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PART I
ITEM 1 - Business
Overview
Performance Technologies, Incorporated (the "Company") is a supplier of
innovative hardware and software products for a broad range of communications
infrastructure, including traditional data communications and wireline/wireless
telecommunication systems. The Company's forward looking development efforts are
directed at future growth opportunities that utilize the evolving IP (Internet
Protocol) standards for communications and networking equipment. IP-based
communications and systems products are the foundation for next-generation
telecommunications systems and services, as well as embedded systems for video,
data communications and mass storage applications. The Company focuses on high
availability network infrastructure solutions that include network access
products, embedded Ethernet switching products and integrated Signaling System 7
systems. Customers who use the Company's products and technologies include:
telecommunications equipment manufacturers (TEMs), communications service
providers/operators, international mobile/cellular wireless operators and
embedded systems platform suppliers/integrators.
Since its founding in 1981 as a Delaware corporation, the Company has
consistently designed innovative solutions for a variety of computer and
communications architectures and has a history of adapting its products to a
constantly changing technology-driven marketplace. The Company has focused its
efforts on providing communications and embedded product solutions where
reliability and performance are key customer requirements.
The Company's annual operating performance is subject to various risks and
uncertainties. The following discussion should be read in conjunction with the
Consolidated Financial Statements and related notes included elsewhere herein,
as well as the section appearing in Item 1 of this Form 10-K under the heading
"Risk Factors." The Company's future operating results may be affected by
various trends and factors, which are beyond the Company's control. These
include, among other factors, general business and economic conditions, rapid or
unexpected changes in technologies, cancellations or delays of customer orders
including those associated with "design wins," changes in the product or
customer mix of sales, delays in new product development, customer delays in
qualification of products and delays in customer acceptance of new products.
Important Year 2001 Milestones
The market environment was very different at the end of 2001 from the
environment at the beginning of the year. In late 2000 and early 2001, the
telecommunications industry was experiencing unprecedented expansion with
substantial effort underway to overhaul and update both the wireline and
wireless network infrastructure. Much of this expansion was forecasted to be
built on the convergence of more traditional telecommunications systems with the
technology known as IP (Internet Protocol) that was used as the building block
in setting up the worldwide Internet. There was also emphasis on widespread
replacement of the current wireline communications system with "Voice-over-IP"
(VoIP) networks. In deploying an IP network for communications, the promise was
reduced costs and a wider array of new features and services that could not be
implemented on the current public switched telephone networks (PSTN).
In the wireless communications area, many of the second-generation (2G)
mobile/cellular systems being operated around the world were experiencing
impressive subscriber growth. However, 2G systems could not adequately support
data communications and the many services that could be built on a data-capable
wireless system. In early 2001, there was a concerted effort by carriers and
equipment suppliers to upgrade the wireless networks to extended
second-generation systems and ultimately, in short order, to third generation
(referred to as 2.5G and 3G, respectively) systems. The 2.5G and 3G systems are
heavily dependent upon the use of "IP Communications" technology in the core.
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During the course of the year, the market and subsequent funding for the
expansion of communications networks declined dramatically. Many of the
alternative wireline communication suppliers, known as Competitive Local Area
Exchange Carriers (CLECs), experienced financial difficulties contributing to
the overall slowdown in the wireline segment. Based on the many services and
potential cost savings of IP technology in networks for both wireline and
wireless infrastructure, it seems reasonable to conclude this build-out will
resume, at some point, despite the downturn in deployment rates that occurred in
2001.
As a result of the changing market environment that occurred during 2001,
management continued its engineering development programs associated with the
Company's long range strategy but emphasis was also placed on delivering
solutions that could be deployed in current-generation networks or in
next-generation networks if a rapid payback of investment could be demonstrated.
Despite a chaotic 2001 market environment, the Company made substantial progress
in a variety of areas including:
Introduction of the SEGwayTM Network Products: As traffic increases, existing
communications systems are expanding, causing expansion of the SS7 network. The
SEGway Network product family is an innovative use of IP networks for carrying
signaling traffic. There are two products in the SEGway Network family
including: 1) The SEGway Edge, and (2) the SEGway Link Concentrator. The SEGway
Edge enables wireless and wireline operators to offload long-haul SS7 traffic
onto lower-cost IP networks. The Company announced this product in February 2001
and customers began deployment of SEGway Edge units on a worldwide basis in the
spring of 2001. The SEGway Link Concentrator is a companion product to the
SEGway Edge and reduces the need to add links to Signal Transfer Points (STPs)
by concentrating SS7 traffic onto fewer, highly utilized links. The SEGway Link
Concentrator is expected to become available in the second quarter 2002. The
SEGway Link Concentrator was recognized as the Product of the Year by
Communications Solutions magazine in December 2001.
Appropriate for current economic conditions, the Company's SEGway Network
products give carriers the ability to reduce operating costs, enhance services
and expand their current networks by utilizing lower cost IP networks for
signaling. To capitalize on the carrier market, sales and marketing personnel
are now dedicated to carrier sales.
GSM Roaming Platform: GSM is the most widely used cellular mobile wireless
protocol in the world. One of the untapped revenue opportunities for many
wireless telephone service providers, that does not require large infrastructure
investments, is enlarging their roaming footprints beyond international borders.
After several successful deployments of the Performance Technologies' Roaming
Platform technology during 2000-2001, the Company introduced the GSM Roaming
Platform as a standard offering in January 2002. This platform enables large GSM
wireless carriers to offer roaming services to small or emerging GSM carriers
who may otherwise not be able to offer extensive roaming coverage to their
subscribers. While the market for these platforms is not large, there is little
competition.
Both the SEGway Network products and the GSM Roaming Platforms are products
produced by the Company's SS7 Signaling group that was acquired in late 1999 as
MicroLegend Telecom Systems Inc. (MicroLegend). The combination of the core
competencies of Performance Technologies and the in-depth SS7 capability of
MicroLegend has elevated the Company to a prominent position in the signaling
part of the telecommunications marketplace.
PICMG 2.16 Specification Ratification: Management believes one of the most
important and far reaching accomplishments by the Company during 2001 was the
development and leadership in the ratification of the PICMGTM 2.16
specification. PICMG 2.16 fully defines a revolutionary new approach to embedded
system design. This new architecture for building embedded systems, called
Compact Packet Switching Backplane (cPSB), dramatically improves scalability
while building on much of the technology that has been developed for local area
networks (LANs) and found in enterprise applications.
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At the beginning of 2002, only three months after ratification of the 2.16
specification, there were more than 30 products available or soon to be
available that interoperate with this new embedded system architecture. The rate
of adoption of this new architecture has been unprecedented in the industry.
Management believes that the Company's intimate role in developing this standard
and then shepherding it through the ratification process, has given the Company
a "first-to-market" advantage for its products that are already in conformance
to this new standard.
In anticipation of the adoption of PICMG 2.16, the Company introduced a family
of products, under the trade name IPnexusTM, in the latter part of 2000. The
cornerstone of the Company's IPnexus family is a full range of high availability
embedded IP Ethernet switching products that are an integral part of
implementing the 2.16 architecture. While a number of competitive products have
been announced in this area, the Company believes it has the broadest, most
flexible and cost effective solutions currently on the market. The Company is
maintaining its market leadership position with the announcement of two
gigabit-class IPnexus switches that will be available in the first half of 2002.
In addition to the embedded IP Ethernet Switching products, the Company has also
continued to enhance the IPnexus product family throughout 2001 with an
expanding set of T1/E1/J1 and T3/DS3 Network Access products, which are PICMG
2.16 compatible.
Industry Overview
2001 was an extremely difficult year for the telecommunications industry. The
year began with continuing strong demand for next-generation infrastructure for
both wireline and wireless applications. As the year progressed, demand
slackened due to the slowing economy and excess capacity developed in some
communications sectors. By year-end, it was evident that a number of factors
within the telecommunications market were clearly different from those that
existed at the beginning of the year.
In the telecommunications arena, many of the large traditional
Telecommunications Equipment Manufacturers (TEMs), such as Lucent, Nortel
Networks and Motorola experienced significant losses and had substantial
reductions-in-force during 2001. Coupled with "time-to-market" pressures and the
growing complexity of communications networks, there appears to be a fundamental
shift in their business models away from developing proprietary network
equipment toward open architecture equipment. New product programs appear to be
relying on the use of equipment platforms and software assembled from
third-party vendors, such as Performance Technologies, who provide open standard
products. These vendors enable faster "time-to-market" for their new platforms
and internal staffs to focus on proprietary applications. So what traditionally
has been the realm of proprietary products and systems, completely designed and
built "in-house" by major TEMs, is now migrating to an "out-sourced" model for
platforms and major elements of technology used in many of the next-generation
equipment applications. This is an important shift in "sourcing" philosophy and
a clear opportunity for the Company, which supplies a variety of standards-based
infrastructure products. Management believes that despite the reduction in new
product programs by the TEMs, the pressure to use technologies and system
elements provided by third-party suppliers is now greater than at the beginning
of 2001.
The Company's products are sold into two parts of the telecommunications market:
1) The current generation of equipment in wireline (PSTN) and wireless/cellular
networks; and 2) The newer/next-generation networks utilizing IP communications
technology. Most of the growth realized in current generation networks is in the
wireless/cellular area rather than the PSTN, which typically involves older
equipment architectures and is less apt to be an "open standard system design."
The second part of the communications market involves infrastructure equipment
for the newer/next-generation network utilizing IP communications technology and
is a target for many of the Company's contemporary products. An important
concept in next-generation communications systems is the ability to converge
voice, data and eventually video information onto one network with a worldwide
reach.
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An essential element of the convergence paradigm, especially in the voice-driven
applications arena, is the SS7 network signaling protocol. Signaling plays a
vital role in the implementation of many enhanced, value-added services, such as
local number portability, 800/900 toll-free services, wireless roaming,
telephone calling cards, call waiting, caller ID and greater cellular coverage.
SS7 is now the most pervasive signaling architecture used by the leading
telephone operators and wireless carriers worldwide. Although convergence of
traditional voice networks and IP-based data networks will cause unprecedented
change, one thing remains certain, circuit-switched equipment in the PSTN will
still need to communicate effectively with the packet-switched equipment in data
networks worldwide. This can only be achieved through the use of the SS7
signaling protocol. The Company's efforts in 2001 were heavily focused on
providing a variety of key technologies and system elements for the continuing
evolution of the current public telephone network into the next-generation
network.
Industry analyst Venture Development Corporation (VDC) estimated the worldwide
market for SS7 products (both equipment and services) at $9.4 billion for 2000,
with flat or declining growth in 2002, beginning to show signs of recovery in
2003 and accelerating out through 2005. The Company's SEGway and Roaming
platforms fit this segment. VDC predicts steady growth through 2005 for the
"enabling SS7 products" (SS7 Software Stacks and Network Interface hardware for
Embedded System Applications) with a market size of $1.85 billion in 2000. In a
signaling market research report, the SS7 software market was estimated at $2.0
billion in 2001 with the non-proprietary, open standards products comprising
approximately 25%, or $500 million of this market place. The Company's Signaling
Gateways, Channel7 and SS7 Signaling Blade products address this open standard
market segment.
While the overall demand for communications systems slowed dramatically during
2001 and is forecast to be approximately flat through 2003, the market is very
large. According to industry analyst, Gartner Dataquest, 2001 telecom spending
was estimated at $210 billion, growing to $224 billion in 2003. The segment of
spending that will be directed at implementation of new infrastructure that
utilizes IP Communication technologies will be the smaller segment of the
equipment investment, but with a larger (and accelerating) growth potential.
This is the market segment that is a major target for the Company's Network
Access, SS7/IP and Embedded Ethernet Switching products.
Another important potential growth segment of telecommunications systems
involves the extension of the current wireless products to be able to handle
high speed Internet connectivity as well as traditional voice service. Most
wireless systems in operation today are second-generation (2G) technology. In
2002, it is expected that the rollout of technology, referred to as
two-and-a-half (2.5G), will continue. 2.5G will increase the bandwidth of the
current 2G systems to allow substantial improvement in data services. 2.5G is
the forerunner to the next full generation of wireless networks, referred to as
3G wireless. Deployment of 3G technologies, which has started, is expected to
continue primarily in Asia and some European regions. This will be the base
technology for an expanding list of value-added services that will be delivered
to a new family of wireless handheld and portable personal digital assistants
(PDAs) supporting wireless voice, data and ultimately video. While the 3G
infrastructure investment has been revised downward to reflect the reduction in
overall economic activity and delays in deployment, the carriers are facing an
increasing challenge in capacity within the existing 2G radio spectrum and there
is a need for additional services to drive continued growth in subscriber
numbers. 3G is a potential solution to both issues.
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Embedded system architectures built on Ethernet are manifesting themselves in a
variety of formats. However, one of the formats with the highest rate of
adoption is the Compact Packet Switching Backplane (cPSB) standard. It is ideal
for communications platforms used in both wireline and wireless infrastructure
systems but finds applications that are well beyond the boundaries of telecom.
The Company was instrumental in designing and standardizing this new embedded
system architecture, built on the CompactPCI standard, that incorporates
Ethernet switching into the basic functions of the embedded platform (known as
PICMG 2.16). While the market for this new paradigm is young, adoption of this
standard is occurring at an unseen rate for previous technology change in this
area. Industry analysts believe the market for this new embedded system had
reached a $50 million revenue rate at the end of 2001 (only three months after
ratification of the standard) and will likely reach a $500 million revenue rate
by the end of 2002. The Company's Ethernet switching products address this
embedded system market.
Also aligned with the embedded systems market are the Company's network access
products. These products address a general segment that an industry analyst
estimated to be $3.9 billion in 2001 and growing to $5.3 billion in 2003.
Certainly, changes in the general state of the economy can alter the outlook and
timing of deployments for a variety of products related to next-generation
networks and embedded systems. A dramatic slowing of economic growth marked
2001, especially in the later part of the year. However, a variety of industry
sources are predicting improved growth after 2002 to fulfill the need for
networking equipment and the communications industry expansion during the next
five years. A new breed of service providers has begun construction and initial
operation of their infrastructures to create the next-generation public network,
where the Internet will also be used to carry real-time voice and video traffic.
Although IP communications technology outside of the Internet and Local Area
Networks is at an early stage of deployment, market analysts estimate a large
demand for products that exploit this technology, given its potential to save
money and expand the service revenue generation of the network operators.
Management believes that the Company's SS7 Signaling Gateway, embedded Ethernet
Switching and Network Access products, designed around the Company's innovative
IPnexus architecture, will play a significant role as the new generations of
communications and embedded systems are built.
Strategy
Despite the turbulent business conditions during 2001, management believes the
Company's products are well positioned to capitalize on the growth of wireless
networks, the Internet and the network convergence of voice, data and emerging
broadband communications. A central theme to improved bandwidth and services is
the use of IP communications technology in the deployment of these capabilities.
While these markets have slowed dramatically, the consensus of industry pundits
appears to be that this growth will resume as we progress toward 2003.
Key components of the Company's business strategy include:
Addressing Growth Oriented Markets. The Company will continue to develop
standards-based, high performance communications, networking and signaling
products for growth markets. In particular, the Company is targeting two
particular growth markets:
(1) Wireless Communications - The continued growth in wireless
communications and the opportunity to supply new, Internet-related
wireless services are requiring wireless carriers to improve their
infrastructure to 2.5G and ultimately to 3G architectures. The Company
will continue to focus on developing high performance, high
reliability SS7 Signaling, Network Access and IP Switching products to
be sold to TEMs building equipment platforms for this market. The
SEGway Network Products and GSM Roaming Platform are two new product
lines introduced during 2001 for this market. (See Important Year 2001
Milestones).
(2) Embedded Systems - Management believes the TEM's reliance on
standards-based embedded systems will continue to grow because of
"time-to-market" pressures and downsizing. The Company has built a
broad line of embedded Ethernet switching, network access and SS7
Gateway products that are fully functional with the new PICMG 2.16
industry specification. It is management's intent to aggressively
pursue "design win" opportunities for these products during 2002,
capitalizing on the Company's "first-to-market" advantage that
resulted from the pioneering efforts in developing this standard.
Management believes these "design wins" can translate into important
growth as demand increases for embedded systems in a variety of
markets.
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Exploit Technological Competencies. In the development of creative and
innovative products, the Company will continue to build on its core knowledge
and expertise in communications technologies, particularly in voice and data
networking, and signaling control. Despite the economic slowdown, management has
continued to invest heavily in new product development. It is the Company's
intention to continue performance enhancements to its existing products and to
develop new products that address the changing needs of its customers.
Management believes that the Company's vision and active participation in
developing industry standards for next-generation IP telecommunications networks
and embedded systems platforms will be important factors in maintaining a
competitive edge in the Company's markets.
Leverage Software Expertise. The Company has continued to develop its core
communications software expertise in signaling, data networking and
communications. In addition, the Company has invested substantially in
developing "high-availability" and "hardened" software implementations used in
embedded switching products and wide area telecommunications applications aimed
at carrier-grade products. Management believes an important element of the
Company's future product strategy is to increase the intellectual property in
its software products. Management also believes that the software content of its
products has a very positive influence on its gross margins.
Expand International Markets. The communications and embedded systems markets
are global in scope. Outside of North America, the Company markets its products
primarily in Western Europe and the Asia Pacific region. As part of its
international growth plan, the Company has been investing in the expansion of
its marketing, sales and support operations in these specific geographic areas.
The Company operates a sales and support office in the United Kingdom that
provides coverage to Western European, African and Middle Eastern markets. This
office was expanded during 2001 to better service these regions of the world. In
the Asia Pacific region, the Company relies on agents to establish both OEM and
distribution channels. During 2000, the Company also assigned a senior
management level salesperson, based in the Company's West Coast facility, the
full-time duties associated with developing business in the Pac Rim. Direct
shipments to international customers amounted to 27% of revenue in 2001.
Acquisitions and Partnerships. The Company continues its ongoing acquisition
effort. Targets that would provide additional technology elements in the
embedded communication or signaling areas; expansion of the Company's ability to
integrate its products into application oriented subsystems; and organizations
that would expand sales/distribution channels are continually being evaluated
for acquisition. With changes in enterprise valuations over the past 12-18
months and the Company's strong balance sheet, management believes there are
potential acquisition opportunities that can accelerate growth that were not
available in the past. Seeking opportunities to grow the Company through
appropriate inorganic additions is an important strategy element for 2002-2003.
Products
Performance Technologies develops and markets high performance communications,
networking and signaling products to the leading suppliers of
telecommunications, embedded systems and network equipment. The Company has
pioneered many recent innovations in networking and signaling technologies and
continues to be a leader in defining standards for both next-generation
telecommunications signaling systems and embedded system architectures that have
a broad application base. New products introduced by the Company during 2001
aggressively implemented these standards. Management will continue to focus on
the development and delivery of new IP-based products in three distinct
communications markets: Signaling, embedded IP Ethernet Switching and
Communications Network Access built on both "open" systems and "open"
communications standards.
Signaling Products. The Company's signaling products fall into three categories
including: Signaling Gateways, the SEGway Network products and SS7 Signaling
Blade.
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The signaling product line was initially developed to address custom turnkey
solutions for specific customer requirements. Recognizing the need to bridge
signaling traffic between traditional telephone networks and IP-based data
networks, the Company developed the industry's first IP-enabled SS7 server in
1997. Since 1997, the Company's SS7/IP Signaling Gateway product has evolved to
support applications such as international wireless roaming, Voice-over-IP and
enhanced Internet-driven services. Numerous wireless carriers have installed the
Company's SS7/IP Signaling Gateway products to allow their customers to travel
to various countries around the world and to initiate and receive telephone
calls as if they were at home. In addition, SS7/IP Signaling Gateways are used
for a variety of applications ranging from "front ends" for distributed
IP-hosted databases, to long-haul transmission of SS7 messages delivered
seamlessly over IP networks. Customers continue to develop other unique and
creative applications for wireless and convergent networks utilizing the
Company's SS7/IP Signaling Gateway.
Signaling products include: SS7/IP Signaling Gateways, which bridge SS7 networks
and IP data networks; SS7 Routing Systems, which extend traditional MTP message
routing with enhanced capabilities such as n-digit global title translation and
routing based on message parameters; and SS7 Protocol Conversion, which provides
interoperability between ANSI SS7, ITU-T C7 and numerous national variants.
During 2001, the Company continued development and deployment of a new family of
signaling products aimed at SS7 system expansion using IP communications
technology. This new product family being marketed under the trade name of
SEGway Network products includes an "Edge" product and a "Link Concentrator"
product. The SEGway Edge provides SS7 link replacement and is designed to save
telecom carriers the leasing or provisioning costs associated with dedicated
long-haul SS7 links. The SEGway Link Concentrator (SLC) provides high-level SS7
functionality to act like an IP STP, providing message consolidation and routing
capability that reduces the number of SS7 links required to terminate traffic in
SS7 networks. In addition the SLC provides the option to route messages to any
entity location within an SS7 network.
Management believes the SEGway Network products offer carriers an ideal option
to expand existing Public Switched Telephone Network or wireless systems using
an incremental approach to IP network technology. The Company's SEGway Network
solutions are appropriate for current economic conditions, as this SS7 expansion
solution provides carriers the ability to reduce operating costs in many
applications when compared to traditional SS7 expansion link.
Conforming to its philosophy for providing high availability products designed
to "open" standards for embedded systems, the Company introduced several
Embedded Signaling BladeTM versions of its Signaling products during 2001, which
can be integrated into CompactPCI (cPCI) system platforms. These "Blade" SS7
products will be expanded in 2002 to be fully compliant with the 2.16 embedded
systems standard.
The entire range of the Company's SS7/IP Signaling products use an internally
developed, network-proven, object-oriented SS7 protocol stack that has been
uniquely configured to allow the use of the same software intellectual property
across all SS7/IP product lines.
Customers for the signaling gateway products include Alcatel SA, Clarent
Corporation, Comfone AG, Ericsson Telecommunications, iBasis Inc., Motorola
Corporation, Nortel Networks, Swisscom AG, Teleglobe and TSI Telecommunictions
Services.
Embedded IP Ethernet Switching Products. The Company has background in designing
products for high availability Ethernet switching applications. While this
background was originally targeted at enterprise network applications, the
Company focused these resources during 2000 on developing an IP Ethernet
switching product for embedded systems. As an important adjunct to this product,
the Company designed a specification that was based on technologies that have
been developed for Local Area Networks but can be applied with numerous
advantages in reliability, performance, ease of integration and time-to-market
for embedded systems. The foundation of this system architecture, that has
become a ratified standard known as PICMG 2.16, is an Ethernet switch. During
2001 and continuing into 2002, the Company is aggressively developing a broad
range of embedded Ethernet switching products. As of early 2002, the Company was
shipping four Ethernet switching products with various features and capabilities
and has announced two new gigabit Ethernet switches for delivery in the first
half of the year.
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Management is aggressively pursuing IP Ethernet switching opportunities with its
family of PICMG 2.16 switches with equipment manufacturers and integrators
working with these manufacturers. The Company's family of embedded switches is
built on a common software platform allowing the Company to provide a broad
range of features across the complete product offering. These embedded Ethernet
switches and the attendant PICMG 2.16 architecture are ideal for communications
platform applications, but there are many other industries where this embedded
design will offer superior cost and performance capabilities. Entering 2002, the
Company is shipping switching products into embedded systems designs for a broad
range of applications. While the Company has realized numerous design wins for
these products, there is no indication that any of the design wins have moved
into a production volume. As a result, management believes there is noteworthy,
unrealized growth potential as design wins move to the production phase.
Despite the general slow-down in economic activity in the latter half of 2001,
additional competition is beginning to address this virgin market. Management
has continued aggressive development and marketing of its embedded switching
products with the objective of being the preeminent embedded switch provider in
this marketplace. The Performance Technologies embedded IP Ethernet switches are
sold under the trade name of IPnexus for PICMG 2.16 compliance.
Announced customers for the embedded IP Ethernet switch products include:
APW/Electronic Solutions, Clarent Corporation, Cognitronics Corporation, General
Dynamics, Kaparel, Lucent Technologies, Nortel Networks, Siemens AG and Soma
Networks.
Communications Network Access Products. The Company's overall Communications
Network Access strategy is to develop and provide products to the leading
communications and telecommunications suppliers that enable voice and data
communications. These products are comprised of hardware, software and
subsystems that support a variety of "open" system platforms and operating
systems. These open systems include CompactPCI (cPCI), PCI, and PMC
architectures. Product applications cover many uses including high-speed
Internet connections for server products, T1/E1 products used for SS7 and T3/DS3
for trunk interfaces. To support these applications, the Company's products are
"intelligent," with embedded microprocessors and memory. During 2001, the
Company continued to enhance a family of contemporary access products introduced
in late 2000 utilizing the Company's IPnexus architecture that is based on the
PICMG 2.16 architecture recently ratified.
The Company offers software systems support for its products across a spectrum
of popular operating systems including UNIX, Sun Microsystems' Solaris(TM),
Microsoft's Windows NT(TM), Wind River's VxWorks and Linux. The Company also
offers an extensive suite of advanced communications software consisting of
Frame Relay, SS7, X.25, HDLC, ProtoKit (a comprehensive development environment
allowing customers to integrate its specific protocols), as well as ComLink and
ChanneLink which are telecommunications-oriented software packages designed by
the Company for operation in Sun's Solaris environment.
During 2001, the Company introduced a comprehensive communications software
suite that is based on the Linux operating system. This new suite of software is
aimed at reducing customer integration efforts and time-to-market. This new
suite is marketed under the trade name NexusWare(TM) and supports the Company's
suite of communications software and the PICMG 2.16 specification.
The Company also markets a specialized Internet Protocol (IP)/Wide Area Network
(WAN) communications server, the MPS800. The MPS800 provides one IP
Communication port and eight high-speed WAN serial ports making it ideal for
intelligent WAN bridging, T1/E1 multiplexing and remote WAN connectivity.
Virtually all computers and workstations equipped with IP Ethernet on the LAN
can access information from these communication servers. The Company's complete
suite of communications protocol products is available on the MPS800, including
SS7, Frame Relay, X.25, HDLC, Radar Receiver, Synchronous Bit Stream Interface
and Asynchronous Data Transfer. Using this unique software, the communications
server can be configured for a variety of applications.
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During 2001, the Company's MPS800 achieved substantial usage in a variety of
applications including air traffic control centers for retrieving radar data
from remote radar antenna sites and in the U.S. Weather Service infrastructure
for retrieving weather satellite and radar images.
Customers for the Company's network access products include ADC
Telecommunications, Inc., Alcatel SA, Compaq Corporation, Lucent Technologies,
Inc., Motorola Corporation, NAVCanada, Nortel Networks, Raytheon, Sun
Microsystems, Inc., and the U.S. Weather Service.
Sales, Marketing and Distribution
The Company markets its products worldwide to a spectrum of customers through
its direct sales force and various channels including Original Equipment
Manufacturers (OEMs), Value Added Resellers (VARs), distributors and systems
integrators. Approximately 80% of the Company's North American business is sold
through the Company's direct sales force to OEMs and systems integrators. Much
of the remainder is sold to carriers (network operators) by the Company's direct
sales force.
Due to the technical nature of the Company's products, it is essential that the
Company's salespeople are technically oriented and are knowledgeable in the
network and communications fields. To supplement its sales force, the Company
has field application engineers who assist prospective customers in determining
if the Company's products will meet their requirements.
The Company's corporate headquarters are in Rochester, New York. It has regional
sales and support facilities in Connecticut and the United Kingdom, as well as
co-located sales and engineering operations in San Diego, California. The
Signaling Systems group has a sales and engineering facility in Ottawa, Canada
with an additional engineering facility in Raleigh, North Carolina. Currently,
27 sales, marketing and support personnel market and sell the Company's
products. In addition, independent sales representatives and agents covering
selected geographic areas nationally and internationally, and distributors or
integrators handling selected products, supplement the Company's direct sales
team on a worldwide basis.
The Company executes various ongoing marketing strategies designed to attract
new OEM and end-user customers and to stimulate additional purchases from
existing customers. These strategies include direct mail and email campaigns,
direct telemarketing, special pricing programs, active participation in
technical standards groups, participation in national, international and
regional trade shows, selected trade press advertisements and technical articles
and an active campaign to direct potential customers to the Company's web site.
International sales represented 27%, 30% and 16% of the Company's revenue in
2001, 2000 and 1999, respectively. Management believes that the international
markets continue to represent important opportunities for its products. During
2000 and 2001, Performance Technologies increased its focus on these markets.
European operations were expanded and a senior management level sales person had
primary responsibility for sales in the Pac Rim. In 2002, our efforts in these
areas will be refocused consistent with our revised product focus. The Company's
products are currently sold by approximately 30 international distributors
throughout the more industrialized countries in Europe and in Asia.
International sales are subject to import and export controls, transportation
delays and interruptions, foreign currency exchange rates, and foreign
governmental regulations. Payments for shipments from the United States to
outside the United States are generally made in U.S. dollars and payments for
shipments from Canada to Canada are generally made in Canadian dollars.
Customers
The Company has over 50 active customers worldwide primarily in the
telecommunications and embedded systems markets. Many of the Company's major
customers are Fortune 500 companies in the United States or of similar stature
in Europe and Asia. In 2001, the largest single customer represented 9% of
revenue and the largest four customers represented 30% of the Company's revenue.
9
The Company's products are generally integrated into products for wireline,
wireless and next-generation IP network infrastructure. These products are
targeted at customers in the following sectors: telecommunication equipment
manufacturers, telecommunications service providers and operators, international
wireless carriers and platform manufacturers. Once the Company's products have
been selected for integration into the customer's product, the customer has to
complete their product development, which can take twelve to eighteen months or
longer to reach the production phase.
Backlog
At February 10, 2002, the scheduled backlog of orders was $3.2 million, compared
to $6.9 million at February 23, 2001. A substantial portion of the Company's
revenue in each quarter results from orders placed within the quarter and is
often shipped in the final month of the quarter. Orders are subject to
cancellation in the normal course of business; however, historically, the
Company has filled most of its firm orders. (See Management's Discussion &
Analysis included elsewhere in this report).
Seasonality
The Company's business is not generally subject to large seasonal swings, but
the revenue typically declines sequentially from the calendar fourth quarter to
the first quarter of the year. Much of the Company's business is
project-related, driven by customer demand, which can cause quarterly
fluctuations in revenue.
Environmental Matters
The Company does not believe that compliance with federal, state or local laws
or regulations relating to the protection of the environment has any material
effect on its capital expenditures, earnings or competitive position.
Competition
The market for communications and networking products is intensely competitive
and characterized by rapid technological innovations resulting in new product
introductions and frequent advances in price/performance ratios. Competitive
factors in this industry include product performance, functionality, product
quality and reliability, customer service and support, marketing capability,
corporate reputation and brand recognition, and increases in relative
price/performance ratios.
In the signaling market, the Company competes with Ulticom, Inc., Tekelec,
Natural Microsystems, Trillium Digital Systems, Inc. (a subsidiary of Intel
Corp.) and several larger companies that have proprietary SS7 technology or
products. The signaling market continues to grow and it is likely that more
competitors will enter this market as the telecom market activity associated
with next-generation infrastructure restarts, as predicted by analysts.
The embedded IP Ethernet switching market was a new market in 2000. The current
competitors include smaller private companies such as Zynx, Ramix and Continuous
Computing and more recently larger public companies such as Radisys Corp. and an
embedded systems division of Intel Corp. The size of this market is small
compared to the enterprise Ethernet switch market. However, larger companies in
the enterprise market may have interest in this segment if they believe that the
embedded market can become of significant size. In some cases, embedded Ethernet
switches may use merchant parts and components produced by the larger companies
and this will represent an opportunity to increase volumes of these components.
In the network access market, the Company's products compete with products from
Adax Incorporated, Audiocodes Ltd., Artisan Components, Interphase Corporation,
Natural Microsystems, Radisys Corporation, and SBS Technology.
10
Research and Development
The Company's research and development expenses were approximately $7.9 million,
$8.9 million and $7.9 million for 2001, 2000 and 1999, respectively. These
expenses consist primarily of employee costs and material consumed in developing
and designing new products. To a lesser degree, amounts are expended for
software license/tools and contract product development. Given stable improving
economic conditions, the Company expects to maintain its research and
development expenditure percentages in 2002.
The Company has developed significant core competencies applicable to voice and
data communications, high availability, redundant switching technologies and
signaling communications. The Company has also invested substantially in
developing and expanding its communication and networking software competencies.
These competencies will contribute to the development of products for next-
generation networks.
Proprietary Technology
The Company's success depends upon retaining and maximizing the Company's
proprietary technologies. To date, the Company has relied principally upon
trademark, copyright and trade secret laws to protect its proprietary
technology. The Company generally enters into confidentiality or license
agreements that contain confidentiality provisions, with its customers,
distributors and potential customers and limits access to, and distribution of,
the source code to its software and other proprietary information. All of the
Company's employees are subject to the Company's employment policy regarding
confidentiality. The Company's software products are provided to customers under
license, generally in the form of object code, which provides a high degree of
confidentiality with respect to the intellectual property value. Such methods
may not afford complete protection and there can be no assurance that the
confidentiality agreements will not be breached, or that such agreements will be
enforceable, or that the Company will have adequate remedies for any breach, or
that the Company's trade secrets will not otherwise become known to, or
independently developed, by competitors. The Company has a patent application
pending. There can be no assurance that any patents will be granted, or that, if
granted, such patents would provide the Company with meaningful protection from
competition.
Although management believes that the Company's products do not infringe on
proprietary rights of third parties, there can be no assurance that third
parties will not assert intellectual property infringement claims against the
Company for its products. The Company has not conducted any searches or obtained
an opinion of counsel with respect to its proprietary rights. Accordingly, there
can be no assurance that no claims will be initiated, that the Company would
prevail in any such litigation seeking damages or an injunction against the sale
of the Company's products, or if necessary, that the Company would be able to
obtain any necessary licenses on reasonable terms or at all. Any such litigation
could be protracted and costly and could have a material adverse effect on the
Company's results of operations regardless of the outcome of the litigation.
Suppliers
In the fast paced technology environment, manufacturers frequently obsolete
electronic components. Furthermore, more situations are arising where the
Company is utilizing sole or limited source components on its products. The
Company has generally been able to obtain adequate supplies of components or has
redesigned specific products when adequate components are not available. The
Company obtains components on a purchase order basis and does not generally have
long-term contracts with any of its suppliers.
Manufacturing
The Company maintains a state-of-the-art manufacturing facility in Rochester,
New York. There is currently no excess space in this facility. In April 2002,
11
the Company will relocate to a new facility in the Rochester area with larger
manufacturing space. Manufacturing operates under an integrated MRP system that
significantly reduces lead-time and inventory investment, and facilitates demand
forecast. The Company's manufacturing facility and quality management systems
are ISO 9002 certified. The Company's products have a high software content and
are generally produced in low volumes. By maintaining an in-house manufacturing
capability, management believes that the Company has, to a certain extent,
insulated itself from the risks inherent with subcontracted manufacturing. These
risks include the sub-contractors inability to meet flexible manufacturing
requirements, inventory control and cost containment. In addition, in-house
manufacturing enables the Company to maintain a high quality level for its
products and timeliness for deliveries. The Company has limited alternative
capabilities through third parties, however, to perform such manufacturing
activities. In the event of an interruption of production at its manufacturing
facility, the Company's ability to deliver products in a timely fashion would be
compromised, which would have a material adverse effect on the Company's results
of operations.
Employees
During January 2002, the Company reduced its annualized operating expenses by
approximately $1.6 million in order to improve its cost structure. Most of this
reduction was the result of a lay-off of approximately 10% of the Company's
staff. As of January 31, 2002, the Company had 168 full-time employees, five
part time and contract employees and five Engineering Cooperative student
employees. Management believes its relations with its employees are good. The
Company's employees are not subject to collective bargaining agreements.
The Company's fulltime employees work in the following areas:
Research and Development 82
Marketing and Sales 27
Manufacturing 45
General and Administrative 14
Through mid-2001, competition for engineering personnel in the Company's
marketplace was intense. Up to that point in time, the use of significant stock
option and cash bonuses was prevalent in our market. Since mid-2001, engineering
personnel seem to be more readily available. Management believes that the
Company's future success will depend on its ability to continue to attract and
retain qualified personnel.
Risk Factors
Technological Change and New Product Introductions. The market for the Company's
products is characterized by rapid technological change and frequent
introduction of products based on new technologies. As these products are
introduced, the industry standards change. Additionally, the overall
communications and networking industry is volatile as the effects of new
technologies, new standards, new products and short life cycles contribute to
changes in the industry and the performance of industry participants. The
Company's future revenue will depend upon the Company's ability to anticipate
technological change and to develop and introduce enhanced products of its own
on a timely basis that comply with new industry standards. New product
introductions, or the delays thereof, could contribute to quarterly fluctuations
in operating results as orders for new products commence and orders for existing
products decline. Moreover, significant delays can occur between a product
introduction and commencement of volume production. The inability to develop and
manufacture new products in a timely manner, the existence of reliability,
quality or availability problems in its products or their component parts, or
the failure to achieve market acceptance for its products would have a material
adverse effect on the Company's revenue and operating results.
Competition. The communications, signaling and networking business is extremely
competitive and the Company faces competition from a number of established and
emerging start-up companies. Many of the Company's principal competitors have
established brand name recognition and market positions and have substantially
greater experience and financial resources to deploy on promotion, advertising,
12
research and product development than the Company. In addition, as the Company
broadens its product offerings, it may face competition from new competitors.
Companies in related markets could offer products with functionality similar or
superior to that offered by the Company's products. Increased competition could
result in price reductions, reduced margins and loss of market share, all of
which would materially and adversely affect the Company's revenue and operating
results. Major networking companies have recently acquired several of the
Company's competitors. These acquisitions are likely to permit the Company's
competition to devote significantly greater resources to the development and
marketing of new competitive products and the marketing of existing competitive
products to their larger installed bases. The Company expects that competition
will increase substantially as a result of these and other industry
consolidations and alliances, as well as the emergence of new competitors. There
can be no assurance that the Company will be able to compete successfully with
its existing or new competitors or that competitive pressures faced by the
Company will not have a material adverse effect on the Company's revenue and
operating results.
Dependence on Key Customers. There can be no assurance that the Company's
principal customers will continue to purchase products from the Company at
current levels. Customers typically do not enter into long-term volume purchase
contracts with the Company and customers have certain rights to extend or delay
the shipment of their orders. The loss of one or more of the Company's major
customers, and the reduction, delay or cancellation of orders, or a delay in
shipment of the Company's products to such customers, would have a material
adverse effect on the Company's revenue and operating results. (See Management's
Discussion & Analysis included elsewhere in this report).
Design Wins. A design win is when a customer or prospective customer notifies
the Company that its product has been selected to be integrated with their
product. Ordinarily, there are a number of steps between the design win and when
customers initiate production shipments. Design wins reach production volumes at
varying rates. Historically, this gestation period prior to volume orders has
been twelve to eighteen months or more after the design win occurs. A variety of
risks such as schedule delays, cancellations of programs and changes in customer
markets can adversely affect a design win from reaching the production phase.
The customer's failure to bring their product to the production phase would have
an adverse effect on the Company's revenue and operating results.
Potential Fluctuations in Annual and Quarterly Results. The Company's future
annual and quarterly operating results can vary significantly depending on
factors such as the timing and shipment of significant orders, new product
introductions by the Company and its competitors, market acceptance of new and
enhanced versions of the Company's products, changes in pricing policies by the
Company and its competitors, the mix of distribution channels through which the
Company's products are sold, inability to obtain sufficient supplies of sole or
limited source components for the Company's products, and seasonal and general
economic conditions. The Company's expense levels are based, in part, on the
Company's expectations as to future revenue. Since a substantial portion of the
Company's revenue in each quarter results from orders placed within the quarter
and often shipped in the final month of that quarter, revenue levels are
extremely difficult to predict. If revenue levels are below expectations,
revenue and operating results will be adversely affected. Net income would be
disproportionately affected by a reduction in revenue because only a small
portion of the Company's net expenses varies with its revenue. (See Management's
Discussion and Analysis included elsewhere in this report).
Dependence on Third Party Component Suppliers. Certain components used in the
Company's products are currently available to the Company from one or a limited
number of sources. There can be no assurance that future supplies will be
adequate for the Company's needs or will be available on prices and terms
acceptable to the Company. The Company's inability in the future to obtain
sufficient limited-source components, or to develop alternative sources, could
result in delays in product introduction or shipments, and increased component
prices could negatively affect the Company's gross margins, either of which will
have a material adverse effect on the Company's revenue and operating results.
Dependence on Internal Manufacturing. In order to avoid relying on outside
contract manufacturers, the Company manufactures almost all of its products at
its Rochester, New York facility. The Company does not have alternative
13
manufacturing capabilities, either internally or through third parties, to
perform those manufacturing functions. Even if the Company were able to identify
alternative third-party contract manufacturers, there can be no assurance that
the Company would be able to retain their services on terms and conditions
acceptable to the Company. In the event of an interruption in production, the
Company would not be able to deliver products on a timely basis, which would
have a material adverse effect on the Company's revenue and operating results.
Although the Company currently has business interruption insurance, no
assurances can be given that such insurance will adequately cover the Company's
lost business as a result of such an interruption.
Dependence on Proprietary Technology. The Company's success depends upon the
Company's proprietary technologies. To date, the Company has relied principally
upon trademark, copyright and trade secret laws to protect its proprietary
technologies. The Company generally enters into confidentiality or license
agreements with its customers, distributors and potential customers and limits
access to and distribution of the source code to its software and other
proprietary information. The Company's employees are subject to the Company's
employment policy regarding confidentiality. There can be no assurance that the
steps taken by the Company in this regard will be adequate to prevent
misappropriation of its technologies or to provide an effective remedy in the
event of a misappropriation by others. The Company holds no patents but
currently has a patent application pending. There can be no assurance that any
patents will be granted or that, if granted, such patents would provide the
Company with meaningful protection from competition.
Although management believes that the Company's products do not infringe on the
proprietary rights of third parties, there can be no assurance that infringement
claims will not be asserted, resulting in costly litigation in which the Company
may not ultimately prevail. Adverse determinations in such litigation could
result in the loss of the Company's proprietary rights, subject the Company to
significant liabilities, require the Company to seek licenses from third parties
or prevent the Company from manufacturing or selling its products, any of which
will have a material adverse effect on the Company's revenue and operating
results.
Because of the existence of a large number of patents in the computer networking
industry and the rapid rate of new patents granted or new standards developed,
or new technology, it may be necessary for the Company to enter into technology
licenses from others. There can be no assurance that these third party
technology licenses will be available to the Company on commercially reasonable
terms. The loss of, or inability to obtain, any of these technology licenses
could result in delays or reductions in product shipments. Any such delays or
reductions in product shipments will have a material adverse effect on the
Company's revenue and operating results.
Dependence on Personnel. The Company's success depends on the continued
contributions of its personnel, many of whom would be difficult to replace. It
will also depend on its ability to attract and retain skilled employees. Through
mid-2001, competition for engineering personnel in the Company's marketplace was
intense. Since mid-2001, engineering personnel seem to be more readily
available. Although the Company's employees are subject to the Company's
employment policy regarding confidentiality and ownership of inventions,
employees are generally not subject to employment agreements or non-competition
covenants. Changes in personnel could adversely affect the Company's operating
results.
ITEM 2 - Properties
The corporate headquarters are currently located in 30,000 square feet of office
and manufacturing space in Rochester, New York. Corporate headquarters include
the executive offices, along with the sales, marketing, engineering and
manufacturing operations for the communications and switching groups of the
Company. There is currently no excess office space in this facility. In April
2002, the Company will relocate its Rochester operations to a new 57,000 square
foot facility in the Rochester area. This new facility is designed to
14
accommodate the Company's immediate business requirements while providing a
variety of expansion options. The Company has also purchased land adjacent to
this new facility for future expansion. The Company also leases sales and
engineering office space in San Diego, California and sales offices in
Connecticut and the United Kingdom. The Company's core signaling group is
located in 14,000 square feet of office space in a building located in downtown
Ottawa, Canada. The office leases in this building expire in April 2002 and May
2003. The Company is in the process of finalizing the lease agreement on the
portion of the office that expires in April 2002. The signaling group also has
an engineering operation in office space in Raleigh, North Carolina. The office
lease in this building expires in February 2005.
ITEM 3 - Legal Proceedings
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. With the
exception of the following items, the Company is not a party to any such legal
proceedings, the adverse outcome of which, individually or in the aggregate,
would have a material adverse effect on the Company's results of operations,
financial condition or cash flows.
During the second quarter 2000, the Company announced that the then current
customer order backlog was not sufficient to meet revenue and earnings
expectations for the second quarter and given the Company's difficulty in
predicting the timing of when customers would begin production shipments for the
Company's new design wins, management adjusted revenue and earnings expectations
for the second quarter and the year. On and after May 24, 2000, several class
action lawsuits were filed against the corporation, as well as several of its
officers and directors, alleging violations of federal securities laws. The
lawsuits were filed in United States District Court for the Western District of
New York. The Lead Counsel was approved by the Court and an Amended Complaint,
dated March 19, 2001, was filed with the Court. On May 18, 2001, the Company
filed a motion to dismiss the consolidated complaint. On June 25, 2001, the
Plaintiffs filed a memorandum of law in opposition to the Company's motion to
dismiss. On July 20, 2001, the Company filed a memorandum of law in further
support of the Company's motion to dismiss the Plaintiffs' class action
complaint.
Performance Technologies believes these claims to be without merit, has mounted
a vigorous defense against these allegations and no costs have been accrued for
this possible loss contingency.
ITEM 4 - Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2001.
PART II
ITEM 5 - Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock is traded on the NASDAQ National Market System under
the trading symbol "PTIX". The following table sets forth the high and the low
quarterly closing prices of the common stock during the two most recent years,
as reported on the NASDAQ National Market System. These prices represent
quotations among securities dealers without adjustments for retail markups,
markdowns or commissions and may not represent actual transactions
2001 High Low
First Quarter $15.75 $10.06
Second Quarter 16.49 10.00
Third Quarter 17.40 8.22
Fourth Quarter $13.55 $8.00
2000 High Low
First Quarter $44.62 $16.12
Second Quarter 40.00 8.19
Third Quarter 15.50 8.50
Fourth Quarter $17.31 $13.25
15
As of February 28, 2002, there were 184 stockholders of record of the Company's
common stock.
To date, the Company has not paid cash dividends on its common stock and has no
intention to do so for the foreseeable future.
ITEM 6 - Selected Financial Data
(in thousands, except per share amounts)
For the Years Ended December 31: 2001 2000 1999 1998 1997
Sales $36,517 $38,963 $44,494 $34,118 $32,435
Income from operations 5,186 7,050 6,226 6,047 5,271
Basic earnings per share:
Income from operations (1) $ .42 $ .54 $ .47 $ .46 $ .41
Weighted average common shares 12,282 13,106 13,165 13,077 13,012
Diluted earnings per share:
Income from operations (1) $ .41 $ .51 $ .45 $ .45 $ .39
Weighted average common and common
equivalent shares 12,708 13,769 13,789 13,517 13,449
Pro forma income from operations:
(Excluding $1.7 million charge for
acquisition expenses in 1999) $ 5,186 $ 7,050 $ 7,970 $ 6,047 $ 5,271
Pro forma basic earnings per share:
(Excluding $1.7 million charge for
acquisition expenses in 1999)(1)$ .42 $ .54 $ .61 $ .46 $ .41
Pro forma diluted earnings per share:
(Excluding $1.7 million charge for
acquisition expenses in 1999)(1)$ .41 $ .51 $ .58 $ .45 $ .39
At December 31: 2001 2000 1999 1998 1997
Working capital $34,728 $36,975 $39,009 $32,221 $26,889
Total assets 42,954 44,758 49,142 40,122 33,544
Long-term debt, less current portion 6 18
Total stockholders' equity $38,342 $39,468 $40,828 $34,180 $28,661
(1) All per share amounts have been adjusted where appropriate, for the
three-for-two stock splits effected in September 1999 and September 1997.
16
ITEM 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
The Company's annual operating performance is subject to various risks and
uncertainties. The following discussion should be read in conjunction with the
Consolidated Financial Statements and related notes included elsewhere herein as
well as the section appearing in Item 1 of this Form 10-K under the heading
"Risk Factors." The Company's future operating results may be affected by
various trends and factors, which are beyond the Company's control. These
include, among other factors, general business and economic conditions, rapid or
unexpected changes in technologies, cancellation or delay of customer orders
including those relating to design wins, changes in the product or customer mix
of sales, delays in new product development, customer acceptance of new products
and customer delays in qualification of products. Furthermore, as the economic
conditions deteriorate, customer's visibility also deteriorates causing delays
in the placement of orders. This results in a substantial portion of the
Company's revenue in each quarter being derived from orders placed within the
quarter and is often shipped in the final month of the quarter.
Matters discussed in Management's Discussion and Analysis of Financial Condition
and Results of Operations and elsewhere in this Form 10-K include
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, and are subject to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. The Company's actual results could
differ materially from those discussed in the forward-looking statements.
Overview
Financial Information: All historical financial information contained herein has
been restated to reflect the acquisition of MicroLegend Telecom Systems, Inc.,
which was accounted for as a pooling of interests during the fourth quarter
1999. Furthermore, per share amounts have been adjusted to reflect a
three-for-two stock split effected in September 1999.
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at year-end and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates. The Company believes that the critical
accounting policies discussed herein can involve additional management judgment
due to the sensitivity of the methods, assumptions and estimates necessary in
determining the related asset, liability, revenue and expense amounts.
FAS 144 - In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets to
be held and used, to be disposed of other than by sale, and to be disposed of by
sale. The Statement is effective for financial statements issued for fiscal
years beginning after December 15, 2001 and interim periods within those fiscal
years, and will thus be adopted by the Company, as required, on January 1, 2002.
The adoption of SFAS No. 144 is not expected to have any impact on the Company's
consolidated financial statements at the time of adoption.
Revenue for 2001 amounted to $36.5 million, compared to $39.0 million in 2000.
Despite the poor economic environment in 2001, revenue from the Company's core
Signaling, Network Access and Embedded Switching products (excluding LAN
interface and other legacy products) remained stable at $33.5 million in 2001,
compared to $33.5 million in 2000. Sales outside of North America amounted to
$9.7 million and $11.7 million in 2001 and 2000, respectively.
Net income in 2001 was $5.2 million, or $.41 per share, compared to $7.0
million, or $.51 per share in 2000, based on 12.7 million and 13.8 million
shares outstanding, respectively.
17
Cash, cash equivalents and marketable securities amounted to $26.9 million, and
no long-term debt existed at the end of 2001. During 2001, the Company generated
$9.0 million from operating activities, compared to $5.9 million generated in
2000. During 2001 and 2000, the Company expended $6.9 million and $8.8 million,
respectively, to buy back its shares in the open market.
Industry Overview: As the telecommunications industry was entering 2001,
worldwide demand for telecommunications services was near its peak and telecom
service providers were experiencing unparalleled competition. At the same time,
telecommunications equipment manufacturers (TEMs) were aggressively designing
next-generation equipment platforms to enable the convergence of voice and data
onto one network (Voice-over-IP) and to upgrade wireless networks to handle
expanded services (2.5G and 3G wireless platforms).
Twelve months later, the telecommunications industry is burdened with
overcapacity and many second and third tier telecom service providers are out of
business or are struggling for survival. Most of the large telecommunications
service providers still remaining have drastically slashed capital expenditure
budgets for 2002 and plans for Voice-over-IP and 2.5G and 3G wireless
deployments are of lesser priority. Many of the smaller service providers
remaining will forge ahead with next-generation network deployments but the
pressure on the larger carriers has subsided for the near term.
Business Strategy: Performance Technologies, Incorporated (the "Company") is a
supplier of innovative hardware and software products for a broad range of
communications infrastructure, including traditional data communications and
wireline/wireless telecommunication systems. The Company's forward-looking
development efforts are directed at future growth opportunities that utilize the
evolving IP (Internet Protocol) standards for communications and networking
equipment. IP based communications and systems products are the foundation for
next-generation telecommunications systems and services, as well as embedded
systems for video, data communications and mass storage applications. Customers
who use the Company's products and technologies include: telecommunications
equipment manufacturers (TEMs), communications service providers/operators,
international mobile/cellular wireless operators and embedded systems platform
suppliers/integrators. The Company's products are based on open-architectures
and are focused on high availability infrastructure.
At the beginning of 2001, the Company's products were positioned to enable
next-generation Voice-over-IP, 2.5G and 3G wireless networks. As the year
progressed and the telecom environment deteriorated, management continued its
engineering development programs on its long-range strategy but emphasis was
also placed on delivering solutions that could be deployed in current-generation
networks or in next-generation networks if a rapid payback of investment could
be demonstrated. (See Signaling Products (SEGway and GSM Roaming Platform) and
IP Ethernet switch products).
Management believes the most important measurement of progress in executing the
Company's product and marketing strategies is the number of "design wins"
realized with its customer base. A "design win" is when a customer or
prospective customer notifies the Company that its product has been selected to
be integrated with their product. During 2001, the Company received notification
for thirty-five new design wins for its signaling (10), IP Ethernet switch (10)
and network access (15) products, compared to twenty new design wins during
2000. Ordinarily, there are a number of steps between the design win and when
customers initiate production shipments, which can take twelve to eighteen
months, or more, for customers to complete this process. Not all design wins are
expected to result in production orders.
The Company's engineering development programs are directed toward expanding
three distinct product areas: signaling products, IP Ethernet switch and network
access products.
Signaling Products: The Company's strategy is to develop signaling products that
will enable signaling traffic over less-costly IP networks. The Company's
signaling product line includes SS7/IP Signaling Gateways, SEGway Network
products and the new GSM Roaming Platform introduced in January 2002. The
Company's signaling products use an internally developed network-proven SS7
protocol stack.
18
SS7/IP Signaling Gateways are designed for wireless applications such as roaming
and transmission of SS7 messages delivered over IP networks and for
Voice-over-IP (VoIP) embedded computing platforms.
The Company broadened its signaling gateway product family in 2000 by
introducing the MicroLegend(R) 4000 Series Signaling Gateway. This was the first
signaling gateway designed to meet the stringent reliability, performance and
international interoperability demands of interfacing Internet Telephony
networks with the Public Switched Telephone Network (PSTN). Gateway products
also provide users with a unique distributed SS7 software environment that
enhances reliability and expandability. In July 2001, the Company introduced the
SS7/IP Signaling Blade(TM). This new product is a full featured, embedded
signaling gateway "system in a slot," specifically designed for telecom
equipment manufacturers seeking to integrate SS7/IP signaling capabilities into
their current and next-generation chassis designs. The SS7/IP Signaling Blade
received the Product of the Year Award from Internet Telephony magazine in
December 2001.
SEGway Network Products: The SEGway Edge product is an innovative SS7/IP
inter-networking device that enables wireless operators to offload long-haul SS7
traffic onto lower-cost IP networks. The Company announced this product in
February 2001 and customers began deployment of SEGway Edge units on a worldwide
basis in the spring of 2001.
The SEGway Link Concentrator reduces the need to add links to Signal Transfer
Points (STPs) by concentrating SS7 traffic onto fewer, highly utilized links.
The SEGway Link Concentrator is expected to become available in the second
quarter 2002. The SEGway Link Concentrator was recognized as the Product of the
Year by Communications Solutions magazine in December 2001. Appropriate for
current economic conditions, the Company's SEGway Network solutions give
carriers the ability to reduce operating costs, enhance services and expand
their network by utilizing lower cost IP networks for signaling.
GSM Roaming Platform: GSM is the most widely used cellular mobile wireless
protocol in the world. In January 2002, the Company introduced the GSM Roaming
Platform. This platform enables large GSM wireless carriers to offer roaming
services to small or emerging GSM carriers, who may otherwise not be able to
offer extensive roaming coverage to their subscribers. This product is based on
the successful deployment of this technology by a variety of customers.
Customers for the Company's signaling products include Alcatel SA, Clarent
Corporation, Comfone AG, Ericsson Telecommunications, iBasis Inc., Motorola
Corporation, Nortel Networks, Swisscom AG, Teleglobe and TSI Telecommunications
Services.
IP Ethernet Switching Products and the Compact Packet Switching Backplane
Architecture: The Company pioneered a new architecture for embedded system
platforms using Ethernet and recommended adoption of this architecture by the
industry standards board, PCI Industrial Computer Manufacturers Group
(PICMG(R)), in September 2000. PICMG established a committee to evaluate this
new architecture and designated a member of the Company's management team to
chair the process. This new industry standard, called PICMG 2.16 was adopted in
September 2001. This architecture overlays an Ethernet switching network on the
industry-standard CompactPCI(R) architecture for embedded system applications.
For platform integrators, PICMG 2.16 dramatically improves scalability and
reliability enabling an entirely new approach to system implementation. A wide
variety of industries including defense, medical, industrial automation, and
telecommunications are expected to utilize this new architecture in their
next-generation platforms. Thus far, more than thirty companies have announced
products and platforms utilizing this standard, quickly validating its
acceptance.
The foundation of the PICMG 2.16 architecture is an embedded IP Ethernet switch.
In August 2000, the Company introduced the CPC4400 embedded IP Ethernet switch,
the market's first carrier-grade, Layer 3 Ethernet switch utilizing CompactPCI
19
hardware. During 2000 and 2001, the Company developed the IPnexus(TM) family of
new IP Ethernet switch and network access products based on the PICMG 2.16
architecture. Three new IPnexus Ethernet switch models (CPC3400, CPC4401 and
CPC4406) began shipping to customers in September 2001 and two new IPnexus
Gigabit Ethernet switch models (CPC5400 and CPC6400) are scheduled for delivery
in the first half of 2002.
The Company's leadership on the standards board committee, coupled with the
introduction of the IPnexus product family, has significantly increased the
Company's visibility within the communications industry and in the broader,
platform market. Many of the Company's customers are already developing new
system level products utilizing the PICMG 2.16 architecture.
Customers for the Company's IP Ethernet switching products include
APW/Electronic Solutions, Clarent Corporation, Cognitronics Corporation, General
Dynamics, Kaparel, Lucent Technologies, Nortel Networks, Siemens AG and Soma
Networks.
Network Access Products, Communications Server Products and NexusWare(TM): There
are three distinct networks in the communications world today: Voice, data and
signaling. The Company's network access strategy includes products that enable
voice, data and signaling communications with comprehensive solutions that
comprise integrated hardware, software and subsystem elements operating in a
variety of open system platforms. The Company's software generally supports the
Solaris(TM), Windows NT(TM), VxWorks and Linux operating environments and an
extensive suite of communication protocols including Frame Relay, SS7, X.25,
HDLC and Radar Receiver. The Company's network access and communications server
products enable current generation, as well as, next-generation networks.
Many industry analysts believe current PCI architectures are reaching maximum
performance capabilities. Developers of highly available wireless, IP telephony
and broadband access platforms are seeking increased system bandwidth,
performance and reliability and new architectures such as the PICMG 2.16
architecture enable those capabilities.
During 2000 and 2001, the Company developed the IPnexus family of network access
and IP Ethernet switch products based on the PICMG 2.16 architecture. The
Company has introduced three new carrier-grade IPnexus access products including
the CPC388 octal T1/E1/J1 adapter, the CPC395 dual T3/DS3 adapter and the PCI384
telecom adapter, an advanced communications subsystem that provides wide area
networking and communications connectivity for developers of next-generation
telecom and IP telephony systems applications.
Target applications for these new access products include Time Division
Multiplex (TDM) and trunk related tasks associated with wireline, wireless and
IP telephony markets. This includes a broad range of embedded platforms built
for base station controllers, radio network controllers, HLRs/VLRs, VoIP media
gateways, signaling gateways, softswitches, enhanced service platforms and
integrated access devices.
NexusWare(TM) is a comprehensive, Linux-based, operating and development
environment intended for system engineers using IPnexus products that provides
integrated communications protocols to expedite the development process.
Introduced in 2001, NexusWare enables software integration at the system level,
rather than the driver-level. This greatly simplifies the design process in both
conventional PCI-based systems and the emerging PICMG 2.16 systems thereby
accelerating system integration and ultimately time-to-market.
The MPS800, an Internet Protocol (IP)/Wide Area Network (WAN) based
communications server began shipping in production volumes during 2000 to a
number of customers. The MPS800 provides a cost-effective platform that is ideal
for intelligent WAN bridging, T1/E1 multiplexing and remote WAN connectivity.
The Company's extensive suite of WAN protocol software products is available on
the MPS800.
20
Network access and communications server customers include ADC
Telecommunications, Inc., Alcatel SA, Compaq Corporation, Lucent Technologies,
Inc., Motorola Corporation, NAV Canada, Nortel Networks, Raytheon, Sun
Microsystems, Inc., and the U.S. National Weather Service.
On January 15, 2002, the Company announced a reduction of its annualized
operating expenses of approximately $1.6 million in order to improve its cost
structure relative to the economic climate and visibility. Management continues
to focus on the preservation of cash and to maintain tight fiscal control over
discretionary expenses and hiring. At the present time, management believes the
business is sized appropriately from a financial perspective to take advantage
of an economic recovery as it occurs.
Results of Operations
The following table sets forth for the years indicated certain consolidated
financial data expressed as a percentage of sales and is included as an aid to
understanding the Company's results and should be read in conjunction with the
selected financial data and Consolidated Financial Statements (including the
notes thereto) appearing elsewhere in this report:
Year Ended December 31,
2001 2000 1999
-------- -------- --------
Sales 100.0% 100.0% 100.0%
Cost of goods sold 36.5 35.3 34.1
-------- -------- --------
Gross profit 63.5 64.7 65.9
-------- -------- --------
Operating expenses:
Selling and marketing 15.2 12.6 13.0
Research and development 21.7 22.9 17.8
General and administrative 8.1 6.4 8.4
Acquisition charges 3.9
-------- -------- --------
Total operating expenses 45.0 41.9 43.1
-------- -------- --------
Income from operations 18.5 22.8 22.8
Other income, net 2.7 5.0 3.3
-------- -------- --------
Income before income taxes 21.2 27.8 26.1
Provision for income taxes 7.0 9.7 12.1
-------- -------- --------
Net income 14.2% 18.1% 14.0%
======== ======== ========
Excluding one-time acquisition expenses:
Income before income taxes
(Excluding $1.7 million charge for
acquisition expenses in 1999) 21.2% 27.8% 30.0%
Provision for income taxes 7.0 9.7 12.1
-------- -------- --------
Pro forma net income 14.2% 18.1% 17.9%
======== ======== ========
Year Ended December 31, 2001, compared with the Year Ended December 31, 2000
Sales. Total revenue for 2001 was $36.5 million, compared to $39.0 million for
2000. For the years indicated, the Company's products are grouped into four
distinct categories in one market segment: Signaling and network access
products, IP Switching products, U.S. Government/LAN interface products, and
Other products. Revenue from each product category is expressed as a percentage
of sales for 2001 and 2000 are as follows:
2001 2000
------------------ -------------------
Signaling and network access products 87% 82%
IP Switching products 5% 1%
U.S. Government/LAN interface products 0% 3%
Other 8% 14%
------------------ -------------------
Total 100% 100%
================== ===================
21
Signaling and Network Access Products: Revenue from this category amounted to
$31.8 million and $32.1 million in 2001 and 2000, respectively. The Company
broadened its signaling product line and developed several new cPCI network
access products during 2001. The Company has invested heavily in new Signaling
and network access products and management expects this product category to be
the key revenue growth driver for the Company.
IP Switching Products: Revenue from this category increased over 300% to $1.7
million in 2001, compared to $.4 million for 2000. The first member of the IP
switch family, the CPC4400 was introduced in September 2000. Three new IPnexus
Ethernet switch models (CPC3400, CPC4401 and CPC4406) began shipping to
customers in September 2001 and two new IPnexus Gigabit Ethernet switch models
(CPC5400 and CPC6400) are scheduled for delivery in the first half of 2002.
Revenue for these products is still modest but is expected to increase when
customers move into production of their new platforms using the recently
ratified PICMG 2.16 embedded architecture.
U.S. Government/LAN Interface Products: Revenue from these U.S. Government
projects amounted to zero and $1.1 million in 2001 and 2000, respectively. This
sub-contract ended in June 2000.
Other product revenue: Revenue from other products amounted to $3.0 million and
$5.4 million in 2001 and 2000, respectively. This revenue is related to legacy
products. Many of these products are project oriented and shipments can
fluctuate on a quarterly basis. Management expects revenue from these products
to continue to decline over future periods as these technologies are replaced.
Gross Profit. Gross profit consists of sales, less cost of goods sold including
material costs, manufacturing expenses, amortization of software development
costs, expenses associated with engineering contracts and technical support
function expenses. Gross margin was 63.5% and 64.7% of sales in 2001 and 2000,
respectively. Fixed expenses spread over lower sales volumes in 2001 as compared
to 2000 impacted gross margin as a percentage of sales.
Total Operating Expenses. Total operating expenses amounted to $16.4 million and
$16.3 million in 2001 and 2000, respectively. As a percentage of sales, total
operating expenses increased to 45.0% in 2001, from 41.9% in 2000. At the
beginning of 2001, the Company increased sales and marketing expense levels to
garner greater market share. Beginning in the second quarter through the
remainder of the year, the Company reduced expense levels due to deteriorating
economic conditions.
Selling and marketing expenses amounted to $5.5 million and $4.9 million in 2001
and 2000, respectively. Expenditures for advertising, travel and trade show
participation were increased at the beginning of 2001 and then began declining
in the second quarter as the economy deteriorated.
Research and development expenses amounted to $7.9 million and $8.9 million in
2001 and 2000, respectively. During 2001, the Company focused its engineering
efforts on the development of the IPnexus embedded switch and network access
products and broadening its signaling product line. In addition, the Company
capitalized certain software development costs. Amounts capitalized were $1.7
million and $.8 million for 2001 and 2000, respectively. Gross expenditures for
engineering and software development were $9.6 million and $9.7 million for 2001
and 2000, respectively.
General and administrative expenses amounted to $2.9 million and $2.5 million in
2001 and 2000, respectively. An incentive related expense amounting to $.2
million was recorded to reflect the attainment of certain corporate goals in
2001. The remaining year-over-year expense increase is primarily attributable to
an increase in corporate insurance costs.
Other Income, net. Other income consists primarily of interest income from
marketable securities and cash equivalents. The funds are primarily invested in
high quality Municipal and U.S. Treasury securities with maturities of less than
one year.
22
Income taxes. The provision for income taxes for 2001 is based on the
combined federal, state and foreign effective tax rate of 33%, compared to 35%
in 2000. Based on operational decisions implemented during 2000, the Company was
able to utilize Canadian tax incentives to lower its net effective tax rate in
2001.
Year Ended December 31, 2000, compared with the Year Ended December 31, 1999
Sales. Total revenue for 2000 was $39.0 million, compared to $44.5 million for
1999. For the years indicated, the Company's sales are in one product segment
and are grouped into four product categories: SS7 and Network Access products,
U.S. Government/LAN interface products, IP Switching products and Other
products.
SS7 and Network Access Products: Revenue for this group, which includes the
Signaling Gateway, Channel7(TM) and network access products, increased 29% to
$32.1 million in 2000, compared to $24.9 million for 1999. The Company broadened
its Signaling Gateway product line, enhanced its Channel7 products and developed
several new cPCI network access products during 2000.
U.S. Government/LAN Interface Products: Revenue from these U.S. Government
projects amounted to $1.1 million and $13.5 million in 2000 and 1999,
respectively. Beginning in 1994, the Company had contracts with various
sub-contractors, including Lockheed Martin, to provide the U.S. Government with
legacy LAN Interface products for various Navy programs. These contracts ended
in June 2000.
IP Switching Products: Revenue from this new embedded IP switch product was not
meaningful for 2000. In August 2000, the Company introduced the CPC4400 embedded
IP Ethernet switch, the market's first carrier-grade, Layer 3 Ethernet switch
utilizing industry-standard cPCI hardware.
Other product revenue: Revenue from other products amounted to $5.4 million and
$6.1 million in 2000 and 1999, respectively. Other products include the
Company's legacy products. Many of these products are project oriented and
shipments can fluctuate on a quarterly basis.
Gross Profit. Gross profit consists of sales, less cost of goods sold including
materials costs, manufacturing expenses and amortization of software development
costs. Gross profit amounted to $25.2 million and $29.3 million in 2000 and
1999, respectively. Gross margin was 65% and 66% of sales in 2000 and 1999,
respectively.
Total Operating Expenses. Total operating expenses amounted to $16.3 million and
$19.2 million in 2000 and 1999, respectively. As a percentage of sales, total
operating expenses increased to 41.9% in 2000, from 39.2% in 1999, excluding
one-time acquisition charges of $1.7 million. During 2000, the Company increased
its investment in research and development to develop new signaling gateway and
embedded IP Ethernet switch products, and reduced its general and administrative
expenses.
Selling and marketing expenses amounted to $4.9 million and $5.8 million in 2000
and 1999, respectively. As a percentage of revenue, sales and marketing expenses
were reduced slightly in 2000 in order to increase the investment in new product
development. In late 1999, the allowance for doubtful accounts was increased by
$.5 million due to a significant OEM customer closing their doors for business
in January 2000.
Research and development expenses increased to $8.9 million, or 23% of sales in
2000, compared to $7.9 million, or 18% of sales in 1999. The market for
next-generation network products expanded considerably as wireline and wireless
IP networks became more widely deployed during 2000 and the Company invested
significantly in the development of new products in order to be positioned as a
leading supplier in this market.
23
General and administrative expense amounted to $2.5 million, or 6% of sales in
2000, compared to $3.8 million (excluding one-time acquisition charges) or 8% of
sales in 1999. The majority of this expense decline is attributable to no
management incentive bonus being earned in 2000. In 1999, acquisition charges of
$1.7 million consisted primarily of fees for investment bankers, attorneys,
accountants and other related charges.
Other Income, net. Other income consists primarily of interest income from cash
equivalents and marketable securities. The funds are primarily invested in high
quality Municipal and U.S. Treasury securities with maturities of less than one
year.
Income Taxes. The provision for income taxes for 2000 is based upon the combined
federal and state effective tax rate of 35%, compared to 46% in 1999. The year
2000 was PTI's first full year with Canadian operations. Based on operational
decisions implemented during 2000, PTI was able to take advantage of certain
Canadian tax incentives that began benefiting the Company in 2000. For 1999, the
net effective tax rate is much higher than normal primarily due to
non-deductible acquisition charges.
Liquidity and Capital Resources
At December 31, 2001, the Company's primary source of liquidity included cash
and cash equivalents of $26.9 million and available borrowings of $5.0 million
under a bank revolving credit facility. No amounts were outstanding under this
credit facility as of December 31, 2001. The Company had working capital of
$34.7 million and $37.0 million at December 31, 2001 and 2000, respectively.
Cash generated by operating activities was $9.0 million, $5.9 million and $7.7
million in 2001, 2000 and 1999, respectively.
During 2001, cash provided by investing activities was $7.0 million. Investing
activities included the maturity of marketable securities of $10.0 million, and
property and capital equipment purchases of $1.3 million. Land was purchased for
$.4 million for future expansion adjacent to the Company's newly leased
facility. Capital equipment purchases of $.9 million consist primarily of
manufacturing equipment, office equipment and computer and related equipment
used in engineering. In addition, the Company capitalizes certain software
development costs. Amounts capitalized and included within investing activities
were $1.7 million, $.8 million and $.2 million in 2001, 2000 and 1999,
respectively.
In August 2000, the Board of Directors authorized the repurchase of up to one
million shares of the Company's Common Stock and the Company repurchased 342,000
and 658,000 of its common shares in 2001 and 2000, respectively. The total cost
of repurchasing such shares was $4.7 million and $8.8 million in 2001 and 2000,
respectively. This program was completed in March 2001.
In March 2001, the Board of Directors authorized the repurchase of an additional
five hundred thousand shares of the Company's Common Stock. During 2001, the
Company repurchased a total of 206,000 shares at a total cost of $2.2 million
under this program.
Assuming there is no significant change in the Company's business, management
believes that its current cash, cash equivalents, and marketable securities
together with cash generated from operations and available borrowings under the
Company's loan agreement will be sufficient to meet the Company's anticipated
needs, including working capital and capital expenditure requirements, for at
least the next twelve months. However, an unfavorable determination in the
outstanding class action litigation could have a material adverse effect on the
Company's working capital. Furthermore, management is continuing its strategic
acquisition program to further accelerate new product and market penetration
efforts. This program could have an impact on the Company's working capital,
liquidity or capital resources.
24
Notes: Solaris is a trademark of Sun Microsystems, Inc. Windows NT is a
trademark of Microsoft Corporation. IPnexus, Channel7, NexusWare, SEGway,
Signaling Blade and MicroLegend are trademarks of Performance Technologies, Inc.
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to various market risks in the normal course of business,
primarily interest rate risk and changes in the market value of its investments
and believes its exposure to such risk is minimal. The Company's investments are
made in accordance with the Company's investment policy and primarily consist of
U.S. Treasury securities, municipal securities and corporate obligations. The
Company does not participate in the investment of derivative financial
instruments.
ITEM 8 - Financial Statements and Supplementary Data
Index to Financial Statements: Page
Report of Independent Accountants 25
Consolidated Balance Sheets at December 31, 2001 and 2000 26
Consolidated Statements of Income for the Years Ended
December 31, 2001, 2000 and 1999 27
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 2001, 2000 and 1999 28
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 29
Notes to Consolidated Financial Statements 30
Index to Financial Statement Schedules:
All schedules have been omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
Report of Independent Accountants
To the Board of Directors and Stockholders of
Performance Technologies, Incorporated
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Performance Technologies, Incorporated and its subsidiaries at December 31, 2001
and 2000, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/PricewaterhouseCoopers LLP
- -----------------------------
PricewaterhouseCoopers LLP
Rochester, New York
February 5, 2002
25
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31,
2001 2000
----------- ------------
Current assets:
Cash and cash equivalents $26,913,000 $ 17,187,000
Marketable securities 9,995,000
Accounts receivable, net 6,905,000 7,393,000
Inventories, net 3,756,000 5,788,000
Prepaid expenses and other 359,000 745,000
Deferred taxes 608,000 679,000
----------- ------------
Total current assets 38,541,000 41,787,000
Property, equipment and improvements, net 2,465,000 2,119,000
Software development costs, net 1,948,000 852,000
----------- ------------
Total assets $42,954,000 $ 44,758,000
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 417,000 $ 1,347,000
Income taxes payable 350,000 219,000
Accrued expenses 3,046,000 3,246,000
----------- ------------
Total current liabilities 3,813,000 4,812,000
Deferred taxes 799,000 478,000
----------- ------------
Total liabilities 4,612,000 5,290,000
----------- ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock-$.01 par value; 1,000,000 shares
authorized; none issued
Common stock-$.01 par value; 50,000,000 shares
authorized; 13,260,038 shares issued 133,000 133,000
Additional paid-in capital 11,305,000 12,375,000
Retained earnings 40,239,000 35,053,000
Treasury stock-at cost, 1,024,547 and 598,313
shares held at December 31, 2001 and 2000,
respectively (13,284,000) (8,042,000)
Accumulated other comprehensive loss (51,000) (51,000)
----------- ------------
Total stockholders' equity 38,342,000 39,468,000
----------- ------------
Total liabilities and stockholders' equity $42,954,000 $ 44,758,000
=========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
26
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
2001 2000 1999
----------- ----------- -----------
Sales $36,517,000 $38,963,000 $44,494,000
Cost of goods sold 13,327,000 13,768,000 15,174,000
----------- ----------- -----------
Gross profit 23,190,000 25,195,000 29,320,000
----------- ----------- -----------
Operating expenses:
Selling and marketing 5,534,000 4,889,000 5,767,000
Research and development 7,941,000 8,926,000 7,906,000
General and administrative 2,946,000 2,497,000 3,756,000
Acquisition charges 1,744,000
----------- ----------- -----------
Total operating expenses 16,421,000 16,312,000 19,173,000
----------- ----------- -----------
Income from operations 6,769,000 8,883,000 10,147,000
Other income, net 971,000 1,947,000 1,478,000
----------- ----------- -----------
Income before income taxes 7,740,000 10,830,000 11,625,000
Provision for income taxes 2,554,000 3,780,000 5,399,000
----------- ----------- -----------
Net income $ 5,186,000 $ 7,050,000 $ 6,226,000
=========== =========== ===========
Basic earnings per share $ .42 $ .54 $ .47
=========== =========== ===========
Diluted earnings per share $ .41 $ .51 $ .45
=========== =========== ===========
Weighted average number of common shares
used in basic earnings per share 12,282,400 13,105,953 13,164,903
Common equivalent shares 425,661 663,080 623,976
----------- ----------- -----------
Weighted average number of common shares
used in diluted earnings per share 12,708,061 13,769,033 13,788,879
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
27
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Additional Other
Common Stock Paid-in Retained Treasury Comprehensive
Shares Amount Capital Earnings Stock Income (Loss) Total
------------------- ----------- ----------- ------------- --------- -----------
Balance -
January 1,
1999 9,632,144 $ 97,000 $13,228,000 $21,777,000 $ (917,000) $ (5,000) $34,180,000
1999 net income 6,226,000 6,226,000
Currency
translation
adjustment 33,000 33,000
Exercise of
options 4,500 928,000 334,000 1,262,000
Issuance of
options 715,000 715,000
Tax benefit
option plan 62,000 62,000
Three-for-two
stock split 3,735,056 37,000 (37,000)
Purchase of
treasury
stock -
91,584 shares (1,650,000) (1,650,000)
Retirement of
treasury
stock (185,174) (2,000) (2,231,000) 2,233,000
---------- -------- ----------- ----------- ------------- --------- -----------
Balance -
December 31,
1999 13,186,526 132,000 12,665,000 28,003,000 28,000 40,828,000
2000 net income 7,050,000 7,050,000
Currency
translation
adjustment (79,000) (79,000)
Excise of
options and
warrants 73,512 1,000 (304,000) 783,000 480,000
Tax benefit
option plan 14,000 14,000
Purchase of
treasury
stock - 658,200
shares (8,825,000) (8,825,000)
---------- -------- ----------- ----------- ------------- --------- -----------
Balance -
December 31,
2000 13,260,038 133,000 12,375,000 35,053,000 (8,042,000) (51,000) 39,468,000
2001 net income 5,186,000 5,186,000
Currency
translation
adjustment
Exercise of options
and warrants (1,089,000) 1,630,000 541,000
Tax benefit
option plan 19,000 19,000
Purchase of
treasury
stock - 547,334
shares (6,872,000) (6,872,000)
---------- -------- ----------- ----------- ------------- --------- -----------
Balance -
December 31,
2001 13,260,038 $133,000 $11,305,000 $40,239,000 $(13,284,000) $(51,000) $38,342,000
========== ======== =========== =========== ============= ========= ===========
The accompanying notes are an integral part of these consolidated financial
statements.
28
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2001 2000 1999
------------ ------------ -------------
Cash flows from operating activities:
Net income $ 5,186,000 $ 7,050,000 $ 6,226,000
Non-cash adjustments:
Depreciation and amortization 1,537,000 1,313,000 1,545,000
Provision for bad debts 152,000 (70,000) 602,000
Reserve for inventory obsolescence 708,000 1,027,000 779,000
Deferred income taxes 392,000 595,000 (764,000)
Compensation expense 715,000
Changes in operating assets and liabilities:
Accounts receivable 336,000 2,131,000 (4,255,000)
Inventories 1,324,000 (2,915,000) (228,000)
Prepaid expenses and other 386,000 (63,000) 410,000
Accounts payable and
accrued expenses (1,130,000) (1,407,000) 1,210,000
Income taxes payable 150,000 (1,760,000) 1,434,000
------------ ------------ -------------
Net cash provided by
operating activities 9,041,000 5,901,000 7,674,000
------------ ------------ -------------
Cash flows from investing activities:
Purchases of property, equipment
and improvements (1,325,000) (1,348,000) (1,047,000)
Capitalized software
development costs (1,654,000) (819,000) (168,000)
Purchase of marketable securities (5,000) (17,988,000) (23,007,000)
Maturities of marketable securities 10,000,000 30,000,000 1,000,000
------------ ------------ -------------
Net cash provided (used) by
investing activities 7,016,000 9,845,000 (23,222,000)
------------ ------------ -------------
Cash flows from financing activities:
Repayment of debt (6,000) (12,000)
Exercise of stock options and warrants 541,000 480,000 543,000
Purchase of treasury stock (6,872,000) (8,825,000) (932,000)
------------ ------------ -------------
Net cash used by financing
activities (6,331,000) (8,351,000) (401,000)
------------ ------------ -------------
Net increase (decrease) in cash
and cash equivalents 9,726,000 7,395,000 (15,949,000)
Cash and cash equivalents at
beginning of year 17,187,000 9,792,000 25,741,000
------------ ------------ -------------
Cash and cash equivalents at end
of year $ 26,913,000 $ 17,187,000 $ 9,792,000
============ ============ =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ $ $ 15,000
Income taxes paid $ 2,033,000 $ 5,005,000 $ 4,319,000
Non-cash financing activity:
Exercise of stock options using 800,
100 and 46,849 shares of common
stock in 2001, 2000 and 1999,
respectively $ 10,000 $ 4,000 $ 718,000
The accompanying notes are an integral part of these consolidated financial
statements.
29
PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A - Nature of Business and Summary of Significant Accounting Policies
The Company: Performance Technologies, Incorporated (the Company) was formed in
1981 under the laws of the State of Delaware and maintains its corporate offices
in Rochester, New York. The Company designs, develops, manufactures and markets
communications and networking products that enable the convergence of wireline,
wireless and next-generation Internet Protocol networks.
Segment Data, Geographic Information and Significant Customers: The Company
operates in one industry segment. Export sales to customers outside North
America represent 27%, 30% and 16% of sales for the years ended December 31,
2001, 2000 and 1999, respectively. For 2001, 2000 and 1999, four customers
accounted for approximately 30%, 32% and 43%, respectively, of sales, with no
single customer representing greater than 9%, 12% and 23%, respectively, of
sales.
Principles of Consolidation: The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. Effective December
10, 1999, the Company merged with MicroLegend Telecom Systems, Inc.
(MicroLegend), which has been accounted for as a pooling of interests and
accordingly all prior period consolidated financial statements have been
restated to include the combined results (Note B). All inter-company
transactions have been eliminated.
Foreign Currency Translation: The Canadian dollar is the functional currency of
the Company's Canadian subsidiary. Assets and liabilities of foreign operations
are translated to U.S. dollars at current rates of exchange, and revenue and
expenses are translated using average rates. Gains and losses from foreign
currency translation are included as a separate component of stockholders'
equity. Translation adjustments are not tax-effected as they relate to
investments considered permanent in nature. Foreign currency transaction gains
and losses are included in the Consolidated Statements of Income.
Use of Estimates: The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at year-end and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
Concentration of Credit Risk: Financial instruments, which potentially expose
the Company to significant concentrations of credit risk, consist principally of
bank deposits, marketable securities and accounts receivable. Marketable
securities consist of high quality, short-term interest bearing financial
instruments. The Company performs ongoing credit evaluations of its customers'
financial condition and the Company maintains an allowance for uncollectable
accounts receivable based upon the expected collectability of all accounts
receivable.
Fair Value of Financial Instruments: The carrying amounts of the Company's
financial instruments, including cash and cash equivalents, marketable
securities, accounts receivable and accounts payable approximate fair values at
December 31, 2001, as the maturity of these instruments are generally short
term.
Cash Equivalents: The Company considers all highly liquid investments purchased
with an original maturity of three months or less to be cash equivalents.
30
Note A - Nature of Business and Summary of Significant Accounting Policies
(continued)
Marketable Securities: The Company has classified all of its marketable debt
securities as held to maturity and has accounted for these investments at
amortized cost. Marketable securities classified as held to maturity are high
credit quality securities in accordance with the Company's investment policy.
Inventories: Inventories are valued at the lower of cost or market using the
first-in, first-out method. The Company provides inventory reserves for excess,
obsolete or slow moving inventory based on changes in customer demand,
technology developments or other economic factors.
Revenue Recognition: The Company adopted the SEC Staff Accounting Bulletin (SAB)
No. 101, "Revenue Recognition in Financial Statements," for 2000. In doing so,
the Company did not incur any adjustments to revenue. Revenue is recognized upon
product shipment. Revenue from arrangements for software systems requiring
significant production, modification, or customization of software is recognized
over the contract period as performance milestones are fulfilled. Revenue from
consulting and other services is recognized at the time the services are
rendered. Any anticipated losses on contracts are charged to operations as soon
as such losses are determined. Revenue from software maintenance contracts is
recognized ratably over the contractual period, or as the service is performed.
Property, Equipment and Improvements: Property, equipment and improvements are
stated at cost. Depreciation of equipment and improvements is provided for using
the straight-line method over the following estimated useful lives:
Engineering equipment and software 3-5 years
Manufacturing equipment 3-5 years
Furniture and equipment 3-5 years
Leasehold improvements the lesser of 10 years or the lease term
Upon retirement or disposal of an asset, the asset and the related accumulated
depreciation are eliminated from the accounts with gains or losses included as a
component of "Other income" in the Consolidated Statements of Income.
Long-Lived Assets: The Company regularly assesses all of its long-lived assets
for impairment when events or circumstances indicate their carrying amounts may
not be recoverable, in accordance with Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets."
Research and Development: Research and development costs are expensed as
incurred.
Advertising: Advertising costs are expensed as incurred and recorded in "Selling
and marketing" in the Consolidated Statements of Income. Advertising expense
amounted to $249,000, $244,000 and $254,000 for 2001, 2000 and 1999,
respectively.
Software Development Costs: On a product-by-product basis, software development
costs incurred subsequent to the establishment of technological feasibility and
prior to general release of the product are capitalized and amortized commencing
after general release over their estimated remaining economic life, generally
three years, or using the ratio of current revenues to current and anticipated
revenues from such software, whichever provides greater amortization.
31
Note A - Nature of Business and Summary of Significant Accounting Policies
(continued)
Income Taxes: The Company accounts for income taxes using the asset and
liability approach which requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of temporary differences between
the carrying amounts and the tax basis of such assets and liabilities. This
method utilizes enacted statutory tax rates in effect for the year in which the
temporary differences are expected to reverse and gives immediate effect to
changes in income tax rates upon enactment. Deferred tax assets are recognized,
net of any valuation allowance, for deductible temporary differences and tax
credit carryforwards. Deferred income tax expense (benefit) represents the
change in net deferred tax asset and liability balances.
Earnings Per Share: Basic earnings per share is computed by dividing net income
available by the weighted average number of common shares outstanding for the
period. Diluted earnings per share calculations reflect the assumed exercise and
conversion of dilutive employee stock options and warrants applying the treasury
stock method. Dilutive earnings per share calculations exclude the effect of
approximately 864,000, 236,000 and 85,000 options for 2001, 2000 and 1999,
respectively, since such options have an exercise price in excess of the average
market price value of the Company's common stock.
Stock-Based Compensation: Stock-based compensation costs are deferred and
recognized over the vesting period in accordance with Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," based on
the difference, if any, between the quoted market price of the stock on the
grant date and the exercise price. Awards to non-employees are accounted for at
fair value following SFAS 123. In early 1999, a compensation charge of $715,000
was recorded to operating expenses for the issuance of stock options granted to
MicroLegend employees with an exercise price below the fair market value of its
common stock.
Note B - Business Combination
On December 10, 1999, MicroLegend Telecom Systems, Inc. was merged with and into
a subsidiary of the Company, and approximately 2,166,000 shares of the Company's
common stock were issued in exchange for all of the outstanding common stock of
MicroLegend. MicroLegend develops and markets Signaling System 7 (SS7)
telecommunications gateway products that provide signaling and control for
wireless, voice-over-IP and other packet applications. The merger has been
accounted for as a pooling of interests under APB Opinion No. 16, "Business
Combinations." Accordingly, all prior period consolidated financial statements
presented, preceding the merger, have been restated to include the combined
results of operations, financial position and cash flows of MicroLegend as
though it had always been a part of the Company.
The following information presents certain pro forma income statement data of
the separate companies for the period preceding the merger:
Nine months ended
September 30,
1999
-----------
(unaudited)
Revenue:
Performance Technologies, Inc. $28,060,000
MicroLegend Telecom Systems, Inc. 3,539,000
-----------
$31,599,000
===========
Net income (loss):
Performance Technologies, Inc. $ 5,665,000
MicroLegend Telecom Systems, Inc. (952,000)
-----------
$ 4,713,000
===========
32
During the year ended December 31, 1999, the Company recorded a charge to
operating expenses of approximately $1.7 million, or $.12 per common share, for
costs pertaining to the merger transaction.
Note C - Accounts Receivable, net
Accounts receivable consisted of the following: At December 31,
2001 2000
----------- -----------
Accounts receivable $ 7,189,000 $ 7,579,000
Less: allowance for doubtful accounts (284,000) (186,000)
----------- -----------
Net $ 6,905,000 $ 7,393,000
=========== ===========
Note D - Inventories, net
Inventories consisted of the following: At December 31,
2001 2000
----------- -----------
Purchased parts and components $ 1,329,000 $ 2,656,000
Work in process 2,778,000 3,959,000
Finished goods 468,000 297,000
----------- -----------
4,575,000 6,912,000
Less: reserve for inventory obsolescence (819,000) (1,124,000)
----------- -----------
Net $ 3,756,000 $ 5,788,000
=========== ===========
Note E - Property, Equipment and Improvements, net
Property, equipment and improvements consisted
of the following: At December 31,
2001 2000
----------- -----------
Land $ 407,000 $
Engineering equipment and software 3,876,000 3,504,000
Manufacturing equipment 1,313,000 1,345,000
Furniture and equipment 1,364,000 1,268,000
Leasehold improvements 166,000 143,000
----------- -----------
7,126,000 6,260,000
Less: accumulated depreciation and amortization (4,661,000) (4,141,000)
----------- -----------
Net $ 2,465,000 $ 2,119,000
=========== ===========
Total depreciation and amortization expense for equipment and improvements for
2001, 2000 and 1999 was $975,000, $894,000 and $775,000, respectively.
Note F - Accrued Expenses
Accrued expenses consisted of the following: At December 31,
2001 2000
----------- -----------
Accrued compensation $ 1,294,000 $ 1,143,000
Accrued professional services 329,000 416,000
Deferred revenue 917,000 793,000
Other accrued expenses 506,000 894,000
----------- -----------
Total $ 3,046,000 $ 3,246,000
=========== ===========
33
Note G - Credit Agreements
At December 31, 2001, the Company had a revolving credit loan agreement with a
bank under which it can borrow up to $5 million which expires in November 2002.
Borrowings bear interest either at the bank's prime rate or the one-month LIBOR
rate plus applicable basis points as outlined in the agreement. Borrowings are
collateralized by trade accounts receivable, inventory, equipment, contract
rights and intangibles. The agreement requires the Company to meet certain
financial and non-financial covenants. The Company was in compliance with such
covenants at December 31, 2001. There were no balances outstanding under this
agreement at December 31, 2001 and 2000. The annual fee on the credit loan
agreement is immaterial.
Note H - Commitments
The Company leases facilities and equipment under operating leases. The lease
agreement for the current facility in Rochester, N.Y. expires in April 2002.
During 2001, the Company entered into a lease agreement for its new Rochester,
N.Y. corporate headquarters and manufacturing facility that is expected to begin
in April 2002. Under the terms of the lease that expires in March 2012, the
Company agrees to pay an annual rental of $740,000 in the first year, with
predetermined adjustments for each year thereafter. For both lease agreements,
the Company is also required to pay the pro rata share of the real property
taxes and assessments, expenses and other charges associated with these
facilities. The Company has leased facilities in its other operating locations
in North America that expire between 2002 through 2005.
Future minimum lease payments for all operating leases having a remaining term
in excess of one year at December 31, 2001 are as follows:
Operating Leases
----------------
2002 $ 825,000
2003 888,000
2004 865,000
2005 771,000
2006 754,000
Thereafter 4,059,000
----------
Total minimum lease payments $8,162,000
==========
Rental expense amounted to $908,000, $830,000 and $787,000 for 2001, 2000 and
1999, respectively.
Note I - Stockholders' Equity
On February 9, 2000, the stockholders approved an amendment to the Restated
Certificate of Incorporation to increase the number of authorized common shares,
from 15 million shares to 50 million shares.
During 1999 pursuant to a stock repurchase program authorized by the Board of
Directors in 1998, the Company repurchased 44,735 of its common shares at a
total cost of $932,000 under this program. On December 10, 1999, the Company
terminated this stock repurchase program. In connection with the business
combination with MicroLegend Telecom Systems, Inc., the Company retired 185,174
shares of Treasury stock acquired at an average cost of $12.06 per share, or
$2.2 million.
In August 2000, the Board of Directors authorized the repurchase of up to one
million shares of the Company's common stock and the Company repurchased 341,800
and 658,200 of its common shares in 2001 and 2000, respectively. The total cost
of repurchasing such shares was $4,699,000 and $8,825,000 in 2001 and 2000,
respectively. This program was completed in March 2001.
In March 2001, the Board of Directors authorized the repurchase of an additional
five hundred thousand shares of the Company's common stock. During 2001, the
Company repurchased a total of 205,534 shares at a total cost of $2,173,000
under this program.
34
The Company declared a three-for-two stock split of its common stock effected in
the form of 50% stock dividend on the outstanding shares payable to shareholders
of record as of August 26, 1999, with a distribution date of September 1, 1999.
Basic and diluted earnings per share, weighted average number of shares
outstanding and all applicable footnotes have been adjusted to reflect the
aforementioned stock split. All agreements concerning stock options and other
commitments payable in shares of the Company's common stock provided for the
issuance of additional shares due to the declaration of the stock split. An
amount equal to the par value of the common shares issued was transferred from
capital in excess of par value to the common stock account.
Note J - Stock Option Plan
In 1986, the Company established the 1986 Incentive Stock Option Plan pursuant
to which the Board of Directors reserved 2,700,000 shares of common stock for
grant. On February 9, 2000, the stockholders approved an amendment to the Stock
Option Plan to increase, by 500,000 shares, the number of authorized shares that
may be issued pursuant to this Plan. On May 31, 2001, the stockholders approved
the 2001 Incentive Stock Option Plan pursuant to which 1,500,000 shares of
common stock were reserved for grant. The 2001 Incentive Stock Option Plan
replaced the 1986 plan which expired on December 31, 2001. 276,000 options
available for issuance under the 1986 plan were cancelled upon adoption of the
2001 plan. Options may be granted to any officer or employee at not less than
the fair market value at the date of grant (not less than 110% of the fair
market value in the case of holders of more than 10% of the Company's common
stock). Options granted under the plans generally expire five or six years from
the date of grant and generally vest over three, four or five years.
With respect to non-qualified options, the Company recognizes a tax benefit upon
exercise in an amount equal to the tax effect of the difference between the
option price and the fair market value of the common stock. Tax benefits related
to such non-qualified stock options are credited to additional paid-in capital.
The following table summarizes stock option activity under these plans:
Weighted-Average Option
Number of Shares Exercise Price Price Range
Outstanding at January 1, 1999 1,009,607 $ 5.89 $1.01 - $ 9.75
Granted 385,375 $13.60 $8.15 - $18.75
Exercised (253,164) $ 4.91 $1.22 - $ 9.75
Expired (26,400) $ 8.49 $1.22 - $ 9.17
----------
Outstanding at December 31, 1999 1,115,418 $ 8.72 $1.22 - $18.75
Granted 526,375 $15.14 $9.00 - $28.75
Exercised (77,249) $ 5.38 $1.22 - $ 9.75
Expired (64,013) $14.09 $5.94 - $28.75
----------
Outstanding at December 31, 2000 1,500,531 $10.91 $4.44 - $28.75
Granted 572,950 $13.85 $8.00 - $14.50
Exercised (65,650) $ 7.36 $4.44 - $10.25
Expired (189,001) $15.05 $6.17 - $28.75
----------
Outstanding at December 31, 2001 1,818,830 $11.54 $4.83 - $28.75
==========
At December 31, 2001, 929,086 options were exercisable and 1,427,800 options
were available for future grant under the stock option plan. During 2001 and
2000, warrants for 56,250 shares for each year, issued at fair market value in
1995, were exercised at an exercise price of $1.22 per share. At December 31,
2001, there are no warrants outstanding.
35
The Company has adopted the disclosure only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation cost has
been recognized for the stock option plan. Had compensation cost for the stock
option plan been determined based on the fair value at the grant date for option
awards consistent with the provisions of SFAS No. 123, the Company's net income
would have been reduced to the pro forma amounts of $3,487,000, $4,570,000 and
$4,765,000, respectively. Basic earnings per share would have been reduced to
the pro forma amounts of $.28, $.35 and $.36, respectively. Diluted earnings per
share would have been reduced to the pro forma amounts of $.27, $.33 and $.34,
respectively. The assumption regarding the annual vesting of stock options was
25% for options granted in 2001 and 33% for options granted in 2000 and 1999,
respectively. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 2001, 2000 and 1999: Dividend
yield of 0%; expected volatility of 64%, 63% and 65%; risk-free interest rate of
4.7%, 6.2% and 5.4%; and expected lives of four years in 2001 and three years in
2000 and 1999, respectively.
Note K - Stockholder Rights Plan
On October 27, 2000, the Company's Board of Directors adopted a Stockholder
Rights Plan. Under this plan, one Preferred Stock Purchase Right was distributed
as a dividend for each share of common stock held by the stockholders of record
as of the close of business of November 8, 2000. Until the occurrence of certain
events, the Rights are traded as a unit with the common stock. Each Right will
separate and entitle stockholders to buy stock upon the occurrence of certain
events generally related to the change of control of the Company as defined in
the Plan. The Rights become exercisable ten days after either (1) an "Acquiring
Person" acquires or commences a tender offer to acquire 15% or more of the
Company's Common Stock, or (2) an "Adverse Person" has acquired 10% or more of
the Company's common stock and the Board determines this person is likely to
cause pressure on the Company to enter into a transaction that is not in the
Company's best long-term interest. All Rights not held by an Acquiring Person or
an Adverse Person become rights to purchase from the Company one one-thousandth
of one share of Preferred Stock at an initial exercise price of $110 per Right.
Each Right entitles the holder of that Right to purchase the equivalent of $220
worth of the Company's common stock for $110. If after such an event the Company
merges, consolidates or engages in a similar transaction in which it does not
survive, each holder has a "flip over" right to buy discounted stock in the
surviving entity.
The Company may redeem the Rights for $.001 each. The Rights Plan expires on
November 1, 2010 or can be modified or terminated, at the option of the Board of
Directors.
Note L - Income Taxes
Pre-tax earnings and provision for income taxes consisted of the following for
the years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
Pre-tax earnings: ----------- ----------- -----------
United States $ 6,265,000 $ 9,784,000 $12,065,000
Outside United States 1,475,000 1,046,000 (440,000)
----------- ----------- -----------
Total pre-tax earnings $ 7,740,000 $10,830,000 $11,625,000
=========== =========== ===========
The provisions for income taxes were as follows:
2001 2000 1999
Current income tax expense: ----------- ----------- -----------
Federal $ 1,551,000 $ 2,874,000 $ 4,603,000
State 198,000 288,000 765,000
Foreign 401,000 99,000 610,000
----------- ----------- -----------
2,150,000 3,261,000 5,978,000
Deferred provision (benefit) 404,000 519,000 (579,000)
----------- ----------- -----------
Total provision $ 2,554,000 $ 3,780,000 $ 5,399,000
=========== =========== ===========
36
Reconciliation of the statutory U.S. federal income tax rate to effective rates
were as follows:
2001 2000 1999
----- ----- -----
Federal income tax at statutory rate 34.0% 34.0% 35.0%
State tax provision, net of federal benefit 1.7 1.8 4.2
Acquisition charges 6.0
Other (2.7) (.9) 1.2
----- ----- -----
Effective tax rate 33.0% 34.9% 46.4%
===== ===== =====
The net deferred income tax balance consists of the following:
At December 31,
Deferred tax liabilities 2001 2000
----------- -----------
Capitalized software development cost, net $ (682,000) $ (321,000)
Difference in tax basis of assets (22,000) (84,000)
Investment tax credit (95,000) (73,000)
----------- -----------
Total deferred tax liabilities $ (799,000) $ (478,000)
=========== ===========
Deferred tax assets
Accrued vacation, payroll and other accrued
expenses $ 111,000 $ 108,000
Inventory obsolescence reserve and other
inventory related items 320,000 427,000
Bad debt reserve 87,000 55,000
Research tax credits 16,000 17,000
Other 74,000 72,000
----------- -----------
Total deferred tax assets 608,000 679,000
----------- -----------
Net deferred tax (liability) asset $ (191,000) $ 201,000
=========== ===========
As of December 31, 2001, no deferred taxes have been provided on the
undistributed earnings of its Canadian subsidiary, as the Company does not plan
to initiate any action that would require the payment of income taxes. It is not
practicable to estimate the amount of additional tax that might be payable on
these undistributed earnings.
Note M - Research and Software Development Costs
The Corporation incurred research and software development costs relating to the
development of new products as follows:
2001 2000 1999
---------- ---------- ----------
Gross expenditures for engineering
and software development $9,595,000 $9,745,000 $8,074,000
Less: amounts capitalized (1,654,000) (819,000) (168,000)
---------- ---------- ----------
Net charged to operating expenses $7,941,000 $8,926,000 $7,906,000
========== ========== ==========
Software Development costs consisted
of the following:
At December 31,
2001 2000
---------- ----------
Capitalized software development costs $5,202,000 $3,548,000
Less: accumulated amortization (3,254,000) (2,696,000)
---------- ----------
Net $1,948,000 $ 852,000
========== ==========
Amortization of software development costs included in cost of goods sold was
$558,000, $419,000 and $770,000 for 2001, 2000 and 1999, respectively.
37
Note N - Employee Benefit Plans
For its operations in the United States, the Retirement Savings Plan qualifies
under Section 401(k) of the Internal Revenue Code. Discretionary matching
contributions by the Company to the plan were $99,000, $133,000 and $116,000 for
2001, 2000 and 1999, respectively. In conjunction with its Flexible Benefits
plan, the Company made additional discretionary qualified contributions to
employee accounts which vest immediately amounting to $119,000, $139,000 and
$134,000 for 2001, 2000 and 1999, respectively.
For its operations in Canada, contributions were made to a Registered Retirement
Savings Plan (RRSP) that is administered by the Canadian government.
Discretionary matching contributions to the Plan were $186,000, $190,000 and
$34,000 for 2001, 2000 and 1999, respectively.
Note O - Litigation
Following the Company's announcement on May 19, 2000 regarding its preliminary
results of operations for the second quarter, several class action lawsuits were
filed against the Corporation, as well as several of its officers and directors,
alleging violations of federal securities laws. The lawsuits were filed in
United States District Court for the Western District of New York and request
unspecified monetary damages. The Lead Counsel has been approved by the Court
and an Amended Complaint, dated March 19, 2001, has been filed with the Court.
On May 18, 2001, the Company filed a motion to dismiss the consolidated
complaint. On June 25, 2001, the Plaintiffs filed a memorandum of law in
opposition to the Company's motion to dismiss. On July 20, 2001, the Company
filed a memorandum of law in further support of the Company's motion to dismiss
the Plaintiffs' class action complaint.
Management believes that the claims contained in these actions described above
are without merit and the Company intends to defend against the claims
vigorously. In the opinion of management, resolution of this litigation is not
expected to have a material adverse effect on the financial position of the
Company. However, depending on the amount and timing of such resolution, an
unfavorable resolution of this matter could materially affect the Company's
future results of operations or cash flows in a particular period. No costs have
been accrued for this possible loss contingency.
The Company is subject to various other legal proceedings and claims that arise
in the ordinary course of business. In the opinion of management, the amount of
any ultimate liability with respect to these actions will not materially affect
the financial position of the Company.
Note P - Transactions with Related Parties
The Company leases its primary facility in Rochester, New York from an entity
controlled by two directors of the Company. During 2001, 2000 and 1999, the
Company paid rent of $347,000, $335,000 and $323,000, respectively, for the use
of this location. (Note H)
Note Q - Subsequent Event- Restructuring Plans
On January 15, 2002, the Company announced plans to improve its cost structure
primarily through reductions in the Company's staff. This plan has been
completed and resulted in a reduction in workforce of approximately 10%. During
the first quarter of 2002, the Company will record a restructuring charge,
primarily related to severance costs, of $163,000.
38
Note R - Quarterly Results (unaudited)
The following is a summary of unaudited quarterly results of operations for the
years ended December 31, 2001 and 2000.
2001
----------
(in thousands, except per share data)
Mar. 31 Jun. 30 Sept. 30 Dec. 31
------- ------- ------- -------
Sales $ 9,700 $ 9,444 $ 9,871 $ 7,502
Gross profit 5,891 5,833 6,493 4,973
Income from operations 1,364 1,638 2,456 1,311
Net income 1,152 1,259 1,770 1,005
Basic earnings per share $ 0.09 $ 0.10 $ 0.14 $ 0.08
======= ======= ======= =======
Diluted earnings per share $ 0.09 $ 0.10 $ 0.14 $ 0.08
======= ======= ======= =======
2000
----------
(in thousands, except per share data)
Mar. 31 Jun. 30 Sept. 30 Dec. 31
------- ------- ------- -------
Sales $11,594 $ 8,089 $ 9,244 $10,036
Gross profit 7,793 5,366 6,268 5,768
Income from operations 3,467 1,242 1,961 2,213
Net income 2,436 1,119 1,521 1,974
Basic earnings per share $ 0.18 $ 0.08 $ 0.12 $ 0.15
======= ======= ======= =======
Diluted earnings per share $ 0.17 $ 0.08 $ 0.11 $ 0.15
======= ======= ======= =======
ITEM 9 - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
The information required by Part III and each of the following items is omitted
from this Report and presented in the Company's definitive proxy statement to be
filed, pursuant to Regulation 14A not later than 120 days after the end of the
fiscal year covered by this Report, in connection with the Company's Annual
Meeting of Stockholders to be held on June 4, 2002, which information included
therein is incorporated herein by reference.
ITEM 10 - Directors and Executive Officers of the Registrant
The section entitled "Election of Directors" appearing in the Company's proxy
statement for the Annual Meeting of Stockholders to be held on June 4, 2002,
sets forth certain information with respect to the directors and executive
officers of the Company and is incorporated herein by reference.
ITEM 11 - Executive Compensation
The section entitled "Executive Compensation" appearing in the Company's proxy
statement for the Annual Meeting of Stockholders to be held on June 4, 2002,
sets forth certain information with respect to the compensation of management of
the Company and is incorporated herein by reference.
39
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
The section entitled "Security Ownership of Certain Beneficial Owners and
Management" appearing in the Company's proxy statement for the Annual Meeting of
Stockholders to be held on June 4, 2002, set forth certain information with
respect to the ownership of the Company's Common Stock and is incorporated
herein by reference.
ITEM 13 - Certain Relationships and Related Transactions
The section entitled "Certain Transactions" appearing in the Company's proxy
statement for the Annual Meeting of Stockholders to be held on June 4, 2002,
sets forth certain information with respect to certain business relationships
and transactions between the Company and its directors and officers and is
incorporated herein by reference.
40
PART IV
ITEM 14 - Exhibits, Financial Statement Schedules, Reports on Form 8-K
(1) Financial Statements
The financial statements filed as part of this report are included in
the response to Item 8 of Part III of this 10-K report.
(2) Financial Statement Schedules
There were no financial statement schedules required to be filed
because they are not applicable or the required information is shown in
the Consolidated Financial Statements or notes thereto.
(3) Exhibits
Exhibit Ref.
Number Number Description
3.1 (1) Restated Certificate of Incorporation
3.2 (5) Certificate of Amendment
3.3 (1) Amended By-laws
4.1 (1) Form of Common Stock Certificate
4.2 (1) Amended and Restated 1986 Incentive Stock Option Plan
4.4 (6) February 2000 Amendment to Amended and Restated 1986
Incentive Stock Option Plan
4.5 (7) Rights Agreement
4.6 (9) 2001 Incentive Stock Option Plan
10 (1) Material Contracts
10.1 (3) Revolving Credit Agreement dated as of December 30,
1998 between the Registrant and The Chase
Manhattan Bank, N.A. - as amended
10.2 (3) Revolving Credit Note in the amount of $5,000,000
dated December 30, 1998 given by the Registrant to
The Chase Manhattan Bank, N.A.
10.3 (1) Security Agreements granted by the Registrant to The
Chase Manhattan Bank, N.A. dated as of April 13,
1985, April 13, 1993 and as of June 17, 1993 and
with respect to Performance Computer Corporation
only, the Security Agreement dated as of June 17,
1993 granted to The Chase Manhattan Bank, N.A. by
Performance Computer Corporation and certain other
Affiliates of the Registrant (which other
Affiliates have been released) and all amendments
and modifications thereto
10.10 (1)(10) Sublease Agreement between the Registrant and C & J
Enterprises dated as of September 1, 1990 - as
amended
10.16 (1) License Agreement between the Registrant and Spider
Systems Limited dated March 18, 1992
10.28 (1) Adoption Agreement between the Registrant and
Principal Mutual Life Insurance Company dated
September 20, 1993
10.29 (1) The Principal Financial Group Prototype Basic Savings
Plan dated May 7, 1990
10.30 (1) Form of Stock Option Agreement
10.31 (1) Form of Warrant Agreement
10.32 (4) Share Acquisition Agreement between Registrant and
MicroLegend Telecom Systems, Inc. as of December
2, 1999
10.33 (4) Amendment to Share Acquisition Agreement between
Registrant and MicroLegend Telecom Systems, Inc.
as of December 10, 1999
10.33a (10) Lease Agreement dated as of May 19, 2001 between the
Registrant and Christa PT, LLC
10.33b (10) First Amendment to Lease dated as of July 19, 2001
between the Registrant and Christa PT, LLC
10.33c (10) Second Amendment to Lease dated as of July 31, 2001
between the Registrant and Christa PT, LLC
41
21 (8) Subsidiaries
23.1 (*) PricewaterhouseCoopers Consent
- --------------------------------------------------------------------------------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 filed November 22, 1995.
(2) Incorporated by reference to the Registrant Statement on Form S-8 filed
July 30, 1997.
(3) Incorporated by reference to the Annual Report on Form 10-K filed March
30,1999.
(4) Incorporated by reference to the Registrant Statement on Form S-3 filed
January 28, 2000.
(5) Incorporated by reference to the Annual Report on Form 10-K filed on March
30, 2000.
(6) Incorporated by reference to the Registrant Statement on Form S-8 filed
June 21, 2000.
(7) Incorporated by reference to the Registrant Statement on Form 8-A
filed November 8, 2000.
(8) Incorporated by reference to the Annual Report on Form 10-K filed on
March 30, 2001.
(9) Incorporated by reference to the Registration Statement on Form DEF
14A filed on April 27, 2001.
(10) Incorporated by reference to the Registrant Statement on Form 10-Q
filed on August 14, 2001.
(*) Filed with this form 10-K
(4) Reports on Form 8-K
None
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Performance Technologies, Incorporated
Date: March 27, 2002 By:/s/ Donald L. Turrell
-----------------
Donald L. Turrell
President and
Chief Executive Officer
By:/s/ Dorrance W. Lamb
-----------------
Dorrance W. Lamb
Chief Financial Officer and
Vice President of Finance
Pursuant to the requirements of the Securities Act of 1934, the
following persons on behalf of the registrant and in the capacities and on the
dates indicated have signed this report.
Signature Title Date
/s/John M. Slusser Chairman of the Board March 27, 2002
- -----------------------
John M. Slusser and Director
/s/Donald L. Turrell President, Chief Executive March 27, 2002
- -----------------------
Donald L. Turrell Officer and Director
/s/Dorrance W. Lamb Chief Financial Officer, and March 27, 2002
- -----------------------
Dorrance W. Lamb Vice President of Finance
/s/Bernard Kozel Director March 27, 2002
- -----------------------
Bernard Kozel
/s/Charles E. Maginness Director March 27, 2002
- -----------------------
Charles E. Maginness
/s/Stuart B. Meisenzahl Director March 27, 2002
- -----------------------
Stuart B. Meisenzahl
/s/John E. Mooney Director March 27, 2002
- -----------------------
John E. Mooney
/s/Paul L. Smith Director March 27, 2002
- -----------------------
Paul L. Smith
/s/Arlen Vanderwel Director March 27, 2002
- -----------------------
Arlen Vanderwel
43
Exhibit 23.1
Consent of Independent Accountants
To the Board of Directors and Stockholders of
Performance Technologies, Inc.
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-3 (No. 333-94371) and S-8 (No. 333-24477) of Performance
Technologies, Incorporated of our report dated February 5, 2002 relating to the
financial statements and financial statement schedules, which appears in this
Form 10-K.
/s/PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Rochester, New York
March 27, 2002