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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from............to.............
Commission file number 1-8191
PORTA SYSTEMS CORP.
-------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2203988
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6851 Jericho Turnpike, Suite 170, Syosset, New York
---------------------------------------------------
(Address of principal executive offices)
11791
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(Zip Code)
516-364-9300
------------
(Company's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by a check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
Common stock (par value $0.01) 9,972,284 shares as of July 22, 2004
PART I.- FINANCIAL INFORMATION
Item 1- Financial Statements
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands)
June 30, December 31,
2004 2003
--------- ------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 717 $ 469
Accounts receivable - trade, less allowance for doubtful accounts 3,698 3,898
Inventories 3,121 3,004
Prepaid expenses and other current assets 464 472
--------- ---------
Total current assets 8,000 7,843
Property, plant and equipment, net 1,356 1,466
Goodwill, net 2,961 2,961
Other assets 73 85
--------- ---------
Total assets $ 12,390 $ 12,355
========= =========
Liabilities and Stockholders' Deficit
Current liabilities:
Senior debt $ 25,562 $ 25,387
Subordinated notes 6,144 6,144
6% convertible subordinated debentures 385 385
Accounts payable 4,827 5,635
Accrued expenses 2,481 3,117
Accrued interest payable 4,040 3,563
Accrued commissions 270 284
Deferred compensation 58 58
Income taxes payable 8 95
--------- ---------
Total current liabilities 43,775 44,668
--------- ---------
Deferred compensation 894 925
--------- ---------
Total long-term liabilities 894 925
--------- ---------
Total liabilities 44,669 45,593
========= =========
Stockholders' deficit:
Preferred stock, no par value; authorized 1,000,000 shares, none issued -- --
Common stock, par value $.01; authorized 20,000,000 shares, issued
10,003,224 shares at June 30, 2004 and December 31, 2003 100 100
Additional paid-in capital 76,059 76,059
Accumulated deficit (102,232) (103,380)
Accumulated other comprehensive loss:
Foreign currency translation adjustment (4,268) (4,079)
--------- ---------
(30,341) (31,300)
Treasury stock, at cost (1,938) (1,938)
--------- ---------
Total stockholders' deficit (32,279) (33,239)
--------- ---------
Total liabilities and stockholders' deficit $ 12,390 $ 12,355
========= =========
See accompanying notes to unaudited consolidated financial statements.
Page 2 of 18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss)
(In thousands, except per share amounts)
Six Months Ended
June 30, June 30,
2004 2003
-------- --------
Sales $ 14,372 $ 8,338
Cost of sales 8,875 6,278
-------- --------
Gross profit 5,497 2,060
-------- --------
Selling, general and administrative expenses 2,642 3,141
Research and development expenses 1,021 1,016
-------- --------
Total expenses 3,663 4,157
-------- --------
Operating income(loss) 1,834 (2,097)
Interest expense (660) (627)
Interest income -- 1
Other income (expense), net -- (26)
-------- --------
Income (loss) before income taxes 1,174 (2,749)
Income tax (expense) benefit (26) 282
-------- --------
Net income (loss) $ 1,148 $ (2,467)
======== ========
Other comprehensive loss:
Foreign currency translation adjustments (189) (50)
-------- --------
Comprehensive income (loss) $ 959 $ (2,517)
======== ========
Per share data:
Basic per share amounts:
Net income (loss) per share of common stock $ 0.12 $ (0.25)
======== ========
Weighted average shares outstanding 9,972 9,972
======== ========
Diluted per share amounts:
Net income (loss) per share of common stock $ 0.12 $ (0.25)
======== ========
Weighted average shares outstanding 9,972 9,972
======== ========
See accompanying notes to unaudited consolidated financial statements.
Page 3 of 18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss)
(In thousands, except per share amounts)
Three Months Ended
June 30, June 30,
2004 2003
------- -------
Sales $ 6,272 $ 3,964
Cost of sales 3,905 2,897
------- -------
Gross profit 2,367 1,067
------- -------
Selling, general and administrative expenses 1,176 1,586
Research and development expenses 508 444
------- -------
Total expenses 1,684 2,030
------- -------
Operating income (loss) 683 (963)
Interest expense (337) (320)
Other income (expense), net -- (26)
------- -------
Income (loss) before income taxes 346 (1,309)
Income tax benefit (expense) (26) 268
------- -------
Net income (loss) $ 320 $(1,041)
======= =======
Other comprehensive gain (loss):
Foreign currency translation adjustments (75) 30
------- -------
Comprehensive income (loss) $ 245 $(1,011)
======= =======
Per share data:
Basic per share amounts:
Net income (loss) per share of common stock $ 0.03 $ (0.10)
======= =======
Weighted average shares outstanding 9,972 9,972
======= =======
Diluted per share amounts:
Net income (loss) per share of common stock $ 0.03 $ (0.10)
======= =======
Weighted average shares outstanding 9,972 9,972
======= =======
See accompanying notes to unaudited consolidated financial statements.
Page 4 of 18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
(In thousands)
Six Months Ended
June 30, June 30,
2004 2003
------- -------
Cash flows from operating activities:
Net income (loss) $ 1,148 $(2,467)
Adjustments to reconcile net income (loss) to net cash
provided by ( used in) operating activities:
Depreciation and amortization 191 259
Changes in operating assets and liabilities:
Accounts receivable 200 1,043
Inventories (117) 429
Prepaid expenses 8 (60)
Other assets 12 223
Accounts payable, accrued expenses and other liabilities (1,100) 114
------- -------
Net cash provided by ( used in) operating activities 342 (459)
------- -------
Cash flows from investing activities:
Capital expenditures, net (80) (74)
------- -------
Net cash used in investing activities (80) (74)
------- -------
Cash flows from financing activities:
Increase in senior debt 175 152
Repayments of short term loans -- (2)
------- -------
Net cash provided by financing activities 175 150
------- -------
Effect of exchange rate changes on cash (189) (59)
------- -------
Increase (decrease) in cash and cash equivalents 248 (442)
Cash and equivalents - beginning of the year 469 779
------- -------
Cash and equivalents - end of the period $ 717 $ 337
======= =======
Supplemental cash flow disclosure:
Cash paid for interest expense $ 34 $ 3
======= =======
Cash paid for income taxes $ 34 $ 6
======= =======
See accompanying notes to unaudited consolidated financial statements.
Page 5 of 18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Management's Responsibility For Interim Financial Statements Including
All Adjustments Necessary For Fair Presentation
Management acknowledges its responsibility for the preparation of the
accompanying interim consolidated financial statements which reflect all
adjustments, consisting of normal recurring adjustments, considered necessary in
its opinion for a fair statement of its consolidated financial position and the
results of its operations for the interim period presented. These consolidated
financial statements should be read in conjunction with the summary of
significant accounting policies and notes to consolidated financial statements
included in the Company's Form 10-K annual report for the year ended December
31, 2003. These financial statements have been prepared assuming that the
Company will continue as a going concern and, accordingly, do not include any
adjustments that might result from the outcome of the uncertainties described in
these financial statements. The audit opinion included in the December 31, 2003
Form 10-K annual report contained an explanatory paragraph regarding the
Company's ability to continue as a going concern. Results for the second quarter
or the first six months of 2004 are not necessarily indicative of results for
the year. See Note 3.
Note 2: Inventories
Inventories are stated at the lower of cost (on the average or first-in,
first-out method) or market. The composition of inventories at the end of the
respective periods is as follows:
June 30, 2004 December 31, 2003
------------- -----------------
(in thousands)
Parts and components $1,563 $1,673
Work-in-process 549 427
Finished goods 1,009 904
------ ------
$3,121 $3,004
====== ======
Note 3: Senior and Subordinated Debt
On June 30, 2004, the Company's debt to its senior lender was $25,562,000.
Under recent amendment, the loan becomes due and payable on August 30, 2004. If
the agreement is not extended beyond August 30, 2004, or if the senior lender
demands payment of all or a significant portion of the loan when due, the
Company will not be able to continue in business and may seek protection under
the Bankruptcy Code.
Pursuant to our agreement with our senior lender, we have not paid or
accrued interest on $22,600,000 of senior debt since March 2002. As a result,
our statements of operations do not reflect any interest charges on this portion
of our senior debt for 2003 or 2004. The senior lender has the right at any time
to require us to pay interest; however, our obligation to pay interest will not
require us to pay interest on such senior debt for periods prior to the date the
senior lender requires us to commence interest payments. We continue to accrue
interest on obligations to our senior lender which were incurred subsequent to
March 2002. The increase in senior debt reflects accrued interest.
Page 6 of 18
As of June 30, 2004, the Company's short-term debt also included
$6,144,000 of subordinated debt that became due on July 3, 2001 and $385,000 of
6% debentures which became due on July 2, 2002. Accrued interest on the
subordinated notes was approximately $3,667,000, which represents interest from
July 2000 through June 30, 2004, and accrued interest on the 6% debentures was
$92,000. The Company's senior lender has precluded it from paying any principal
or interest on the subordinated debt.
Note 4: Accounting for Stock Based Compensation
The Company applies the intrinsic value method as outlined in APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations
in accounting for stock options. Under the intrinsic value method, no
compensation expense is recognized if the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of the grant. Accordingly, no compensation cost has been recognized. SFAS
No. 123, "Accounting for Stock-based Compensation," requires the Company to
provide pro forma information regarding net loss and net loss per share of
common stock as if compensation cost for the Company's stock option programs had
been determined in accordance with the fair value method prescribed therein.
Since there was no stock-based compensation in the six months ended June 30,
2004 and 2003, pro forma income (loss) is the same as the reported net income
(loss).
Note 5: Segment Data
The Company has three reportable segments: Line Connection and Protection
Equipment ("Line") whose products interconnect copper telephone lines to
switching equipment and provide fuse elements that protect telephone equipment
and personnel from electrical surges; Signal Processing ("Signal") whose
products are used in data communication devices that employ high frequency
transformer technology, and Operating Support Systems ("OSS") whose products
automate the testing, provisioning, maintenance and administration of
communication networks and the management of support personnel and equipment.
The factors used to determine the above segments focused primarily on the
types of products and services provided, and the type of customer served. Each
of these segments is managed separately from the others, and management
evaluates segment performance based on operating income.
There has been no significant change from December 31, 2003 in the basis
of measurement of segment revenues and profit or loss, and no significant change
in the Company's assets.
Six Months Ended Three Months Ended
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------- ------------- ------------- -------------
Sales:
Line $ 10,399,000 $ 4,232,000 $ 4,427,000 $ 2,071,000
Signal 2,591,000 2,071,000 1,289,000 1,006,000
OSS 1,346,000 1,590,000 536,000 677,000
------------ ------------ ------------ ------------
$ 14,336,000 $ 7,893,000 $ 6,252,000 $ 3,754,000
============ ============ ============ ============
Segment profit (loss):
Line $ 2,755,000 $ (15,000) $ 1,120,000 $ (18,000)
Signal 1,036,000 559,000 580,000 210,000
OSS (900,000) (1,333,000) (602,000) (480,000)
------------ ------------ ------------ ------------
$ 2,891,000 $ (789,000) $ 1,098,000 $ (288,000)
============ ============ ============ ============
Page 7 of 18
The following table reconciles segment totals to consolidated totals:
Six Months Ended Three Months Ended
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------- ------------- ------------- -------------
Sales:
Total revenue for reportable
segments $ 14,336,000 $ 7,893,000 $ 6,252,000 $ 3,754,000
Other revenue 36,000 445,000 20,000 210,000
------------ ------------ ------------ ------------
Consolidated total revenue $ 14,372,000 $ 8,338,000 $ 6,272,000 $ 3,964,000
============ ============ ============ ============
Operating income (loss):
Total segment income (loss)
for reportable segments $ 2,891,000 $ (789,000) $ 1,098,000 $ (288,000)
Corporate and unallocated (1,057,000) (1,308,000) (415,000) (675,000)
------------ ------------ ------------ ------------
Consolidated total
Operating income (loss) $ 1,834,000 $ (2,097,000) $ 683,000 $ (963,000)
============ ============ ============ ============
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Company's consolidated statements of operations for the periods
indicated below, shown as a percentage of sales, are as follows:
Six Months Ended Three Months Ended
---------------- ------------------
June 30, June 30,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Sales 100% 100% 100% 100%
Cost of sales 62% 75% 62% 73%
Gross profit 38% 25% 38% 27%
Selling, general and administrative expenses 18% 38% 19% 40%
Research and development expenses 7% 12% 8% 11%
Operating income (loss) 13% (25%) 11% (24%)
Interest expense - net (5%) (8%) (5%) (8%)
Other 0% 3% (1)% 6%
Net income (loss) 8% (30%) 5% (26%)
Page 8 of 18
The Company's sales by product line for the periods ended June 30, 2004
and 2003 are as follows:
Six Months Ended June 30,
-------------------------
$(000)
2004 2003
---- ----
Line connection/protection equipment $10,399 72% $ 4,232 51%
Signal Processing 2,591 18% 2,071 25%
OSS equipment 1,346 10% 1,590 19%
Other 36 0% 445 5%
----------------- ------------------
$14,372 100% $ 8,338 100%
================= ==================
Three Months Ended June 30,
---------------------------
$(000)
2004 2003
---- ----
Line connection/protection equipment $ 4,427 71% $ 2,071 52%
Signal Processing 1,289 21% 1,006 26%
OSS equipment 536 8% 677 17%
Other 20 0% 210 5%
----------------- ------------------
$ 6,272 100% $ 3,964 100%
================= ==================
Overview
We operate in the telecommunications industry, and our customer base
consists largely of government-owned and privately-owned telecommunications
companies. During the recent past, the telecommunications industry has been
affected by a worldwide slowdown, and many, if not most, telecommunications
companies have scaled back plans for expansion, which has resulted in a
significant drop in the requirements for products including products such as
those sold by the Company. The improvement shown in the results of operations
for the quarter and six months ended June 30, 2004 results from an increase in
sales of our Line products to British Telecommunications and, to a lesser extent
in the US and other international markets.
Our business is divided into three segments -- line connection and
protection equipment ("Line") which interconnects copper telephone lines to
switching equipment and provides fuse elements that protect telephone equipment
and personnel from electrical surges; signal processing ("Signal") equipment
which is used in data communication devices that employ high frequency
transformer technology; and Operating Support Systems ("OSS") which automate the
testing, provisioning, maintenance and administration of communication networks
and the management of support personnel and equipment.
Because our OSS contracts are long-term contracts, our customers and
potential customers have raised concerns about our financial condition and our
ability to perform our obligations under our contracts, as well as to provide
ongoing services. We recognize revenue from OSS contracts on a
percentage-of-completion basis primarily measured by the attainment of
milestones. We recognize anticipated losses, if any, in the period in which they
are identified. We are continuing to sustain operating losses from the OSS
division. As a result, during 2003 we further scaled back our OSS operations. We
now perform maintenance and warranty services for existing customers and we have
limited our marketing effort for
Page 9 of 18
OSS products to selected markets. Even with the reduced scale of OSS operations,
we are continuing to incur an operating loss in this division, and we may never
be able to operate profitably with our present level of marketing and sales
activity in this division. If we are not able to generate profits from these
operations, we may discontinue our OSS operations.
Our Line equipment is designed to connect copper-wired telecommunications
networks and to protect telecommunications equipment from voltage surges. We
market this equipment to telephone operating companies in the United States and
foreign countries. Our Line division generated an operating profit for the three
and six months ended June 30, 2004 as a result of increased sales to British
Telecommunications and to a lesser extent in the US and other international
markets. We market Signal equipment principally for use in defense and aerospace
applications. The Signal division generated an operating profit for the three
and six months ended June 30, 2004 and the comparable periods of 2003. We
recognize revenue from Line and Signal products when the product is shipped.
Our obligations to our senior lender mature on August 30, 2004. The senior
lender has expressed concern as to whether our business is or can be either
viable or saleable in the context of its ability to realize any meaningful
percentage of our debt to it. Although the senior lender has during the past
years, extended the maturity date from time to time as we approached an
expiration date, we cannot give any assurance that the senior lender will extend
the loan beyond August 30, 2004 or that if an extension is granted, that the
extension will not be the final extension which the senior lender grants to us.
If the senior lender does not extend the maturity date of our obligations or
demands payment of all or a significant portion of our obligations due to the
senior lender, we will not be able to continue in business and it will be
necessary for us to seek protection under the Bankruptcy Code. We cannot assure
you that our senior lender will not demand payment of all or a significant
portion of our obligations or that we will not seek protection under the
Bankruptcy Code in anticipation of a decision by the senior lender to demand
payment.
Results of Operations
Our sales for the six months ended June 30, 2004 compared to the six
months ended June 30, 2003 increased by $6,034,000 (72%) from $8,338,000 in 2003
to $14,372,000 in 2004. Sales for the quarter ended June 30, 2004 were
$6,272,000, an increase of $2,308,000 (58%) from the sales of $3,964,000 for the
quarter ended June 30, 2003. The increased sales level resulted primarily from
increased sales of Line products to British Telecommunications that commenced in
the third quarter of 2003, as a result of an increase by British
Telecommunication in the availability of DSL Lines in the United Kingdom, and to
a lesser extent, from increase in sales of our domestic and other international
Line business and Signal products. The cash flow generated from the increased
sales to BT enabled us to improve our relations with our suppliers and increase
our sales of Line equipment in the domestic and other international markets.
Line equipment sales for the six months ended June 30, 2004 compared to
the six months ended June 30, 2003 increased by $6,167,000 (146%) from
$4,232,000 to $10,399,000. Sales for the three months ended June 30 increased by
$2,356,000 (114%) from $2,071,000 in 2003 to $4,427,000 in 2004. The increase in
sales for the six and the three months primarily reflects increased sales volume
to British Telecommunications as stated above.
Signal sales for the six months ended June 30, 2004 were $2,591,000,
compared to $2,071,000 in the same period of 2003, an increase of $520,000
(25%). Sales for the three months ended June 30, 2004 compared to 2003,
increased by $283,000 (28%) from $1,006,000 to $1,289,000. These increases
resulted
Page 10 of 18
from an increased level of business and our ability to ship orders from backlog
on a more timely basis, the result of a better cash flow of operations, than in
the comparable period of 2003.
OSS sales for the six months ended June 30, 2004 were $1,346,000, compared
with $1,590,000 in the same period of 2003, a decrease of $244,000 (15%). OSS
sales for the three months ended June 30, 2004 were $536,000 compared to
$677,000 in the same period of 2003, a decrease of $141,000 (21%). The decrease
in sales for the six and three months resulted from a lower level of new
contracts resulting from the reduction in the scope of our OSS operations and
marketing effort.
Gross margin for the six months ended June 30, 2004 was 38% compared to
25% for the six months ended June 30, 2003. Gross margin for the quarter ended
June 30, 2004 was 38% compared to 27% for the quarter ended June 30, 2003. This
increase is the result of better absorption of manufacturing overhead created by
the increase in revenue from our Line business and reduced OSS costs, both of
which enabled us to operate more efficiently than in the comparable periods of
2003.
Selling, general and administrative expenses decreased by $499,000 (16%)
from $3,141,000 to $2,642,000 for the six months ended June 30, 2004 compared to
2003. For the quarter ended June 30, 2004 selling, general and administrative
expenses decreased by $410,000 (26%) from 2003. This decrease relates primarily
to the scaleback in our sales expenses in our OSS division.
Research and development expenses increased modestly by $5,000 and by
$64,000 for the six and three months ended June 30, 2004 from the comparable
periods in 2003. However, because of our limited resources, our research and
development effort is not substantial, and is oriented more toward modest
enhancements on our existing products rather than developments of new
technology. Our absence of significant research and development could impair our
business over the long term.
Income tax expense for the six months and the three months ended June 30,
2004 relates to state and foreign taxes. No federal income tax expense has been
provided due to the availability of net operating loss carryforwards. The tax
benefit for the six months and three months ended June 30, 2003 resulted
principally from the settlement of an outstanding tax obligation of one of our
subsidiaries.
As a result of the above, for the six months ended June 30, 2004, we had
an operating income of $1,834,000 versus an operating loss of $2,097,000 for the
comparable period of 2003. We had an operating income of $683,000 for the
quarter ended June 30, 2004 as compared to an operating loss of $963,000 for the
quarter ended June 30, 2003.
Pursuant to our agreement with our senior lender, we have not paid or
accrued interest on $22,600,000 of senior debt since March 2002. As a result,
our statements of operations do not reflect any interest charges on this portion
of our senior debt for 2003 or 2004. The senior lender has the right at any time
to require us to pay interest; however, our obligation to pay interest will not
require us to pay interest on such senior debt for periods prior to the date the
senior lender requires us to commence interest payments. We continue to accrue
interest on obligations to our senior lender which were incurred subsequent to
March 2002.
As a result of the foregoing, we generated net income of $1,148,000, $0.12
per share (basic and diluted), for the six months ended June 30, 2004, compared
with a net loss of $2,467,000, $0.25 per share (basic and diluted), for the six
months ended June 30, 2003. The net income for the three months ended June 30,
2004 was $320,000, $0.03 per share (basic and diluted), compared with a net loss
for the three months ended June 30, 2003 of $1,041,000, $0.10 per share (basic
and diluted).
Page 11 of 18
Liquidity and Capital Resources
At June 30, 2004, we had cash and cash equivalents of $717,000 compared
with $469,000 at December 31, 2003. Our working capital deficit at June 30, 2004
was $35,775,000 compared to a working capital deficit of $36,825,000 at December
31, 2003, a reduction of $1,050,000 in our working capital deficit. This
improvement was a result of our improved operating results for the six months
ended June 30, 2004. During the six months of 2004, our operations generated net
cash of $342,000.
As of June 30, 2004, our debt includes $25,562,000 of senior debt which
matured on June 30, 2004, $6,144,000 of subordinated debt that became due on
July 3, 2001, and $385,000 of 6% debentures which became due on July 2, 2002. We
were unable to pay the interest payment on the subordinated notes of
approximately $3,667,000, that represents interest from July 2000 through June
30, 2004, and interest on the 6% debentures was $92,000. We have been notified
by the trustee of 6% debentures that the non-payment of the principal and
interest caused an event of default. At June 30, 2004, we did not have
sufficient resources to pay either the senior lender or the subordinated
lenders; and it is unlikely that we can generate such cash from our operations,
and our senior lender has precluded us from making any payments on the
subordinated debt.
Our financial condition and stock price effectively preclude us from
raising funds through the issuance of debt or equity securities, we have no
other source of funds other than operations, which is not sufficient to make any
significant payment on the principal or interest on our senior debt. We do not
have any prospects of obtaining an alternate senior lender to replace our
present lender.
Although we have scaled back our OSS operations, we are having, and may
continue to have, difficulty performing our obligations under our OSS contracts,
which could result in the cancellation of contracts or the loss of future
business and penalties for non-performance. Furthermore, one creditor has
engaged a collection agency, and a vendor has commenced arbitration proceedings
against us alleging breach of contract.
We have sought to address our need for liquidity by exploring
alternatives, including the possible sale of one or more of our divisions.
During the past three years, we were engaged in discussions with respect to the
possible sale of one or more of our divisions; however, those negotiations were
terminated without reaching an agreement, and we may not be able to sell those
divisions on acceptable, if any, terms. We will continue to consider the sale of
one or more of our divisions; however, if we sell a division, we anticipate that
a substantial portion, if not all, of the net proceeds will be paid to our
senior lender and we will not receive any significant amount of working capital
from such a sale. Furthermore, if we only sell one division, we may be unable to
reduce overhead sufficiently to enable us to operate the remaining divisions
profitably.
During 2002 and 2003, we took steps to reduce overhead and headcount by
relocating the executive, sales/marketing, accounting and research and
development departments to less expensive offices in Syosset, NY and further
reduced the OSS personnel as part of the scaling-down effort. During the six
months ended June 30, 2004, we have continued to look to reduce costs while we
seek additional business from new and existing customers.
In the event that we are unable to extend our debt obligations and sell
one or more of our divisions, we cannot assure you that we will be able to
continue in operations. Furthermore, although we generated net income for the
quarter and six months ended June 30, 2004, our ability to operate profitably in
the
Page 12 of 18
future is dependent upon the continuation of orders from British
Telecommunications and the domestic and other international markets.
Our senior lender has waived payment of interest on $22,600,000 of our
debt to our senior lender. See Note 3. The senior lender has the right to
require us to pay interest on a current basis at any time. If the senior lender
requires us to pay interest, it may impair our ability to continue in
operations, since the interest, at the loan rate, could exceed any profit which
we may generate.
Forward Looking Statements
Statements contained in this Form 10-Q include forward-looking statements
that are subject to risks and uncertainties. In particular, statements in this
Form 10-Q that state the Company's intentions, beliefs, expectations,
strategies, predictions or any other statements relating to our future
activities or other future events or conditions are "forward-looking
statements." Forward-looking statements are subject to risks, uncertainties and
other factors, including, but not limited to, those identified under "Risk
Factors," in our Form 10-K for the year ended December 31, 2003 and those
described in Management's Discussion and Analysis of Financial Conditions and
Results of Operations" in our Form 10-K and this Form 10-Q, and those described
in any other filings by us with the Securities and Exchange Commission, as well
as general economic conditions and economic conditions affecting the
telecommunications industry, any one or more of which could cause actual results
to differ materially from those stated in such statements.
Item 3. Quantitative and Qualitative Disclosure About Market Risk.
Although we conduct operations outside of the United States, most of our
contracts and sales are dollar denominated. A portion of the revenue from our
United Kingdom operations and the majority of our United Kingdom expenses are
denominated in Sterling. Any Sterling-denominated receipts are promptly
converted into United States dollars. We do not engage in any hedging or other
currency transactions. For the six months ended June 30, 2004 and 2003, the
currency translation adjustment was not significant in relation to our total
revenue.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, our Chief Executive
Officer and Chief Financial Officer evaluated the effectiveness of our
disclosure controls and procedures. Based on their evaluation, the Chief
Executive Officer and the Chief Financial Officer have concluded that our
disclosure controls and procedures are effective in alerting them to material
information that is required to be included in the reports that we file or
submit under the Securities Exchange Act of 1934.
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Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting
that occurred during the period covered by this quarterly report that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 3. Defaults Upon Senior Securities.
See Note 3 of Notes to Unaudited Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for information concerning
defaults on our subordinated debt.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certificate of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(b) Reports on Form 8-K
On April 1, 2004 the Company reported its results of operations for
the year ended December 31, 2003.
On May 17, 2004 the Company reported its results of operations for
the first quarter ended March 31, 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PORTA SYSTEMS CORP.
Dated: August 12, 2004 By /s/William V. Carney
--------------------
William V. Carney
Chairman of the Board
and Chief Executive Officer
Dated: August 12, 2004 By /s/Edward B. Kornfeld
---------------------
Edward B. Kornfeld
President, Chief Operating Officer
and Chief Financial Officer
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