Table of Contents

 

 

UNITED STATES

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, 2011

or

 

¨

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 1-16103

LOGO

PINNACLE DATA SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Ohio   31-1263732
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
6600 Port Road, Groveport, Ohio   43125
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number: (614) 748-1150 

 

 

No change

(Former name, former address, and former fiscal year, if changed since last reports)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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 check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   ¨         Accelerated filer   ¨         Non-accelerated filer   ¨         Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

On July 26, 2011, the registrant had outstanding 7,871,349 common shares without par value, which is the registrant’s only class of common equity.

 

 

 


Table of Contents

PINNACLE DATA SYSTEMS, INC.

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

     1   

ITEM 1     C ONDENSED C ONSOLIDATED F INANCIAL S TATEMENTS

     1   

ITEM 2     M ANAGEMENT S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS

     11   

ITEM 4    C ONTROLS AND P ROCEDURES

     17   

PART II – OTHER INFORMATION

     18   

ITEM 6    E XHIBITS

     18   

SIGNATURES

     19   

CERTIFICATIONS

     20   


Table of Contents

PART I – FINANCIAL INFORMATION

 

ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     June 30,
2011
    December 31,
2010
 
ASSETS    (Unaudited)        

CURRENT ASSETS

    

Cash

   $ 1,292      $ 465   

Accounts receivable, net of allowance for doubtful accounts of $109 and $106, respectively

     4,784        4,469   

Inventory, net

     2,698        3,226   

Deferred income taxes

     806        762   

Other current assets

     374        492   
                

Total current assets

     9,954        9,414   

Property and equipment, net

     934        685   

Goodwill

     830        767   

Deferred income taxes

     1,200        929   

Other assets

     179        193   
                

TOTAL ASSETS

   $ 13,097      $ 11,988   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

CURRENT LIABILITIES

    

Line of credit

   $ —        $ 273   

Accounts payable

     1,786        1,404   

Accrued wages, payroll taxes and employee benefits

     552        581   

Unearned revenue

     168        30   

Other current liabilities

     576        743   
                

Total current liabilities

     3,082        3,031   

Other liabilities

     491        296   
                

TOTAL LIABILITIES

     3,573        3,327   
                

STOCKHOLDERS’ EQUITY

    

Preferred stock; no par value; 4,000 shares authorized; no shares issued or outstanding

     —          —     

Common stock; no par value; 25,000 shares authorized; 7,871 and 7,864 shares issued and outstanding, respectively

     5,793        5,790   

Additional paid-in capital

     2,000        1,962   

Accumulated other comprehensive income (loss)

     (3     (90

Retained earnings

     1,734        999   
                

Total stockholders’ equity

     9,524        8,661   
                

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 13,097      $ 11,988   
                

See accompanying notes to condensed consolidated financial statements.

 

1


Table of Contents

PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share)

 

     For the Three Months Ended
June 30,
     For the Six Months  Ended
June 30,
 
     2011      2010      2011     2010  

Sales

   $ 6,821       $ 7,968       $ 13,226      $ 16,780   

Cost of sales

     4,577         5,733         8,899        12,396   
                                  

Gross profit

     2,244         2,235         4,327        4,384   

Operating expenses

     1,895         1,835         3,719        3,563   
                                  

Income from operations

     349         400         608        821   

Other expense

          

Interest expense

     —           18         1        41   
                                  

Income before income taxes

     349         382         607        780   

Income tax expense (benefit)

     169         82         (128     171   
                                  

Net income

   $ 180       $ 300       $ 735      $ 609   
                                  

Weighted average common shares outstanding:

          

Basic

     7,867         7,826         7,866        7,825   

Diluted

     8,156         7,966         8,173        7,891   

Earnings per common share:

          

Basic

   $ 0.02       $ 0.04       $ 0.09      $ 0.08   

Diluted

     0.02         0.04         0.09        0.08   

See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(in thousands)

 

     Common Stock      Additional
Paid-In
Capital
     Accumulated
Other
Comprehensive
Income (Loss)
    Retained
Earnings
(Deficit)
    Total
Stockholders’
Equity
 
     Outstanding
Shares
     Amount            

Balance – December 31, 2009

     7,825       $ 5,769       $ 1,912       $ (29   $ (2,064   $ 5,588   

Stock issued

     14         8         —           —          —          8   

Share-based payment expense

     —           —           24         —          —          24   

Comprehensive income, net of taxes:

               

Net income

     —           —           —           —          609        609   

Foreign currency translation

     —           —           —           (140     —          (140
                     

Total comprehensive income

                  469   
                                                   

Balance – June 30, 2010

     7,839       $ 5,777       $ 1,936       $ (169   $ (1,455   $ 6,089   
                                                   

Balance – December 31, 2010

     7,864       $ 5,790       $ 1,962       $ (90   $ 999      $ 8,661   

Stock issued

     7         3         —           —          —          3   

Share-based payment expense

     —           —           38         —          —          38   

Comprehensive income, net of taxes:

               

Net income

     —           —           —           —          735        735   

Foreign currency translation

     —           —           —           87        —          87   
                     

Total comprehensive income

                  822   
                                                   

Balance – June 30, 2011

     7,871       $ 5,793       $ 2,000       $ (3   $ 1,734      $ 9,524   
                                                   

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

PINNACLE DATA SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

     For the Six Months  Ended
June 30,
 
     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 735      $ 609   
                

Adjustments to reconcile net income to net cash provided by operating activities:

    

Bad debt expense

     28        (32

Inventory reserves

     132        135   

Depreciation and amortization

     174        201   

Provision (benefit) for deferred income taxes

     (315     —     

Share-based payment expense

     38        24   

(Increase) decrease in assets:

    

Accounts receivable

     (299     953   

Inventory

     410        550   

Other assets

     98        202   

Increase (decrease) in liabilities:

    

Accounts payable

     392        (907

Unearned revenue

     138        195   

Other liabilities

     (249     (233
                

Total adjustments

     547        1,088   
                

Net cash provided by operating activities

     1,282        1,697   
                

CASH FLOWS FROM INVESTING ACTIVITIES

    

Additions to property and equipment

     (176     (22
                

Net cash used in investing activities

     (176     (22
                

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net change in line of credit

     (273     (2,184

Net change in outstanding checks

     (45     303   

Other

     12        36   
                

Net cash used in financing activities

     (306     (1,845
                

EFFECT OF EXCHANGE RATE ON CASH

     27        (18
                

INCREASE (DECREASE) IN CASH

     827        (188

Cash at beginning of period

     465        323   
                

Cash at end of period

   $ 1,292      $ 135   
                

SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY:

    

Acquisitions of equipment through capital lease

   $ 196      $ 40   
                

See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

June 30, 2011 and 2010

1. Nature of Operations

Pinnacle Data Systems, Inc. (“PDSi” or the “Company”) is a global provider of electronics repair and reverse logistics services; system integration and original design manufacturer (“ODM”) computing design and manufacturing services; and embedded computing products and design services for the diversified computing, telecommunications, imaging, defense/aerospace, medical, semiconductor and industrial automation markets. PDSi provides a variety of engineering and manufacturing services for global original equipment manufacturers (“OEMs”) requiring custom product design, system integration, repair programs, warranty management, and/or specialized production capabilities. PDSi’s product capabilities range from board-level designs to globally certified, fully integrated systems, specializing in long-life computer products and unique, customer-centric solutions. The Company has facilities in the United States, Europe and Asia. The common shares of PDSi are traded on NYSE Amex under the stock symbol “PNS.”

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements of PDSi have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all information and footnotes required by GAAP for complete financial statements. The financial information included herein reflects all normal and recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of financial position and results of operations. Operating results for all periods presented are not necessarily indicative of the results that may be expected for the full year. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes for the year ended December 31, 2010 included in the Company’s 2010 Annual Report on Form 10-K, which includes a complete summary of the Company’s significant accounting policies in Note 2. There have been no material changes to these policies since December 31, 2010.

Use of Estimates

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates. The Company’s most critical estimates include those related to revenue recognition, accounts receivable, inventory, goodwill and income taxes. Although some variability is inherent in these estimates, recorded amounts reflect management’s best estimates based on available facts and circumstances at that time. Management believes the amounts provided are appropriate.

Consolidation Policy

The Company’s condensed consolidated financial statements include the accounts of PDSi and PDSi B.V., a wholly-owned private limited liability company located in Tiel, the Netherlands. All significant intercompany balances and transactions were eliminated. Certain prior year amounts have been reclassified to conform to the current presentation.

Inventory

As of June 30, 2011 and December 31, 2010, the Company provided reserves of $2.0 million and $1.9 million, respectively, to reduce the carrying value of inventory. The following table summarizes the Company’s inventory as of the dates indicated (net of inventory reserves):

 

(in thousands)

   June 30,
2011
     December 31,
2010
 

Component parts (raw materials)

   $ 2,368       $ 2,963   

Work-in-process

     210         110   

Finished goods

     120         153   
                 

Total inventory

   $ 2,698       $ 3,226   
                 

 

5


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2011 and 2010

 

3. Line of Credit

On March 24, 2011, the Company entered into a Credit Agreement and a Security Agreement with Wells Fargo Bank, National Association (“Wells Fargo”), providing for a revolving credit facility (the “Line”) with a maximum line of credit of $3.0 million, subject to borrowing base restrictions. The borrowing base is determined as follows: 1) the sum of (a) 85% of the aggregate amount of eligible accounts receivable located within the United States, plus (b) 75% of the aggregate amount of eligible accounts receivable located outside of the United States, plus (c) the lesser of 10% of the aggregate amount of eligible inventory or $0.5 million.

The Line is evidenced by a Revolving Line of Credit Note made by the Company in favor of Wells Fargo, and is secured by substantially all of the assets of the Company, as provided for in the Security Agreement. The Line is subject to customary affirmative and negative covenants for credit facilities of this type, including limitations on the Company with respect to liens, indebtedness, guaranties, investments, mergers and dispositions of assets.

The Credit Agreement also contains certain financial covenants, including a maximum ratio of total liabilities to tangible net worth, minimum net income on a rolling four-quarter basis, and a minimum debt service coverage ratio.

The outstanding balance on the Line bears interest monthly at a fluctuating annual rate of 3% above the Daily One Month London Interbank Offered Rate. The Line matures on March 22, 2013.

The Company may use borrowings under the Credit Agreement for general corporate purposes. Any unused portions of the Line will be subject to unused Line fees. Wells Fargo may terminate the Credit Agreement immediately upon default.

On March 24, 2011, in connection with entering into the Credit Agreement and Security Agreement described above, the Company terminated its prior line of credit agreement with Wells Fargo. The Company did not incur any early termination penalties in connection with the termination of the prior line of credit agreement.

4. Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction, various states and foreign countries. There are no federal or state income tax examinations currently underway for these jurisdictions. Open tax years exist for 2007 and beyond for the Company’s federal income tax returns and for 2006 and beyond for state income tax returns.

The Company maintains a $0.1 million valuation allowance against deferred tax assets related to certain state net operating loss (“NOL”) carryforwards. The Company can provide no assurance that changes in its deferred tax asset valuation allowance will not be required in the future. The Company will continue to monitor events and circumstances to determine whether any change in its valuation allowance is warranted in the future.

Although the Company periodically had considered the potential tax savings associated with pursuing research and development (“R&D”) tax credits, the Company’s then recent operating losses, combined with existing federal U.S. NOL carryforwards, precluded an economical pursuit of such credits. However, based on positive changes in the Company’s operating results and financial position in 2010, as well as the use of existing NOL carryforwards, management determined during the fourth quarter of 2010 that the benefits would outweigh both the cost of an R&D tax credit study and the establishment of the necessary infrastructure to be able to claim such credits in the future. Accordingly, the Company recorded a net tax benefit of $0.5 million during the fourth quarter of 2010 for estimated R&D tax credits for tax years 2001 through 2010 that the Company believed were more likely than not to be sustained upon examination by the Internal Revenue Service. The Company substantially completed the calculation and documentation of these R&D tax credits during the first quarter of 2011, resulting in an additional net tax benefit of $0.3 million. During the second quarter of 2011, the Company recorded net tax expense of $0.1 million associated with the finalization of the amended federal and state tax returns for prior years impacted by the R&D tax credit study.

The Company maintains a liability for unrecognized tax benefits related to R&D tax credit positions to be taken on its various income tax returns. If recognized, the entire amount of these unrecognized tax benefits would favorably impact the Company’s effective tax rate in future periods. The Company had $0.2 million and $0.1 million of unrecognized tax benefits as of June 30, 2011, and December 31, 2010, respectively, which were recorded in other liabilities on the consolidated balance sheets.

 

6


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2011 and 2010

 

The following table summarizes the Company’s income tax expense (benefit) for the periods indicated:

 

     Three months ended June 30,     Six months ended June 30,  

(in thousands)

   2011      2010     2011     2010  

Current:

         

Federal

   $ 68       $ 69      $ 138      $ 136   

Foreign

     30         15        28        18   

State and local

     13         (2     21        17   
                                 

Total current expense

     111         82        187        171   
                                 

Deferred:

         

Federal

     47         —          (345     —     

Foreign

     8         —          27        —     

State and local

     3         —          3        —     
                                 

Total deferred expense (benefit)

     58         —          (315     —     
                                 

Total income tax expense (benefit)

   $ 169       $ 82      $ (128   $ 171   
                                 

The following table reconciles tax expense (benefit) computed at the federal statutory rate to amounts reported for financial statement purposes for the periods indicated:

 

     Three months ended June 30,     Six months ended June 30,  
     2011     2010     2011     2010  

(dollars in thousands)

   Amount     %     Amount     %     Amount     %     Amount     %  

Income tax provision at statutory rate

   $ 118        34.0      $ 130        34.0      $ 206        34.0      $ 265        34.0   

R&D tax credits

     —          —          —          —          (321     NM        —          —     

R&D related tax impacts

     69        19.7        —          —          69        11.4        —          —     

Valuation allowance

     —          —          (51     (13.3     —          —          (96     (12.3

Foreign rate differential

     (27     (7.8     (11     (2.9     (39     (6.4     (13     (1.7

Other, net

     9        2.5        14        3.7        (43     (7.1     15        1.9   
                                                                

Total

   $ 169        48.4      $ 82        21.5      $ (128     NM      $ 171        21.9   
                                                                

For the six months ended June 30, 2011, the Company received federal tax refunds totaling $0.2 million, and state income tax payments were immaterial. During the six months ended June 30, 2010, the Company received federal tax refunds totaling $0.2 million and made no state income tax payments. As of June 30, 2011, the Company had state NOL carryforwards of $4.2 million that will expire, if unused, between December 31, 2021 and December 31, 2031. The Company had no federal NOL carryforwards as of June 30, 2011.

 

7


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2011 and 2010

 

The following table summarizes the tax effect of temporary differences that give rise to significant portions of the Company’s deferred tax assets and deferred tax liabilities as of the dates indicated:

 

(in thousands)

   June 30,
2011
    December 31,
2010
 

Deferred tax assets

    

R&D credits

   $ 1,021      $ 719   

Inventory reserves

     759        714   

Net operating loss

     103        107   

Depreciation and amortization

     77        113   

Other

     185        177   
                

Gross deferred tax assets

     2,145        1,830   

Less valuation allowance

     (79     (79
                

Deferred tax asset

     2,066        1,751   
                

Deferred tax liabilities

    

Prepaids

     60        60   
                

Gross deferred tax liability

     60        60   
                

Net deferred tax asset

   $ 2,006      $ 1,691   
                

The following table summarizes the classification of the above amounts in the Company’s consolidated balance sheets as of the dates indicated:

 

(in thousands)

   June 30,
2011
     December 31,
2010
 

Current assets

     

Deferred income taxes

   $ 806       $ 762   

Other assets

     

Deferred income taxes

     1,200         929   
                 

Net deferred tax asset

   $ 2,006       $ 1,691   
                 

The tables above do not include the unrecognized tax benefit liability described previously.

 

8


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2011 and 2010

 

5. Earnings Per Share

Basic earnings per share (EPS) represents the amount of earnings available to each share of common stock outstanding during the reporting period. Diluted EPS represents the amount of earnings available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares for stock options, if dilutive.

The following table presents the Company’s calculation of basic and diluted weighted average common shares outstanding for the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  

(in thousands)

   2011      2010      2011      2010  

Weighted average common shares outstanding – basic

     7,867         7,826         7,866         7,825   

Dilutive effect of stock options

     289         140         307         66   
                                   

Weighted average common shares outstanding – diluted

     8,156         7,966         8,173         7,891   
                                   

The computation of diluted EPS for the three and six months ended June 30, 2011 excluded options to purchase approximately 427,000 shares and 412,000 shares, respectively, that were anti-dilutive because the exercise price of these options was greater than the average market price of the common shares during the respective periods (approximately 413,000 shares and 579,000 shares, respectively, for the three and six months ended June 30, 2010).

6. Segment Information

The Company’s reportable segments are Product and Service. PDSi is a global provider of electronics repair and reverse logistics services; ODM and OEM integrated computing services; and embedded computing products and design services for the diversified computing, telecommunications, imaging, defense/aerospace, medical, semiconductor and industrial automation markets. PDSi provides a variety of engineering and manufacturing services for global OEMs requiring custom product design, system integration, repair programs, warranty management, and/or specialized production capabilities. PDSi’s engineering, technical and operational capabilities span the entire product lifecycle allowing the Company to better understand and develop custom solutions for each of its customer’s unique requirements.

PDSi’s product capabilities range from board-level designs to globally certified, fully integrated systems, specializing in long-life computer products and unique, customer-centric solutions. PDSi’s capability to perform higher-level repair services in-region allows the Company to customize solutions for its customers so that they can deliver world-class service levels to their customers with reduced logistics, component replacement and inventory costs.

The “Other” line item in the following tables reflects the costs and assets of the functional and administrative groups of the Company that are not allocated to the reportable segments, including finance, information technology, human resources and executive management. The Company evaluates performance based on the operating results of the Product and Service segments and based on their effectiveness in covering the other administrative expenses of the Company. The Company sells its products and services in the United States and internationally and attributes sales based on shipping point.

 

9


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

June 30, 2011 and 2010

 

The following table summarizes the Company’s segment operating results for the periods indicated:

 

     Three Months Ended June 30,     Six Months Ended June 30,  

(in thousands)

   2011     2010     2011     2010  

Sales

        

Product

   $ 2,164      $ 4,842      $ 4,890      $ 10,769   

Service

     4,657        3,126        8,336        6,011   
                                

Total

   $ 6,821      $ 7,968      $ 13,226      $ 16,780   
                                

Gross profit

        

Product

   $ 286      $ 986      $ 850      $ 2,055   

Service

     1,958        1,249        3,477        2,329   
                                

Total

   $ 2,244      $ 2,235      $ 4,327      $ 4,384   
                                

Income (loss) from operations

        

Product

   $ 45      $ 660      $ 323      $ 1,364   

Service

     1,382        862        2,395        1,514   

Other

     (1,078     (1,122     (2,110     (2,057
                                

Total

   $ 349      $ 400      $ 608      $ 821   
                                

The following table summarizes segment assets as of the dates indicated:

 

(in thousands)

   June 30,
2011
     December 31,
2010
 

Product

   $ 2,690       $ 3,280   

Service

     5,571         5,443   

Other

     4,836         3,265   
                 

Total

   $ 13,097       $ 11,988   
                 

The following table summarizes sales by geographic region for the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  

(in thousands)

   2011      2010      2011      2010  

United States

   $ 5,764       $ 7,135       $ 11,367       $ 15,176   

International

     1,057         833         1,859         1,604   
                                   

Total

   $ 6,821       $ 7,968       $ 13,226       $ 16,780   
                                   

The following table summarizes long-lived assets by geographic region as of the dates indicated:

 

(in thousands)

   June 30,
2011
     December 31,
2010
 

United States

   $ 1,762       $ 1,277   

International

     1,381         1,297   
                 

Total

   $ 3,143       $ 2,574   
                 

International long-lived assets include goodwill of $0.8 million as of June 30, 2011 and December 31, 2010. All international sales and long-lived assets are in the Service segment.

 

10


Table of Contents
ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SAFE HARBOR STATEMENT

Portions of this Quarterly Report on Form 10-Q (including information incorporated by reference) include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, but not limited to, statements regarding Pinnacle Data Systems, Inc. (“PDSi”, the “Company” or “we”) achieving its financial growth and profitability goals, or its sales, earnings and profitability expectations for the fiscal year ending December 31, 2011. The words “believe,” “expect,” “anticipate,” “estimate,” “intend,” “seek,” “may” and similar expressions identify forward-looking statements that speak only as of the date of this Quarterly Report on Form 10-Q. Investors are cautioned that such statements involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results due to many factors. These factors include, but are not limited to, the following:

 

   

changes in general economic conditions, including prolonged or substantial economic downturn, and any related financial difficulties experienced by original equipment manufacturers, end users, customers, suppliers or others with whom the Company does business;

 

   

changes in customer order patterns;

 

   

changes in our business or our relationship with major technology partners or significant customers;

 

   

failure to maintain adequate levels of inventory;

 

   

production components and service parts cease to be readily available in the marketplace;

 

   

lack of adequate financing to meet working capital needs or to take advantage of business and future growth opportunities that may arise;

 

   

inability of cost reduction initiatives to lead to a realization of savings in labor, facilities or other operational costs;

 

   

deviation of actual results from estimates and/or assumptions used by the Company in the application of its significant accounting policies;

 

   

lack of success in technological advancements;

 

   

inability to retain certifications, authorizations or licenses to provide certain products and/or services;

 

   

risks associated with new business practices, processes and information systems;

 

   

impact of judicial rulings or government regulations, including related compliance costs;

 

   

disruption in the business of suppliers, customers or service providers due to adverse weather, casualty events, technological difficulty, acts of war or terror, or other causes;

 

   

risks associated with doing business internationally, including economic, political and social instability and foreign currency exposure; and

 

   

other factors from time to time described in the Company’s filings with the United States Securities and Exchange Commission (“SEC”).

The Company undertakes no obligation to publicly update or revise any such statements, except as required by applicable law.

The following is management’s discussion and analysis of financial condition and results of operations of the Company for the three and six months ended June 30, 2011 and 2010. This discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes contained in its 2010 Annual Report on Form 10-K.

Executive Overview

PDSi is a global provider of electronics repair and reverse logistics services; system integration and original design manufacturer (“ODM”) computing design and manufacturing services; and embedded computing products and design services for the diversified computing, telecommunications, imaging, defense/aerospace, medical, semiconductor and industrial automation markets. PDSi provides a variety of engineering and manufacturing services for global original equipment manufacturers (“OEMs”) requiring custom product design, system integration, repair programs, warranty management, and/or specialized production capabilities. We have facilities in the United States (“U.S.”), Europe and Asia. More than just an ODM, integrator or reverse logistics provider, PDSi’s engineering, technical and operational capabilities span the entire product lifecycle allowing us to better understand and develop custom solutions for each of our customer’s unique requirements. Our product capabilities range from board-level designs to globally certified, fully integrated systems, specializing in long-life computer products and unique, customer-centric solutions. Our capability to perform higher-level repair services in-region allows us to customize solutions for our customers so that they can deliver world-class service levels to their customers with reduced logistics, component replacement and inventory costs. The common shares of PDSi are traded on NYSE Amex under the stock symbol “PNS.”

 

11


Table of Contents

During the quarter ended June 30, 2011, we recorded net income of $180,000, or $0.02 per diluted share, versus net income of $300,000, or $0.04 per diluted share, for the prior year quarter. During the six months ended June 30, 2011, we recorded net income of $735,000, or $0.09 per diluted share, versus net income of $609,000, or $0.08 per diluted share, for the prior year period. See below for further discussion of consolidated and reportable segment results of operations for the three and six months ended June 30, 2011 and 2010.

Although we periodically had considered the potential tax savings associated with pursuing research and development (“R&D”) tax credits, our then recent operating losses, combined with existing federal U.S. net operating loss (“NOL”) carryforwards, precluded an economical pursuit of such credits. However, based on positive changes in our operating results and financial position in 2010, as well as the use of existing NOL carryforwards, we determined during the fourth quarter of 2010 that the benefits would outweigh both the cost of an R&D tax credit study and the establishment of the necessary infrastructure to be able to claim such credits in the future. Accordingly, we recorded a net tax benefit of $0.5 million during the fourth quarter of 2010 for estimated R&D tax credits for tax years 2001 through 2010 that we believed were more likely than not to be sustained upon examination by the Internal Revenue Service. We substantially completed the calculation and documentation of these R&D tax credits during the first quarter of 2011, resulting in an additional net tax benefit of $0.3 million. During the second quarter of 2011, we recorded net tax expense of $0.1 million associated with the finalization of the amended federal and state tax returns for prior years impacted by the R&D tax credit study.

Results of Operations

Consolidated Operations

Second Quarter – 2011 Compared to 2010

The following table summarizes the Company’s consolidated results of operations for the three months ended June 30:

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 6,821         100.0   $ 7,968         100.0     -14

Cost of sales

     4,577         67.1     5,733         72.0     -20
                                          

Gross profit

     2,244         32.9     2,235         28.0     0

Operating expenses

     1,895         27.8     1,835         23.0     3
                                          

Income from operations

     349         5.1     400         5.0     -13

Other expense

            

Interest expense

     —           0.0     18         0.2     -100
                                          

Income before income taxes

     349         5.1     382         4.8     -9

Income tax expense

     169         2.4     82         1.0     106
                                          

Net income

   $ 180         2.6   $ 300         3.8     -40
                                          

The decrease in net income for the three months ended June 30, 2011 compared to the prior year quarter primarily was due to the aforementioned net tax expense of $0.1 million associated with the finalization of the amended federal and state tax returns for prior years impacted by the R&D tax credit study as well as increased operating expenses, reflecting investments in personnel necessary to support and grow the business. Strong growth in sales and gross profit in the Service segment offset the impact on gross profit of lower sales in the Product segment. Service segment gross profit increased 57% primarily due to a 49% increase in Service sales driven by the growth of business in the U.S. and Europe for both new customers and new programs within existing customers. Interest expense was zero as the Company did not utilize its line of credit during the second quarter of 2011.

For the second quarter of 2011, the Company had three customers that generated $1.7 million, $1.6 million and $1.2 million, or 25%, 24% and 18%, respectively, of total sales. Of the revenues from these customers, 31% and 69% were included in Product and Service segment sales, respectively. For the second quarter of 2010, the Company had three customers that generated $2.5 million, $0.9 million and $0.9 million, or 32%, 11% and 11%, respectively, of total sales. Of the revenues from these customers, 53% and 47% were included in Product and Service segment sales, respectively. Major customer relationships consist of multiple product or service programs in various stages of their lifecycle. The Company continues to work toward developing a more diversified customer revenue base across both its Product and Service segments.

 

12


Table of Contents

Year-to-Date – 2011 Compared to 2010

The following table summarizes the Company’s consolidated results of operations for the six months ended June 30:

 

(dollars in thousands)

   2011     % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 13,226        100.0   $ 16,780         100.0     -21

Cost of sales

     8,899        67.3     12,396         73.9     -28
                                         

Gross profit

     4,327        32.7     4,384         26.1     -1

Operating expenses

     3,719        28.1     3,563         21.2     4
                                         

Income from operations

     608        4.6     821         4.9     -26

Other expense

           

Interest expense

     1        0.0     41         0.2     -98
                                         

Income before income taxes

     607        4.6     780         4.6     -22

Income tax expense (benefit)

     (128     -1.1     171         1.0     NM   
                                         

Net income

   $ 735        5.6   $ 609         3.6     21
                                         

Higher net income for the first six months of 2011 compared to the prior year period primarily was due to the aforementioned net income tax benefit of $0.2 million related to R&D tax credit adjustments during the first and second quarters of 2011. In addition, strong growth in the Service segment offset the impact of lower sales in the Product segment, with an increase in overall gross profit as a percentage of sales to 33% in 2011 from 26% in 2010 driven by the shift in mix toward higher margin Service segment business. Service segment gross profit increased 49% primarily due to a 39% increase in Service sales driven by the growth of business in the U.S. and Europe for both new customers and new programs within existing customers. The increased operating expenses primarily reflect investments in personnel needed to support and grow the business. Interest expense was reduced to virtually zero due to minimal usage of the Company’s line of credit over the first half of 2011.

For the first six months of 2011, the Company had three customers that generated $3.0 million, $2.8 million and $2.2 million, or 23%, 21% and 17%, respectively, of total sales. Of the revenues from these customers, 31% and 69% were included in Product and Service segment sales, respectively. For the first six months of 2010, the Company had three customers that generated $5.3 million, $2.1 million and $2.0 million, or 32%, 13% and 12%, respectively, of total sales. Of the revenues from these customers, 75% and 25% were included in Product and Service segment sales, respectively.

Segment Operations

Product

Second Quarter – 2011 Compared to 2010

The following table summarizes the Company’s gross profit for the Product segment for the three months ended June 30:

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 2,164         100.0   $ 4,842         100.0     -55

Cost of sales

     1,878         86.8     3,856         79.6     -51
                                          

Gross profit

   $ 286         13.2   $ 986         20.4     -71
                                          

The decline in Product segment gross profit was driven by a 55% decrease in sales. This decline primarily was attributable to significantly lower sales to telecommunications and defense OEMs that had very strong activity in the prior year quarter, along with declines at larger imaging and other OEM customers that had occurred over the course of 2010. Reduced operating leverage on lower sales levels resulted in a 13% gross margin in the second quarter of 2011 compared to 20% in the comparable quarter of 2010.

 

13


Table of Contents

Year-to-Date – 2011 Compared to 2010

The following table summarizes the Company’s gross profit for the Product segment for the six months ended June 30:

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 4,890         100.0   $ 10,769         100.0     -55

Cost of sales

     4,040         82.6     8,714         80.9     -54
                                          

Gross profit

   $ 850         17.4   $ 2,055         19.1     -59
                                          

A 55% decrease in Product sales, including $3.7 million lower sales to OEMs in the telecommunications industry that had especially strong activity in 2010, drove the decline in Product segment gross profit. Lower gross margins, which fell to 17% for the first six months of 2011 compared to 19% in the comparable period of 2010, were mitigated by a continued shift in sales mix to higher margin products and management of manufacturing overhead costs to levels consistent with lower Product revenues.

Service

Second Quarter – 2011 Compared to 2010

The following table summarizes the Company’s gross profit for the Service segment for the three months ended June 30:

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 4,657         100.0   $ 3,126         100.0     49

Cost of sales

     2,699         58.0     1,877         60.0     44
                                          

Gross profit

   $ 1,958         42.0   $ 1,249         40.0     57
                                          

Gross profit in the Service segment increased primarily due to the growth of business in the U.S. and Europe for both new customers and new programs within existing customers. The continuing shift toward higher margin programs and gains in operating leverage on 49% sales growth drove an increase in gross profit as a percentage of sales to 42% in the second quarter of 2011 from 40% in the comparable quarter of 2010.

Year-to-Date – 2011 Compared to 2010

The following table summarizes the Company’s gross profit for the Service segment for the six months ended June 30:

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 8,336         100.0   $ 6,011         100.0     39

Cost of sales

     4,859         58.3     3,682         61.3     32
                                          

Gross profit

   $ 3,477         41.7   $ 2,329         38.7     49
                                          

The improvement in Service segment gross profit was driven by a 39% increase in Service sales, reflecting business growth in the U.S. and Europe for both new customers and new programs within existing customers. Gross profit as a percentage of sales increased to 42% in the first six months of 2011 from 39% in the comparable period of 2010 due to a continuing shift toward higher margin programs and gains in operating leverage.

 

14


Table of Contents

Liquidity and Capital Resources

Liquidity and capital resources demonstrate the overall financial strength of the Company and its ability to generate cash flows from operations and borrow funds at competitive rates to meet operating and growth needs.

Our current capital structure consists of a line of credit and stockholders’ equity. The following table summarizes the Company’s capital structure as of the dates indicated:

 

(in thousands)

   June 30,
2011
    December 31,
2010
 

Line of credit

   $ —        $ 273   
                

Stockholders’ equity, excluding accumulated other comprehensive income (loss)

     9,527        8,751   

Accumulated other comprehensive income (loss)

     (3     (90
                

Total stockholders’ equity

     9,524        8,661   
                

Total capital

   $ 9,524      $ 8,934   
                

Based on the Company’s historical cash flow, current financial results and unused available capacity on the line of credit, we believe we have access to adequate resources to provide sufficient liquidity for the operations of the Company over the next year. See further discussion in “Financing Activities” below.

The following table summarizes the Company’s condensed consolidated cash flows for the six months ended June 30:

 

(in thousands)

   2011     2010  

Net cash provided by operating activities

   $ 1,282      $ 1,697   

Net cash used in investing activities

     (176     (22

Net cash used in financing activities

     (306     (1,845

Effect of exchange rate on cash

     27        (18
                

Increase (decrease) in cash

     827        (188

Cash at beginning of period

     465        323   
                

Cash at end of period

   $ 1,292      $ 135   
                

Operating Activities

Net cash provided by operating activities was $1.3 million and $1.7 million for the six months ended June 30, 2011 and 2010, respectively. Net income adjusted for the effects of non-cash items, which primarily include deferred income taxes, inventory reserves and depreciation expense, resulted in cash inflows of $0.8 million and $0.9 million in the first six months of 2011 and 2010, respectively. Changes in working capital resulted in $0.5 million in cash provided for the first six months of 2011 compared to $0.8 million for the comparable period of 2010.

Investing Activities

Net cash used in investing activities represents additions to property and equipment. Increased activity in 2011 primarily relates to acquisitions of equipment needed to support growth and added capability in the Service segment.

Financing Activities

Net cash used in financing activities was $0.3 million and $1.8 million for the first six months of 2011 and 2010, respectively. Financing activity in both periods primarily reflects net repayments on the Company’s line of credit. All cash generated by U.S. operations after funding investing activities is applied to any existing balance on the line of credit.

 

15


Table of Contents

On March 24, 2011, we entered into a Credit Agreement and a Security Agreement with Wells Fargo Bank, National Association (“Wells Fargo”), providing for a revolving credit facility (the “Line”) with a maximum line of credit of $3.0 million, subject to borrowing base restrictions. The borrowing base is determined as follows: 1) the sum of (a) 85% of the aggregate amount of eligible accounts receivable located within the United States, plus (b) 75% of the aggregate amount of eligible accounts receivable located outside of the United States, plus (c) the lesser of 10% of the aggregate amount of eligible inventory or $0.5 million.

The Line is evidenced by a Revolving Line of Credit Note made by the Company in favor of Wells Fargo, and is secured by substantially all of the assets of the Company, as provided for in the Security Agreement. The Line is subject to customary affirmative and negative covenants for credit facilities of this type, including limitations on the Company with respect to liens, indebtedness, guaranties, investments, mergers and dispositions of assets.

The Credit Agreement also contains certain financial covenants, including a maximum ratio of total liabilities to tangible net worth, minimum net income on a rolling four-quarter basis, and a minimum debt service coverage ratio.

The outstanding balance on the Line bears interest monthly at a fluctuating annual rate of 3% above the Daily One Month London Interbank Offered Rate. The Line matures on March 22, 2013.

The Company may use borrowings under the Credit Agreement for general corporate purposes. Any unused portions of the Line will be subject to unused Line fees. Wells Fargo may terminate the Credit Agreement immediately upon default.

On March 24, 2011, in connection with entering into the Credit Agreement and Security Agreement described above, we terminated our prior line of credit agreement with Wells Fargo. The Company did not incur any early termination penalties in connection with the termination of the prior line of credit agreement.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements with (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets or similar arrangement that serves as credit, liquidity or market risk support for such assets; or (3) any other obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument or arising out of a variable interest.

During the normal course of business, we may have numerous outstanding purchase orders with vendors to purchase inventory for use in products that are sold to our customers or are used in performing repair services for our customers. We do not record such orders as liabilities on the condensed consolidated balance sheets until the material is placed on a common carrier or delivered to the Company’s facilities, depending on terms of the arrangement, or when pulled from on-site vendor managed inventory. We have no minimum purchase quantity requirements with any of our vendors.

Critical Accounting Policies and Recently Issued Accounting Standards

The preparation of financial statements and related disclosures in conformity with United States generally accepted accounting principles (“GAAP”) requires management to make judgments, assumptions and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates. Our most critical estimates include those related to revenue recognition, accounts receivable, inventory, goodwill and income taxes. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with no need for judgment in application. In addition, there are areas in which management’s judgment in selecting an available alternative would not produce a materially different result. Note 2 to the audited consolidated financial statements included in the Company’s 2010 Annual Report on Form 10-K describes the significant accounting policies and methods used by the Company. We do not expect the adoption of any recently issued accounting standards to have a material impact on our consolidated financial position, results of operations or cash flows. Our critical accounting policies have not changed materially from those disclosed in the Company’s 2010 Annual Report on Form 10-K.

 

16


Table of Contents
ITEM 4 CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report (the “Evaluation Date”). The disclosure controls and procedures are to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

No change was made in the Company’s internal control over financial reporting during the Company’s second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

17


Table of Contents

PART II – OTHER INFORMATION

 

ITEM 6. EXHIBITS

 

Exhibit

No.

  

Description of Exhibit

  

If incorporated by reference, document with which

Exhibit was previously filed with the SEC

31.1   

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems, Inc. for the quarter ended June 30, 2011

   Contained herein
31.2   

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems, Inc. for the quarter ended June 30, 2011

   Contained herein
32.1   

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems, Inc. for the quarter ended June 30, 2011

   Contained herein
32.2   

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Quarterly Report on Form 10-Q of Pinnacle Data Systems, Inc. for the quarter ended June 30, 2011

   Contained herein
101.INS*   

XBRL Instance Document

   Contained herein
101.SCH*   

XBRL Taxonomy Extension Schema Document

   Contained herein
101.CAL*   

XBRL Taxonomy Extension Calculation Linkbase Document

   Contained herein
101.DEF*   

XBRL Taxonomy Definition Linkbase Document

   Contained herein
101.LAB*   

XBRL Taxonomy Extension Label Linkbase Document

   Contained herein
101.PRE*   

XBRL Taxonomy Extension Presentation Linkbase Document

   Contained herein

 

*

XBRL (“Extensible Business Reporting Language”) information is furnished and not filed; is not a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933; is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934; and otherwise is not subject to liability under these sections.

 

18


Table of Contents

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.

 

        

PINNACLE DATA SYSTEMS, INC.

Date: July 29, 2011

    

/s/    John D. Bair

    

John D. Bair

    

Chief Executive Officer

Date: July 29, 2011

    

/s/    Nicholas J. Tomashot

    

Nicholas J. Tomashot

    

Chief Financial Officer

 

19

Pinnacle Data Sys In (AMEX:PNS)
Historical Stock Chart
Von Okt 2024 bis Nov 2024 Click Here for more Pinnacle Data Sys In Charts.
Pinnacle Data Sys In (AMEX:PNS)
Historical Stock Chart
Von Nov 2023 bis Nov 2024 Click Here for more Pinnacle Data Sys In Charts.