Company is precluded by the holder of
its
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 three and six months ended June 30, 2006 as all
options are either fully vested or will vest in future periods.
Stock
option activity through the six months ended June 30, 2006 is as
follows:
|
|
Options
|
|
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
at March 31, 2006
|
|
|
309,280
|
|
$
|
1.22
|
|
|
2.71
|
|
$
|
3,240
|
|
Granted
|
|
|
20,000
|
|
|
0.11
|
|
|
9.84
|
|
|
--
|
|
Forfeited
|
|
|
(2,000
|
)
|
|
3.69
|
|
|
--
|
|
|
--
|
|
Exercised
|
|
|
--
|
|
|
--
|
|
|
--
|
|
|
--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
Outstanding at June 30, 2006
|
|
|
327,280
|
|
$
|
1.13
|
|
|
2.91
|
|
$
|
5,690
|
|
Options
Exercisable at June 30, 2006
|
|
|
307,280
|
|
$
|
1.20
|
|
|
2.46
|
|
$
|
4,890
|
|
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 and six
months ended June 30, 2005, there was no pro-forma disclosure as there were
no
unvested options.
Presented
in the table below are the options granted, weighted average fair value using
a
Black Sholes pricing model and total compensation charges, net of estimated
forfeitures:
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Options
|
|
Black
Scholes
|
|
Compensation
|
|
|
|
Granted
|
|
Value
|
|
Charge
|
|
Options
granted subsequent to SFAS 123R
|
|
|
20,000
|
|
$
|
0.0432
|
|
$
|
874
|
|
Non-vested
options granted prior to adoption
|
|
|
|
|
|
|
|
|
|
|
of
SFAS 123R
|
|
|
---
|
|
|
---
|
|
|
---
|
|
Total
|
|
|
20,000
|
|
$
|
|
|
$
|
874
|
|
Unrecognized
stock compensation charges, weighted average stock compensation expenses charged
to operations for the quarter and six months ended June 30, 2006 are as
follows:
|
·
|
$874.00
of total unrecognized compensation cost, net of estimated forfeitures,
related to non-vested share-based compensation arrangements and options
granted subsequent to the January 1, 2006 adoption of SFAS 123R is
outstanding.
|
|
·
|
Compensation
cost is expected to be recognized in the fourth quarter of
2006.
|
A
summary
of our non-vested shares as of June 30, 2006 and changes during the six months
ended June 30, 2006 is presented below:
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
|
|
|
Grant
Date
|
|
|
|
Shares
|
|
Fair
Value
|
|
|
|
|
|
|
|
Non-vested
as of January 1, 2006
|
|
|
---
|
|
|
---
|
|
Granted
|
|
|
20,000
|
|
$
|
0.11
|
|
Vested
|
|
|
---
|
|
|
---
|
|
Forfeited
|
|
|
---
|
|
|
---
|
|
Non-vested
as of June 30, 2006
|
|
|
20,000
|
|
$
|
0.11
|
|
The
Company has two 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, and Signal Processing (“Signal”) whose
products are used in data communication devices that employ high frequency
transformer technology.
Due
to
continuing losses in the Operating Support Systems (“OSS”) division,
combined
with difficulties in marketing OSS products in view of our financial condition,
the
Company decided to exit this operating segment in December, 2003. We
currently limit our OSS activities to the performance of contractual maintenance
and warranty services which are anticipated to expire in June, 2007 (see Note
8
to the unaudited consolidated financial statements). It is currently anticipated
that these services will cease by June 2007. Accordingly, as of June 30, 2006,
the
assets
and liabilities and results of operations of the OSS division have been
segregated and reported separately as discontinued operations on the
Consolidated Financial Statements
present
in this Form 10-Q.
OSS was
engaged in the business whose products automate the testing, provisioning,
maintenance and administration of communication networks and the management
of
support personnel and equipment. Currently we limit OSS activities to the
performance
of
contractual maintenance and warranty services.
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 for the Line and Signal reporting segments.
|
|
Six
Months Ended
|
|
Three
Months Ended
|
|
|
|
June
30, 2006
|
|
June
30, 2005
|
|
June
30, 2006
|
|
June
30, 2005
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
|
|
$
|
13,468,000
|
|
$
|
12,281,000
|
|
$
|
6,981,000
|
|
$
|
6,574,000
|
|
Signal
|
|
|
2,407,000
|
|
|
3,255,000
|
|
|
994,000
|
|
|
1,598,000
|
|
Total
of Continuing Operations
|
|
$
|
15,875,000
|
|
$
|
15,536,000
|
|
$
|
7,975,000
|
|
$
|
8,172,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
|
|
$
|
2,615,000
|
|
$
|
3,109,000
|
|
$
|
1,410,000
|
|
$
|
1,537,000
|
|
Signal
|
|
|
606,000
|
|
|
1,387,000
|
|
|
222,000
|
|
|
689,000
|
|
Total
of Continuing Operations
|
|
$
|
3,221,000
|
|
$
|
4,496,000
|
|
$
|
1,632,000
|
|
$
|
2,226,000
|
|
The
following table reconciles segment totals to consolidated totals:
|
|
Six
Months Ended
|
|
Three
Months Ended
|
|
|
|
June
30, 2006
|
|
June
30, 2005
|
|
June
30, 2006
|
|
June
30, 2005
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue for reportable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
segments
|
|
$
|
15,875,000
|
|
$
|
15,536,000
|
|
$
|
7,975,000
|
|
$
|
8,172,000
|
|
Other
revenue
|
|
|
146,000
|
|
|
95,000
|
|
|
109,000
|
|
|
51,000
|
|
Consolidated
total revenue
|
|
$
|
16,021,000
|
|
$
|
15,631,000
|
|
$
|
8,084,000
|
|
$
|
8,223,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
segment income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
for
reportable segments
|
|
$
|
3,221,000
|
|
$
|
4,496,000
|
|
$
|
1,632,000
|
|
$
|
2,226,000
|
|
Corporate
and unallocated
|
|
|
(1,216,000
|
)
|
|
(1,201,000
|
)
|
|
(633,000
|
)
|
|
(748,000
|
)
|
Consolidated
total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income
|
|
$
|
2,005,000
|
|
$
|
3,295,000
|
|
$
|
999,000
|
|
$
|
1,478,000
|
|
Note
6: |
Legal
Proceedings
|
In
April,
2006, the Company commenced legal action against a former officer of one of
its
operating divisions and against the corporation he is currently employed by,
in
which the Company asserts that the former officer breached his duties to the
Company and engaged in unfair competition by using the Company's confidential
and proprietary information and trade secrets, without authorization, to
manufacture and sell products which are identical in all material respects
to
those sold by the Company’s division which he managed. At this time the Company
is uncertain about the outcome.
Note
7: |
New
Accounting
Pronouncements
|
In
June
2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109. The
objective of this interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement
of
a tax position taken or expected to be taken in a tax return. FIN 48 is
effective for the fiscal years beginning after December 15, 2006. The adoption
of this statement is not expected to have a material effect on our financial
position or results of operations.
Note
8: |
Discontinued
operations
|
Operating
Support Systems (“OSS”)
In
December, 2003, the Company decided to wind down its OSS business. This decision
was made because of continuing losses combined
with difficulties in marketing OSS products in view of our financial
condition. The Company anticipates the discontinuation of this business by
June 30, 2007. Accordingly, as of June 30, 2006, the OSS operating segment
is
reported in the Consolidated Financial Statements as a discontinued operation.
Currently,
its operating activities are limited to the performance
of
contractual maintenance and warranty services.
The
following amounts related to OSS have been segregated from the Company’s
continuing operations and are reported as assets and liabilities of discontinued
operations in the consolidated balance sheet:
|
|
June
30, 2006
|
|
December
31, 2005
|
|
Assets
of discontinued operations:
|
|
|
|
|
|
|
|
Prepaid
expenses
|
|
$
|
39,000
|
|
$
|
35,000
|
|
Accounts
receivable
|
|
|
37,000
|
|
|
184,000
|
|
Inventories
|
|
|
339,000
|
|
|
311,000
|
|
Property,
plant and equipment
|
|
|
39,000
|
|
|
57,000
|
|
Other
assets
|
|
|
1,000
|
|
|
1,000
|
|
Total
assets of discontinued operations
|
|
$
|
455,000
|
|
$
|
588,000
|
|
|
|
|
|
|
|
|
|
Liabilities
of discontinued operations:
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
575,000
|
|
$
|
2,033,000
|
|
Total
liabilities of discontinued operations
|
|
$
|
575,000
|
|
$
|
2,033,000
|
|
Results
of operations for OSS have been segregated from continuing operations and are
reflected as discontinued operations approximately as follows:
|
|
Six
Months Ended June 30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
196,000
|
|
$
|
410,000
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
$
|
(159,000
|
)
|
$
|
(536,000
|
)
|
|
|
Three
Months Ended June 30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
91,000
|
|
$
|
202,000
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
$
|
(76,000
|
)
|
$
|
(264,000
|
)
|
Part
II - Other Information
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:
|
|
Six
Months Ended
|
|
Three
Months Ended
|
|
|
|
June
30,
|
|
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Cost
of sales
|
|
|
66
|
%
|
|
59
|
%
|
|
66
|
%
|
|
60
|
%
|
Gross
profit
|
|
|
34
|
%
|
|
41
|
%
|
|
34
|
%
|
|
40
|
%
|
Selling,
general and administrative expenses
|
|
|
17
|
%
|
|
16
|
%
|
|
17
|
%
|
|
18
|
%
|
Research
and development expenses
|
|
|
5
|
%
|
|
4
|
%
|
|
4
|
%
|
|
4
|
%
|
Operating
income
|
|
|
13
|
%
|
|
21
|
%
|
|
12
|
%
|
|
18
|
%
|
Interest
expense - net
|
|
|
(4
|
%)
|
|
(4
|
%)
|
|
(4
|
%)
|
|
(4
|
%)
|
Other
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Discontinued
operations
|
|
|
(1
|
%)
|
|
3
|
%
|
|
(1
|
%)
|
|
3
|
%
|
Net
income
|
|
|
7
|
%
|
|
13
|
%
|
|
7
|
%
|
|
11
|
%
|
The
Company’s sales, from continuing operations, by product line for the periods
ended June 30, 2006 and 2005 are as follows:
|
|
Six
Months Ended June 30,
|
|
|
|
$(000)
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Line
connection/protection equipment
|
|
$
|
13,468
|
|
|
84
|
%
|
$
|
12,281
|
|
|
79
|
%
|
Signal
Processing
|
|
|
2,407
|
|
|
15
|
%
|
|
3,255
|
|
|
21
|
%
|
Other
|
|
|
146
|
|
|
1
|
%
|
|
95
|
|
|
0
|
%
|
|
|
$
|
16,021
|
|
|
100
|
%
|
$
|
15,631
|
|
|
100
|
%
|
|
|
Three
Months Ended June 30,
|
|
|
|
$(000)
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Line
connection/protection equipment
|
|
$
|
6,981
|
|
|
86
|
%
|
$
|
6,574
|
|
|
80
|
%
|
Signal
Processing
|
|
|
994
|
|
|
12
|
%
|
|
1,598
|
|
|
19
|
%
|
Other
|
|
|
109
|
|
|
2
|
%
|
|
51
|
|
|
1
|
%
|
|
|
$
|
8,084
|
|
|
100
|
%
|
$
|
8,223
|
|
|
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.
We
currently limit our OSS activities to the performance of contractual maintenance
and warranty services which are anticipated to cease in June, 2007 (see Note
8
to the unaudited consolidated financial statements). Accordingly, as of June
30,
2006,
the
Company’s Consolidated Results of Operations present the OSS division as
discontinued operations.
Our
Line
equipment is designed to connect copper-wired telecommunications networks and
to
protect telecommunications equipment from voltage surges. We market this
equipment primarily to telephone operating companies outside the United States
and through distribution to designers, engineers and installers in the United
States. Our Line division operated at a profit for the three and six months
ended June 30, 2006 and June 30, 2005. We market Signal equipment principally
for use in defense and aerospace applications. The Signal division generated
operating profit for the three and six months ended June 30, 2006 and the
comparable periods of 2005. We recognize revenue from Line and Signal products
when the product is shipped.
On
June
30, 2006, our liability to the holder of our senior debt was $24,124,000. 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 Continuing Operations
The
below
narratives discuss the activities of our continuing operations.
Line
equipment sales for the six months ended June 30, 2006, compared to the six
months ended June 30, 2005, increased by $1,187,000 (10%) from $12,281,000
to
$13,468,000. Sales for the three months ended June 30, 2006 increased by
$407,000 (6%) from $6,574,000 in 2005 to $6,981,000 in 2006. The increase in
sales for the six and the three months is the result of increased sales volume
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
sales for the six months ended June 30, 2006 were $2,407,000, compared to
$3,255,000 in the same period of 2005, a decrease of $848,000 (26%). Sales
for
the three months ended June 30, 2006 compared to 2005, decreased by $604,000
(38%) from $1,598,000 to $994,000. The decline in Signal revenue from the first
half of 2006 resulted primarily from sluggish order rates from the military
sector in the first six months of 2006. In addition, the revenue for the six
months ended June 30, 2005 was positively impacted by shipments to customers
from 2004 backlog that were not shipped in 2004 due to cash constraints which
existed back then. Sales
for
the second quarter and six months of 2006 represent shipments of current orders
and backlog.
Gross
margin, for the six months ended June 30, 2006, was 34% compared to 41% for
the
six months ended June 30, 2005. Gross margin for the quarter ended June 30,
2006
was 34% compared to 40% for the quarter ended June 30, 2005. This
decrease for the six months was attributable to a change in products sold to
British Telecommunications during the first quarter of the year (from the higher
gross margin DSL products to the lower margin local loop unbundling products)
and additional freight costs associated with on time deliveries to customers.
The quarter ended June 30, 2006 was negatively impacted primarily by short-term
manufacturing inefficiencies at our assembly facility in Mexico, additional
freight costs and, to a lesser extent, the continuation of sales to British
Telecommunications of lower margin products. Also, our Signal segment gross
margin decreased during the quarter and six months due to sales of lower margin
products.
Selling,
general and administrative expenses increased by $216,000 (9%) from $2,488,000
to $2,704,000 for the six months ended June 30, 2006 compared to 2005. For
the
quarter ended June 30, 2006 selling, general and administrative expenses
decreased by $51,000 (4%) from $1,457,000 in 2005 to $1,406,000 in 2006. The
increase for the six months ended June 30, 2006 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.
Additionally, 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 were winding down that operation in the
first
quarter
For
the
six months ended June 30, 2006 compared to 2005, research and development
expenses increased by $105,000 (16%) to $756,000 from $651,000. For the quarter
ended June 30, 2006 compared to 2005, research and development expenses
increased by $6,000 (2%) to $346,000 from $340,000. The increase for the six
months resulted primarily from increased spending by our line
connection/protection division of approximately $100,000 to enhance our existing
line products and develop new products.
As
a
result of the above, for the six months ended June 30, 2006, we had an operating
income from continuing operations of $2,005,000 compared with $3,295,000 in
the
same period of 2005. We had an operating income of $999,000 for the quarter
ended June 30, 2006 as compared with $1,478,000 in the same period of
2005.
We
continue to accrue interest on obligations to the holder of $1,514,000 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
$22,610,000, 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 six months ended June 30, 2006 relates to federal, state
and
foreign taxes.
As
a
result of the foregoing, we generated net income, from continuing operations,
of
$1,350,000, $.13 per share (basic and diluted), for the six months ended June
30, 2006, compared with $2,627,000, $0.26 per share (basic and diluted), in
2005. The net income for the three months ended June 30, 2006, from continuing
operations, was $663,000, $.07 per share (basic and diluted), compared with
$1,151,000, $0.12 per share (basic and diluted) in 2005.
DISCONTINUED
OPERATIONS
Operating
Support Systems (“OSS”)
In
December, 2003, the Company decided to wind down its OSS business. This decision
was made because of continuing losses combined
with difficulties in marketing OSS products in view of our financial condition.
The Company anticipates the discontinuation of this business by June 30, 2007.
Accordingly, as of June 30, 2006, the OSS operating segment is reported in
the
Consolidated Financial Statements as a discontinued operation. Currently,
its operating activities are limited to the performance
of
contractual maintenance and warranty services. (See
Note
8 to the unaudited consolidated financial statements.)
Liquidity
and Capital Resources
At
June
30, 2006, we had cash and cash equivalents of $1,539,000 compared with
$1,254,000 at December 31, 2005. Our working capital deficit at June 30, 2006
was $32,536,000 compared to a working capital deficit of $33,719,000 at December
31, 2005, a reduction of $1,183,000 in our working capital deficit since
December 31, 2005. This decrease in the working capital deficiency reflects
our
improved operating results for the six months ended June 30, 2006. During the
six months of 2006, we made payments to the holder of our senior debt of
$675,000, of which
approximately $124,000 was applied to interest and the remaining $551,000 was
applied to principal.
As
of
June 30, 2006, our debt includes $24,124,000 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 subordinated debt
that
became due on July 3, 2001, and $385,000 of 6% debentures that became due on
July 2, 2002. We were unable to pay the interest payment on the subordinated
notes of approximately $5,515,000 that represents interest from July 2000
through June 2006, or the interest on the subordinated debentures of
approximately $139,000. 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 June 30, 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, or seek to sell one or more of our divisions. As a result
of
the significant reduction in the operations of our OSS division, we do not
believe that we will be able to sell that division on terms which would generate
any significant cash. Further, the dependence of our copper business on several
significant customers, principally British Telecommunications, are major factors
which may impair our ability to sell the copper division or our business as
a
whole or may affect the terms on which we would be able to sell the business.
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 the Company’s 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.
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
|
Evaluation
of 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.
Changes
in Internal Control over Financial Reporting
There
has
been no change in our internal control over financial reporting that occurred
during the fiscal 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.
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:
August 14, 2006 |
By: |
/s/
Edward B. Kornfeld |
|
Edward
B. Kornfeld |
|
Chief
Executive Officer
and
Chief Financial Officer
|