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 September 30, 2007
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) 10,075,561 shares as of October 26,
2007.
PART
I.- FINANCIAL INFORMATION
Item
1- Financial
Statements
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Consolidated
Balance Sheets
(In
thousands, except shares and par value)
|
|
Unaudited
|
|
|
|
|
|
September
30,
|
|
December
31,
|
|
Assets
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
396
|
|
$
|
2,102
|
|
Accounts
receivable - trade, less allowance for doubtful accounts of $23 in
2007
and $13 in 2006
|
|
|
5,514
|
|
|
5,417
|
|
Inventories
|
|
|
5,976
|
|
|
4,591
|
|
Prepaid
expenses and other current assets
|
|
|
480
|
|
|
697
|
|
Assets
of discontinued operations
|
|
|
—
|
|
|
383
|
|
Total
current assets
|
|
|
12,366
|
|
|
13,190
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
1,601
|
|
|
1,571
|
|
Goodwill,
net
|
|
|
2,961
|
|
|
2,961
|
|
Other
assets
|
|
|
51
|
|
|
51
|
|
Long
term assets of discontinued operations
|
|
|
—
|
|
|
11
|
|
Total
assets
|
|
$
|
16,979
|
|
$
|
17,784
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Deficit
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Senior
debt, principal amount
|
|
$
|
23,373
|
|
$
|
23,513
|
|
Subordinated
notes, principal amount
|
|
|
6,144
|
|
|
6,144
|
|
6%
convertible subordinated debentures, principal amount
|
|
|
385
|
|
|
385
|
|
Accounts
payable
|
|
|
5,472
|
|
|
6,106
|
|
Accrued
expenses and other
|
|
|
2,478
|
|
|
2,136
|
|
Accrued
interest payable
|
|
|
7,157
|
|
|
6,127
|
|
Liabilities
of discontinued operations
|
|
|
—
|
|
|
425
|
|
Total
current liabilities
|
|
|
45,009
|
|
|
44,836
|
|
|
|
|
|
|
|
|
|
Deferred
compensation, net of current portion
|
|
|
724
|
|
|
771
|
|
Total
long-term liabilities
|
|
|
724
|
|
|
771
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
45,733
|
|
|
45,607
|
|
|
|
|
|
|
|
|
|
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 10,106,501
shares in 2007 and 10,106,501 in 2006
|
|
|
101
|
|
|
101
|
|
Additional
paid-in capital
|
|
|
76,125
|
|
|
76,125
|
|
Accumulated
deficit
|
|
|
(98,765
|
)
|
|
(97,713
|
)
|
Accumulated
other comprehensive loss:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
(4,277
|
)
|
|
(4,398
|
)
|
|
|
|
(26,816
|
)
|
|
(25,885
|
)
|
Treasury
stock, at cost, 30,940 shares
|
|
|
(1,938
|
)
|
|
(1,938
|
)
|
Total
stockholders’ deficit
|
|
|
(28,754
|
)
|
|
(27,823
|
)
|
Total
liabilities and stockholders’ deficit
|
|
$
|
16,979
|
|
$
|
17,784
|
|
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)
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Sales
|
|
$
|
21,922
|
|
$
|
25,039
|
|
Cost
of sales
|
|
|
15,139
|
|
|
16,593
|
|
Gross
profit
|
|
|
6,783
|
|
|
8,446
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
4,526
|
|
|
4,090
|
|
Research
and development expenses
|
|
|
1,201
|
|
|
1,164
|
|
Total
expenses
|
|
|
5,727
|
|
|
5,254
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
1,056
|
|
|
3,192
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(1,536
|
)
|
|
(848
|
)
|
Other
income (expense), net
|
|
|
7
|
|
|
2
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before income taxes
|
|
|
(
473
|
)
|
|
2,346
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(58
|
)
|
|
(92
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before discontinued
operations
|
|
|
(531
|
)
|
|
2,254
|
|
|
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Loss
from discontinued operations (net of taxes of zero)
|
|
|
(87
|
)
|
|
(245
|
)
|
Write
off of net assets of discontinued operations
|
|
|
(434
|
)
|
|
—
|
|
Total
loss from discontinued operations
|
|
|
(521
|
)
|
|
(245
|
)
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,052
|
)
|
$
|
2,009
|
|
|
|
|
|
|
|
|
|
Other
comprehensive (loss):
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
(121
|
)
|
|
(173
|
)
|
|
|
|
|
|
|
|
|
Comprehensive
income (loss)
|
|
$
|
(1,173
|
)
|
$
|
1,836
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per share of common stock:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(.05
|
)
|
$
|
0.22
|
|
Discontinued
operations
|
|
|
(.05
|
)
|
|
(0.02
|
)
|
|
|
$
|
(.10
|
)
|
$
|
0.20
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
10,076
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per share of common stock:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(.05
|
)
|
$
|
0.22
|
|
Discontinued
operations
|
|
|
(.05
|
)
|
|
(0.02
|
)
|
|
|
$
|
(.10
|
)
|
$
|
0.20
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
10,104
|
|
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
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2007
|
|
2006
|
|
Sales
|
|
$
|
6,651
|
|
$
|
9,018
|
|
Cost
of sales
|
|
|
4,563
|
|
|
6,036
|
|
Gross
profit
|
|
|
2,088
|
|
|
2,982
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
1,533
|
|
|
1,386
|
|
Research
and development expenses
|
|
|
423
|
|
|
408
|
|
Total
expenses
|
|
|
1,956
|
|
|
1,794
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
132
|
|
|
1,188
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(547
|
)
|
|
(261
|
)
|
Other
income, net
|
|
|
9
|
|
|
—
|
|
Income
(loss) from continuing operations before income taxes
|
|
|
(406
|
)
|
|
927
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(19
|
)
|
|
(22
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before discontinued
operations
|
|
|
(425
|
)
|
|
905
|
|
|
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Loss
from discontinued operations (net of taxes of zero)
|
|
|
—
|
|
|
(87
|
)
|
Write
off of net assets of discontinued operations
|
|
|
—
|
|
|
—
|
|
Total
loss from discontinued operations
|
|
|
—
|
|
|
(87
|
)
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(425
|
)
|
$
|
818
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
(26
|
)
|
|
(47
|
)
|
|
|
|
|
|
|
|
|
Comprehensive
income (loss)
|
|
$
|
(451
|
)
|
$
|
771
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per share of common stock:
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(.04
|
)
|
$
|
0.09
|
|
Discontinued
operations
|
|
|
(—
|
)
|
|
(0.01
|
)
|
|
|
$
|
(.04
|
)
|
$
|
0.08
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
10,076
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per share of common stock
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(.04
|
)
|
$
|
0.09
|
|
Discontinued
operations
|
|
|
(—
|
)
|
|
(0.01
|
)
|
|
|
$
|
(
.04
|
)
|
$
|
0.08
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,076
|
|
|
10,103
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Cash Flows
(In
thousands)
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2007
|
|
2006
|
|
Cash
flows from operating activities of continuing operations:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,052
|
)
|
$
|
2,009
|
|
Loss
from discontinued operations
|
|
|
521
|
|
|
245
|
|
Adjustments
to reconcile net income (loss) to net cash provided by (used in)
operating
activities of continuing operations:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
281
|
|
|
193
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(18
|
)
|
|
(2,883
|
)
|
Inventories
|
|
|
(1,346
|
)
|
|
625
|
|
Prepaid
expenses and other current assets
|
|
|
209
|
|
|
(349
|
)
|
Other
assets
|
|
|
—
|
|
|
4
|
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
240
|
|
|
2,879
|
|
Net
cash (used in) provided by continuing operations
|
|
|
(1,165
|
)
|
|
2,723
|
|
|
|
|
|
|
|
|
|
Net
cash used in operations of discontinued operations
|
|
|
(87
|
)
|
|
(1,406
|
)
|
|
|
|
|
|
|
|
|
Net
cash (used in) provided by operating activities
|
|
|
(1,252
|
)
|
|
1,317
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures, net
|
|
|
(304
|
)
|
|
(149
|
)
|
Net
cash used in investing of discontinued operations
|
|
|
—
|
|
|
(184
|
)
|
Net
cash used in investing activities
|
|
|
(304
|
)
|
|
(333
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Increase
in senior debt
|
|
|
—
|
|
|
154
|
|
Repayments
of senior debt
|
|
|
(140
|
)
|
|
(1,013
|
)
|
Net
cash used in financing activities
|
|
|
(140
|
)
|
|
(859
|
)
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash
|
|
|
(10
|
)
|
|
(24
|
)
|
|
|
|
|
|
|
|
|
Increase
(decrease) in cash and cash equivalents
|
|
|
(1,706
|
)
|
|
101
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - beginning of the year
|
|
|
2,102
|
|
|
1
,254
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - end of the period
|
|
$
|
396
|
|
$
|
1,355
|
|
|
|
|
|
|
|
|
|
Supplemental
cash flow disclosure:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for interest expense
|
|
$
|
568
|
|
$
|
159
|
|
|
|
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
—
|
|
$
|
74
|
|
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, 2006.
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, 2006 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 third quarter or the first nine months of 2007
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 method)
or market. The composition of inventories at the end of the respective periods
is as follows (net of reserve of $1,953,000 for 2007 and $2,345,000 for
2006):
|
|
September 30, 2007
|
|
December 31, 2006
|
|
|
|
(In
thousands)
|
|
Parts
and components
|
|
$
|
3,535
|
|
$
|
3,637
|
|
Work-in-process
|
|
|
1,096
|
|
|
543
|
|
Finished
goods
|
|
|
1,345
|
|
|
411
|
|
|
|
$
|
5,976
|
|
$
|
4,591
|
|
Note
3: Senior and Subordinated Debt
On
September 30, 2007, the Company’s liability to its senior debt holder was
$23,373,000 plus accrued interest of $312,000. 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 September 30, 2007 totaling
$2,876,000 as required by amendments and extensions of the loan agreement,
of
which $659,000 was applied to interest and $2,217,000 was applied to principal.
On February 7, 2007 Cheyne Special Situations Fund L.P (“Cheyne”) purchased the
Company’s senior debt of approximately $23,400,000 from SHF IX, LLC and
subsequently extended the maturity of the senior debt to February 1, 2008.
Through September 30, 2007, the Company had made interest payments of
approximately $493,000 to Cheyne. The Company can not give any assurance that
the holder of its senior debt will extend the loan beyond February 1, 2008.
Any
adverse event, including declines in business, could have an effect on the
decision of the senior debt holder to extend or demand payment on the notes.
If
the senior debt holder does not extend the maturity of the Company’s senior debt
beyond February 1, 2008 or if the senior debt holder demands payment of all
or a
significant portion of the senior debt when due, the Company will not be able
to
continue in business, and it is likely that it will seek protection under the
Bankruptcy Code. See Note 8 regarding additional loans to the Company,
subsequent to September 30, 2007.
As
of
September 30, 2007, the Company’s short-term debt also included $6,144,000
principal amount of subordinated notes that became due on July 3, 2001 and
$385,000 principal amount of 6% debentures which became due on July 2, 2002.
The
interest rate on the 6% debentures increased to 8.26% as a result of our failure
to make interest payments on the debentures since July 1, 2000 and our failure
to pay principal on July 2, 2002. The interest rate on the subordinated note
increased to 15% as a result of our failure to pay the subordinated notes when
due on July 3, 2001. Accrued interest on the subordinated notes and the 6%
debentures was approximately $6,844,000, which represents interest through
September 30, 2007. We are precluded by our senior debt holder from paying
any
principal or interest on the subordinated debt.
Note
4: Accounting for Stock Based Compensation
For
the
nine months ended September 30, 2007, the Company issued nonqualified stock
options to purchase 20,000 shares of common stock under its 1999 Plan that
provides for the automatic grant to non-management directors. This 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 this Plan have a term
of
10 years. The Company uses the Black-Scholes valuation model and straight-line
amortization of compensation expense over the requisite service period when
granting stock options. All options previously granted are fully vested. Based
on the Black-Scholes valuation model there is no non-cash compensation expense
attributable to stock options granted during the quarters. Stock compensation
expense for all vested options to date is diminutive.
Note
5: Segment Data
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.
The
Company formerly had a third reportable segment - Operating Support Systems
(“OSS”), which was engaged in the business of marketing, manufacturing and
selling products that automated the testing, provisioning, maintenance and
administration of communication networks and the management of support personnel
and equipment. Due to continuing losses in the OSS division, combined
with difficulties in marketing OSS products in view of the Company’s financial
condition, the
Company decided in December 2003 that it would discontinue this operating
segment. As a result, the Company limited
the OSS activities to the performance of contractual maintenance and warranty
services through June 2007 (see Note 7). Accordingly, as of June 30, 2007,
the
net
assets of $434,000 of this operation were written off and the results of
operations of the OSS division have been segregated and reported separately
as
discontinued operations on the consolidated financial statements
in this
Form 10-Q.
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, 2006, 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.
|
|
Nine
Months Ended
|
|
Three
Months Ended
|
|
|
|
September
30,
2007
|
|
September
30,
2006
|
|
September
30,
2007
|
|
September
30,
2006
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
|
|
$
|
18,228,000
|
|
$
|
21,308,000
|
|
$
|
5,594,000
|
|
$
|
7,694,000
|
|
Signal
|
|
|
3,694,000
|
|
|
3,731,000
|
|
|
1,057,000
|
|
|
1,324,000
|
|
Total
of Continuing Operations
|
|
$
|
21,922,000
|
|
$
|
25,039,000
|
|
$
|
6,651,000
|
|
$
|
9,018,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Line
|
|
$
|
2,383,000
|
|
$
|
3,956,000
|
|
$
|
637,000
|
|
$
|
1,341,000
|
|
Signal
|
|
|
933,000
|
|
|
1,067,000
|
|
|
235,000
|
|
|
462,000
|
|
Total
of Continuing Operations
|
|
$
|
3,316,000
|
|
$
|
5,023,000
|
|
$
|
872,000
|
|
$
|
1,803,000
|
|
The
following table reconciles segment totals to consolidated totals:
Operating
income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
segment income for reportable segments
|
|
$
|
3,316,000
|
|
$
|
5,023,000
|
|
$
|
872,000
|
|
$
|
1,803,000
|
|
Corporate
and unallocated
|
|
|
(2,260,000
|
)
|
|
(1,831,000
|
)
|
|
(740,000
|
)
|
|
(615,000
|
)
|
Consolidated
total operating income
|
|
$
|
1,056,000
|
|
$
|
3,192,000
|
|
$
|
132,000
|
|
$
|
1,188,000
|
|
Note
6: 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 did not have an effect on our financial position or results
of
operations.
In
September 2006, FASB issued SFAS No. 157, “Fair Value Measurements,”
which provides enhanced guidance for using fair value to measure assets and
liabilities. SFAS No. 157 establishes a common definition of fair value,
provides a framework for measuring fair value under U.S. GAAP and expands
disclosures requirements about fair value measurements. SFAS No. 157 is
effective for financial statements issued in fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The
adoption of this statement is not expected to have a material effect on our
financial position or results of operations.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" or SFAS 159. SFAS 159 provides
companies with an option to report selected financial assets and liabilities
at
fair value. SFAS 159 is effective for fiscal years beginning after November
15,
2007. We are currently evaluating the impact of implementation of SFAS No.
159
on our consolidated financial statements.
Note
7: Discontinued
operations
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 the Company’s financial
condition. As of June 30, 2007, the Company discontinued operating this
business. Accordingly, as of June 30, 2007, the OSS net assets of $434,000
were
written off and the operations of the segment are reported in the Consolidated
Financial Statements as a discontinued operation.
Results
of operations for OSS have been segregated from continuing operations and are
reflected as discontinued operations approximately as follows:
|
|
Nine Months Ended September 30,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
100,000
|
|
$
|
276,000
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
|
(87,000
|
)
|
|
(245,000
|
)
|
Write
off of net assets of discontinued operations
|
|
|
(434,000
|
)
|
|
—
|
|
Loss
from discontinued operations
|
|
$
|
(521,000
|
)
|
$
|
(245,000
|
)
|
|
|
Three Months Ended September 30,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
—
|
|
$
|
80,000
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
|
—
|
|
|
(87,000
|
)
|
Write
off of net assets of discontinued operations
|
|
|
—
|
|
|
—
|
|
Loss
from discontinued operations
|
|
$
|
—
|
|
$
|
(87,000
|
)
|
Note
8: Subsequent
events
On
October 23, 2007 the Company borrowed $1,000,000 (“the New Note”) from Cheyne ,
our senior debt holder. Interest accrues at an amount equal to the six month
Libor rate plus 10%. Principal and accrued interest is payable December 1,
2007
and January 1, 2008, based on average excess cash availability over $250,000.
The principal balance of the note and accrued interest is due on February 1,
2008.
The
new
note is collateralized by all of the assets which are secured to the existing
senior debt holder.
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:
|
|
Nine
Months Ended
September
30,
|
|
Three
Months Ended
September
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Cost
of sales
|
|
|
69
|
%
|
|
66
|
%
|
|
69
|
%
|
|
67
|
%
|
Gross
profit
|
|
|
31
|
%
|
|
34
|
%
|
|
31
|
%
|
|
33
|
%
|
Selling,
general and administrative expenses
|
|
|
21
|
%
|
|
17
|
%
|
|
23
|
%
|
|
16
|
%
|
Research
and development expenses
|
|
|
5
|
%
|
|
5
|
%
|
|
6
|
%
|
|
4
|
%
|
Operating
income
|
|
|
5
|
%
|
|
12
|
%
|
|
2
|
%
|
|
13
|
%
|
Interest
expense - net
|
|
|
(7
|
)%
|
|
(3
|
)%
|
|
(8
|
)%
|
|
(3
|
)%
|
Income
(loss) from continuing operations
|
|
|
(2
|
)%
|
|
9
|
%
|
|
(6
|
)%
|
|
10
|
%
|
Loss
from discontinued operations
|
|
|
(3
|
)%
|
|
(1
|
)%
|
|
(0
|
)%
|
|
(1
|
)%
|
Net
(loss) income
|
|
|
(5
|
)%
|
|
8
|
%
|
|
(6
|
)%
|
|
9
|
%
|
The
Company’s sales, from continuing operations, by product line for the periods
ended September 30, 2007 and 2006 are as follows:
|
|
Nine
Months Ended September 30,
|
|
|
|
$(000)
|
|
|
|
2007
|
|
2006
|
Line
|
|
$
|
18,228
|
|
|
83
|
%
|
$
|
21,308
|
|
|
85
|
%
|
Signal
|
|
|
3,694
|
|
|
17
|
%
|
|
3,731
|
|
|
15
|
%
|
|
|
|
21,922
|
|
|
100
|
%
|
$
|
25,039
|
|
|
100
|
%
|
|
|
Three
Months Ended September 30,
|
|
|
|
$(000)
|
|
|
|
2007
|
|
|
2006
|
|
Line
|
|
$
|
5,594
|
|
|
84
|
%
|
$
|
7,694
|
|
|
85
|
%
|
Signal
|
|
|
1,057
|
|
|
16
|
%
|
|
1,324
|
|
|
15
|
%
|
|
|
$
|
6,651
|
|
|
100
|
%
|
$
|
9,018
|
|
|
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
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 generated net income from operations for the three
and
nine months ended September 30, 2007 and the comparable periods of 2006. We
market Signal equipment principally
for use in defense and aerospace applications. The Signal division generated
net
income from operations for the three and nine months ended June 30, 2007 and
2006. We recognize revenue from Line and Signal products when the product is
shipped.
On
September 30, 2007, our liability to our senior debt holder was $23,373,000
plus
accrued interest of $312,000. On
February 7, 2007, Cheyne purchased our senior debt of $23,400,000 from SHF
IX,
LLC and subsequently extended the maturity of our senior debt to February 1,
2008. In October 2007, Cheyne lent us an additional $1,000,000 which is due
on
February 1, 2008. We cannot give any assurance that our senior debt holder
will
extend the maturity date beyond February 1, 2008. Any adverse event, including
declines in business, could have an effect on the decision of our senior debt
holder to extend or demand payment on the notes. If our senior debt holder
does
not extend the maturity of our senior debt beyond February 1, 2008 or if our
senior debt holder demands payment of all or a significant portion of the senior
debt when due, we will not be able to continue in business, and it is likely
that we will seek protection under the Bankruptcy Code.
We
are
very dependent upon a small number of customers, particularly British
Telecommunications. Total
sales to British Telecommunications, consisting of direct sales and sales to
systems integrators for British Telecommunications (including Fujitsu) were
$10,200,000 (47 % of sales) for the nine months ended September 30, 2007,
$20,000,000 (62%) for the year end 2006, $13,900,000 (50%) for the year 2005
and
$13,600,000 (50%) for the year 2004. To the extent that British
Telecommunications reduces its purchases from, or purchases products at a price
which results in a reduced gross margin, our ability to operate profitably
will
be impaired. During the nine months ended September 30, 2007, British
Telecommunication changed its equipment purchase practices, with a result that
our sales to British Telecommunications and its systems integrators declined
from $15,500,000 for the nine months ended September 30, 2006 to $10,200,000
for
the nine months ended September 30, 2007. This decline in sales is the principal
reason for our loss from continuing operation of $531,000 as compared to income
of $2,254,000 for the comparable period of 2006. We may not be able to replace
this business from other customers and we cannot give any assurance that British
Telecommunications will increase its purchases from us in the
future.
We
are
engaged in discussions with Cheyne and the holders of our subordinated debt
and
other creditors regarding the restructuring of our debt. Any such restructuring,
if approved by our lenders and our stockholders, would result in both a
reduction of senior,subordinated debt and other debt and a significant increase
in the number of our outstanding shares of common stock. If we are unable to
increase our sales to a level where we can operate profitably or if we are
unable to obtain stockholder approval, we may not be able to effect a debt
restructuring, in which event 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 nine months ended September 30, 2007, compared to the
nine months ended September 30, 2006, decreased by $3,080,000 (14%) from
$21,308,000 to $18,228,000. Sales for the three months ended September 30,
2007
decreased by $2,100,000 (27%) from $7,694,000 in 2006 to $5,594,000 in 2007.
The
decrease in sales for the nine and the three months is the result of a
significant decline in orders from British Telecommunications that was partially
offset by higher demand for connection and protection product from North America
customers. The increased demand of connection and protection product was
$1,908,000 and $541,000 for the nine and three months ending September 30,
2007,
respectively. A
significant percentage of our revenues are derived from British
Telecommunications and its installers. Any continuation of the significant
reductions in the level of business from British Telecommunications and its
installers could continue to have a material adverse effect upon both our
revenue and net income. Thus far this year we have experienced a significant
drop off of orders from British Telecommunications’ installers, although direct
sales to British Telecommunications remain significant.
Signal
sales for the nine months ended September 30, 2007 were $3,694,000, compared
to
$3,731,000 in the same period of 2006, a decrease of $37,000 (1%). Sales
for the
three months ended September 30, 2007 compared to 2006, decreased by $267,000
(20%) from $1,324,000 to $1,057,000. The decline in Signal revenue for the
third
quarter of 2007 was $267,000 (20%) primarily due to the deferral of anticipated
orders from the military sector resulting from Congress' failure to approve
the
U.S. military budget.
Gross
margin for the nine months ended September 30, 2007 was 31% compared to 34%
for
the nine months ended September
30, 2006. Gross margin for the quarter ended September 30, 2007 was 31% compared
to 33% for the quarter ended September 30, 2006. The decrease for the quarter
and nine months is primarily related to a change in product mix sold to British
Telecommunications from the higher gross profit DSL products to the lower
margin
local loop unbundling products and less absorption of manufacturing overhead
due
to the lower level of revenue.
Our
Signal segment gross margin slightly increased during the quarter and nine
months due to sales mix.
Selling,
general and administrative expenses increased by $436,000 (11%) from $4,090,000
to $4,526,000 for the nine months ended September 30, 2007 compared to 2006.
For
the quarter ended September 30, 2007 selling, general and administrative
expenses increased by $147,000 (11%) from $1,386,000 in 2006 to $1,533,000
in
2007.
The
selling expense increase for the nine months ended September 30, 2007 relates
primarily to increased commission expenses. Selling expenses decreased in the
third quarter primarily due to less advertising expenses, somewhat offset by
higher commission, when compared to the 2006 quarter. General and administrative
costs increased, for the nine months and the quarter, primarily due to increased
expenses related to our debt restructuring efforts.
For
the
nine months ended September 30, 2007 compared to 2006, research and development
expenses increased by $37,000 (3%) to $1,201,000 from $1,164,000. For the
quarter ended September 30, 2007 compared to 2006, research and development
expenses increased by $15,000 (4%) to $423,000 from $408,000. The increase
for
the nine months and the quarter resulted primarily from increased spending
by
our line division to enhance our existing line products and develop new
products.
As
a
result of the foregoing, for the nine months ended September 30, 2007, we had
an
operating income from continuing operations of $1,056,000 compared with
$3,192,000 in the same period of 2006. We had an operating income from
continuing operations of $132,000 for the quarter ended September 30, 2007
as
compared with $1,188,000 in the same period of 2006.
Interest
expense, net, for the nine months ended September 30, 2007 was $1,536,000,
an
increase of $688,000 from $848,000 for the nine months ended September 30,
2006.
For the three months ended September 30, 2007 the interest expense was $547,000
compared to $261,000 for the comparable period last year. These increases of
$688,000 and $286,000 for the nine months and three months, respectively, are
primarily related to interest on our senior debt under the terms of our
extension agreement with the senior debt holder. We do not accrue interest
on
the entire amount of the senior debt of $23,373,000 under the terms of our
agreement with the holder of our senior debt. Interest has accrued from February
7, 2007 on $10,000,000 of the senior debt at 12.5% as a result of the terms
of
the February 7, 2007 extension of the maturity of our senior debt.
Income
tax expense for the quarter and nine months ended September 30, 2007 relates
to
state and foreign taxes. No federal income tax expense has been provided due
to
losses incurred during the nine month period
As
a
result of the foregoing, we generated a net loss from continuing operations
of
($531,000), or ($.05) per share (basic and diluted), for the nine months ended
September 30, 2007, compared with net income from continuing operations of
$2,254,000, or $.22 per share (basic and diluted) in 2006. The net loss for
the
three months ended September 30, 2007, from continuing operations, was
($425,000), or ($.04) per share (basic and diluted), compared with net income
of
from continuing operations $905,000, or $.09 per share (basic and diluted)in
the
comparable quarter of 2006.
Liquidity
and Capital Resources
At
September 30, 2007, we had cash and cash equivalents of $396,000 compared with
$2,102,000 at December 31, 2006. The reduction in our cash position primarily
reflects increases of $97,000 in accounts receivable and $1,385,000 in
inventory, a decrease of $634,000 in accounts payable and payments of $633,000
with respect to our senior debt, of which $140,000 was principal and $493,000
was interest. These factors were also reflected in our working capital deficit
at September 30, 2007 of $32,643,000, as compared with a working capital deficit
of $31,646,000 at December 31, 2006, an increase of $997,000 in our working
capital deficit.
During
the first nine months of 2007, we paid $633,000 to our senior debt holder of
which approximately $140,000 was applied to principal and $493,000 was applied
to interest.
As
of
September 30, 2007, our senior debt includes $23,373,000 of principal and
$312,000 of accrued interest, which matures on February 1, 2008; and $6,529,000
of principal and $6,844,000 of accrued interest on our subordinated notes and
6%
debentures that became due on July 3, 2001 and July 2, 2002, respectively.
We
are prohibited by our senior debt holder from paying principal or interest
on
any of the subordinated debt. At September 30, 2007, we did not have sufficient
resources to repay either the senior lender or the subordinated lenders and
it
is unlikely that we can generate such cash from our operations. Subsequent
to
the quarter ended September 30, 2007 the Company borrowed $1,000,000 from Cheyne
Special Situation Fund, our senior debt holder in order to meet current working
capital requirements. This loan, along with the existing senior debt, matures
on
February 1, 2008.
As
of
June 30, 2007, the Company discontinued operating the OSS division. Accordingly,
as of June 30, 2007, the OSS net assets of $434,000 were written off and the
operations of the OSS segment are reported in the Consolidated Financial
Statements as a discontinued operation.
We
are
seeking to address our working capital and liquidity problems by seeking a
restructuring of our senior and subordinated debts as well as significant
amounts of unsecured debt due to third parties. Although the debt restructuring,
if implemented, will improve our working capital, it will not provide us with
any additional cash for our operations. Our only source of funds is Cheyne,
which advanced us $1,000,000 in October 2007. However, our continuing losses
and
the uncertainty of any significant increase in business from British
Telecommunications will increase the difficulties in obtaining financings from
other sources, and we cannot give any assurance that Cheyne will provide us
with
any additional funding if the need arises. Any restructuring of our Company
will
result in very significant dilution to the holders of our common stock and
will
require the approval of the holders of our common stock and subordinated debt.
If we do not restructure our debt and the senior lender does not extend the
maturity of our senior debt beyond February 1, 2008, or if our senior debt
holder demands payment of all or a significant portion of the senior debt when
due, whether on February 1, 2008 or upon the expiration of a subsequent
extension, we will not be able to continue in business, and it is likely that
we
will seek protection under the Bankruptcy Code.
We
have
in the past, and may in the future, consider the sale of one or more of our
divisions. However, all of our past discussions terminated without any agreement
and we cannot give any assurance that we would be able to effect any sale of
our
business or that such a sale would not be part of a bankruptcy
reorganization.
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, 2006 and in the Form 10-Q 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
Management’s
assessment identified the following weaknesses at December 31, 2006 in our
internal control over financial reporting and, subsequent to December 31, 2006,
we took the following steps to address those weaknesses. Accordingly, 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
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, 2006, which could materially
affect our business, financial condition or future results. The risks described
in our Annual Report on Form 10-K and in this Form 10-Q are not the only risks
facing our Company.
During
the quarter and nine months ended September 30, 2007, we sustained declines
in
revenue from our largest customer, British Telecommunications, from the
comparable three and nine month periods of 2006, and, based on a change in
the
product mix, our gross margin declined on our sales to British
Telecommunications. Due to our reliance on significant business from British
Telecommunications, our revenue and net income could be impaired by any material
reduction of sales to British Telecommunications or any material reduction
in
the gross margin on sales to British Telecommunications
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
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.
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PORTA
SYSTEMS CORP.
|
|
|
|
Dated:
November 13, 2007
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By
|
/s/Edward
B. Kornfeld
|
|
|
Edward
B. Kornfeld
|
|
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Chief
Executive Officer
|
|
|
and
Chief Financial Officer
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