Attached files

file filename
EX-32.1 - SECTION 906 CEO CERTIFICATION - PINNACLE DATA SYSTEMS INCd227247dex321.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - PINNACLE DATA SYSTEMS INCd227247dex311.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - PINNACLE DATA SYSTEMS INCd227247dex312.htm
EXCEL - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCFinancial_Report.xls
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR9.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR5.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR6.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR3.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR8.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR4.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR2.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR7.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR1.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR11.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR10.htm
XML - IDEA: XBRL DOCUMENT - PINNACLE DATA SYSTEMS INCR12.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - PINNACLE DATA SYSTEMS INCd227247dex322.htm
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 September 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

(State or other jurisdiction of incorporation or organization)

 

31-1263732

(I.R.S. Employer Identification No.)

6600 Port Road, Groveport, Ohio

(Address of principal executive offices)

 

43125

(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 October 25, 2011, the registrant had outstanding 7,888,349 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 SEPTEMBER 30, 2011

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

     1   

ITEM 1     CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     1   

ITEM 2     MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     11   

ITEM 4     CONTROLS AND PROCEDURES

     17   

PART II – OTHER INFORMATION

     18   

ITEM 6    EXHIBITS

     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)

 

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

CURRENT ASSETS

    

Cash

   $ 1,529      $ 465   

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

     4,076        4,469   

Inventory, net

     3,046        3,226   

Deferred income taxes

     771        762   

Other current assets

     425        492   
  

 

 

   

 

 

 

Total current assets

     9,847        9,414   

Property and equipment, net

     1,015        685   

Goodwill

     767        767   

Deferred income taxes

     1,224        929   

Other assets

     105        193   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 12,958      $ 11,988   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

CURRENT LIABILITIES

    

Line of credit

   $ —        $ 273   

Accounts payable

     1,707        1,404   

Accrued wages, payroll taxes and employee benefits

     501        581   

Unearned revenue

     101        30   

Other current liabilities

     529        743   
  

 

 

   

 

 

 

Total current liabilities

     2,838        3,031   

Other liabilities

     449        296   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     3,287        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; 7,888 and 7,864 shares issued and outstanding, respectively

     5,802        5,790   

Additional paid-in capital

     2,022        1,962   

Accumulated other comprehensive income (loss)

     (101     (90

Retained earnings

     1,948        999   
  

 

 

   

 

 

 

Total stockholders’ equity

     9,671        8,661   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 12,958      $ 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
September 30,
    For the Nine Months Ended
September 30,
 
     2011      2010     2011     2010  

Sales

   $ 6,695       $ 6,314      $ 19,921      $ 23,094   

Cost of sales

     4,479         4,088        13,378        16,484   
  

 

 

    

 

 

   

 

 

   

 

 

 

Gross profit

     2,216         2,226        6,543        6,610   

Operating expenses

     1,981         1,732        5,700        5,295   
  

 

 

    

 

 

   

 

 

   

 

 

 

Income from operations

     235         494        843        1,315   

Other expense

         

Interest expense

     —           4        1        45   
  

 

 

    

 

 

   

 

 

   

 

 

 

Income before income taxes

     235         490        842        1,270   

Income tax expense (benefit)

     21         (1,183     (107     (1,012
  

 

 

    

 

 

   

 

 

   

 

 

 

Net income

   $ 214       $ 1,673      $ 949      $ 2,282   
  

 

 

    

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding:

         

Basic

     7,880         7,842        7,870        7,831   

Diluted

     8,125         8,011        8,116        7,960   

Earnings per common share:

         

Basic

   $ 0.03       $ 0.21      $ 0.12      $ 0.29   

Diluted

     0.03         0.21        0.12        0.29   

See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

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

     19         10         —           —          —          10   

Share-based payment expense

     —           —           35         —          —          35   

Comprehensive income, net of taxes:

               

Net income

     —           —           —           —          2,282        2,282   

Foreign currency translation

     —           —           —           (42     —          (42
               

 

 

 

Total comprehensive income

                  2,240   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance – September 30, 2010

     7,844       $ 5,779       $ 1,947       $ (71   $ 218      $ 7,873   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance – December 31, 2010

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

Stock issued

     24         12         —           —          —          12   

Share-based payment expense

     —           —           60         —          —          60   

Comprehensive income, net of taxes:

               

Net income

     —           —           —           —          949        949   

Foreign currency translation

     —           —           —           (11     —          (11
               

 

 

 

Total comprehensive income

                  938   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance – September 30, 2011

     7,888       $ 5,802       $ 2,022       $ (101   $ 1,948      $ 9,671   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

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 Nine Months Ended
September 30,
 
     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 949      $ 2,282   
  

 

 

   

 

 

 

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

    

Bad debt expense

     29        (19

Inventory reserves

     124        246   

Depreciation and amortization

     273        298   

Provision (benefit) for deferred income taxes

     (304     (1,037

Share-based payment expense

     60        34   

Decrease in assets:

    

Accounts receivable

     353        1,111   

Inventory

     52        113   

Other assets

     93        16   

Increase (decrease) in liabilities:

    

Accounts payable

     196        (956

Unearned revenue

     71        62   

Other liabilities

     (338     (357
  

 

 

   

 

 

 

Total adjustments

     609        (489
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,558        1,793   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Additions to property and equipment

     (366     (110
  

 

 

   

 

 

 

Net cash used in investing activities

     (366     (110
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net change in line of credit

     (273     (2,076

Net change in outstanding checks

     132        136   

Other

     9        59   
  

 

 

   

 

 

 

Net cash used in financing activities

     (132     (1,881
  

 

 

   

 

 

 

EFFECT OF EXCHANGE RATE ON CASH

     4        (1
  

 

 

   

 

 

 

INCREASE (DECREASE) IN CASH

     1,064        (199

Cash at beginning of period

     465        323   
  

 

 

   

 

 

 

Cash at end of period

   $ 1,529      $ 124   
  

 

 

   

 

 

 

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)

September 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; PDSi B.V., a wholly-owned private limited liability company located in Tiel, the Netherlands; and PDSi Singapore Pte. Ltd., a wholly-owned private limited liability company located in Singapore. All significant intercompany balances and transactions were eliminated. Certain prior year amounts have been reclassified to conform to the current presentation.

Inventory

As of September 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)

   September 30,
2011
     December 31,
2010
 

Component parts (raw materials)

   $ 2,705       $ 2,963   

Work-in-process

     207         110   

Finished goods

     134         153   
  

 

 

    

 

 

 

Total inventory

   $ 3,046       $ 3,226   
  

 

 

    

 

 

 

 

5


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

September 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 Company was in compliance with all financial covenants as of September 30, 2011.

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 reviewed its net deferred tax assets as of September 30, 2009 to assess the need to establish a valuation allowance due to the continuing uncertain economic environment and the Company’s pre-tax loss for the nine months ended September 30, 2009. At that time, the Company’s net deferred tax assets primarily consisted of temporary differences related to inventory reserves and federal net operating loss (“NOL”) carryforwards. Based on the Company’s analysis and application of the GAAP framework, the Company established a valuation allowance of $1.6 million against its net deferred tax assets.

During the third quarter of 2010, the Company concluded that its operations had demonstrated sustainable profitability, and that future taxable income would more likely than not allow for realization of benefits from existing deferred income tax assets. Accordingly, the Company reversed substantially all of its deferred tax asset valuation allowance. As a result, the year-to-date U.S. effective tax rate for the third quarter of 2010 was approximately 34%, versus an effective rate of approximately 22% applied in the first six months of 2010. The combined impact of the valuation allowance reversal and the adjustment of the year-to-date U.S. effective tax rate resulted in a $1.3 million net non-cash benefit.

The Company maintains a $0.1 million valuation allowance against deferred tax assets related to certain state 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.

 

6


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

September 30, 2011 and 2010

 

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 and third quarters of 2011, the Company recorded net tax expense of $0.1 million and a net benefit of $0.1 million, respectively, 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 September 30, 2011 and December 31, 2010, respectively, which were recorded in other liabilities on the consolidated balance sheets.

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

 

     Three months ended Sept. 30,     Nine months ended Sept. 30,  

(in thousands)

   2011     2010     2011     2010  

Current:

        

Federal

   $ (51   $ (368   $ 87      $ (1

Foreign

     51        17        79        35   

State and local

     10        (2     31        (9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current expense

     10        (353     197        25   
  

 

 

   

 

 

   

 

 

   

 

 

 

Deferred:

        

Federal

     37        468        (308     286   

Foreign

     (31     —          (4     —     

State and local

     5        133        8        133   

Valuation allowance

     —          (1,431     —          (1,456
  

 

 

   

 

 

   

 

 

   

 

 

 

Total deferred expense (benefit)

     11        (830     (304     (1,037
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income tax expense (benefit)

   $ 21      $ (1,183   $ (107   $ (1,012
  

 

 

   

 

 

   

 

 

   

 

 

 

 

7


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

September 30, 2011 and 2010

 

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 Sept. 30,     Nine months ended Sept. 30,  
     2011     2010     2011     2010  

(dollars in thousands)

   Amount     %     Amount     %     Amount     %     Amount     %  

Income tax provision at statutory rate

   $ 80        34.0      $ 167        34.0      $ 286        34.0      $ 432        34.0   

R&D tax credits

     (8     (3.4     —          —          (329     NM        —          —     

R&D related tax impacts

     (56     (23.8     —          —          13        1.5        —          —     

Valuation allowance

     —          —          (1,431     NM        —          —          (1,456     NM   

Foreign rate differential

     (14     (6.0     (26     (5.3     (53     (6.3     (43     (3.4

Other, net

     19        8.1        107        21.8        (24     (2.9     55        1.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 21        8.9      $ (1,183     NM      $ (107     NM      $ (1,012     NM   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the nine months ended September 30, 2011, the Company received federal tax refunds totaling $0.3 million, and state income tax payments were immaterial. During the nine months ended September 30, 2010, the Company made federal tax payments of $0.2 million and received federal tax refunds totaling $0.3 million, and state income tax payments were immaterial. As of September 30, 2011, the Company had state NOL carryforwards of $3.9 million that will expire, if unused, between December 31, 2021 and December 31, 2031. The Company had no federal NOL carryforwards as of September 30, 2011.

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:

 

     September 30,     December 31,  

(in thousands)

   2011     2010  

Deferred tax assets

    

R&D credits

   $ 1,029      $ 719   

Inventory reserves

     745        714   

Net operating loss

     99        107   

Depreciation and amortization

     111        113   

Other

     150        177   
  

 

 

   

 

 

 

Gross deferred tax assets

     2,134        1,830   

Less valuation allowance

     (79     (79
  

 

 

   

 

 

 

Deferred tax asset

     2,055        1,751   
  

 

 

   

 

 

 

Deferred tax liabilities

    

Prepaids

     60        60   
  

 

 

   

 

 

 

Gross deferred tax liability

     60        60   
  

 

 

   

 

 

 

Net deferred tax asset

   $ 1,995      $ 1,691   
  

 

 

   

 

 

 

 

8


Table of Contents

PINNACLE DATA SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

September 30, 2011 and 2010

 

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

 

(in thousands)

   September 30,
2011
     December 31,
2010
 

Current assets

     

Deferred income taxes

   $ 771       $ 762   

Other assets

     

Deferred income taxes

     1,224         929   
  

 

 

    

 

 

 

Net deferred tax asset

   $ 1,995       $ 1,691   
  

 

 

    

 

 

 

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

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 Sept. 30,      Nine Months Ended Sept. 30,  

(in thousands)

   2011      2010      2011      2010  

Weighted average common shares outstanding – basic

     7,880         7,842         7,870         7,831   

Dilutive effect of stock options

     245         169         246         129   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding – diluted

     8,125         8,011         8,116         7,960   
  

 

 

    

 

 

    

 

 

    

 

 

 

The computation of diluted EPS for the three and nine months ended September 30, 2011 excluded options to purchase approximately 827,000 shares and 545,000 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 484,000 shares and 489,000 shares, respectively, for the three and nine months ended September 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

September 30, 2011 and 2010

 

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

 

     Three Months Ended Sept. 30,     Nine Months Ended Sept. 30,  

(in thousands)

   2011     2010     2011     2010  

Sales

        

Product

   $ 2,151      $ 2,343      $ 7,041      $ 13,112   

Service

     4,544        3,971        12,880        9,982   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 6,695      $ 6,314      $ 19,921      $ 23,094   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

        

Product

   $ 325      $ 375      $ 1,175      $ 2,430   

Service

     1,891        1,851        5,368        4,180   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 2,216      $ 2,226      $ 6,543      $ 6,610   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

        

Product

   $ 71      $ 137      $ 394      $ 1,501   

Service

     1,267        1,367        3,662        2,881   

Other

     (1,103     (1,010     (3,213     (3,067
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 235      $ 494      $ 843      $ 1,315   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

(in thousands)

   September 30,
2011
     December 31,
2010
 

Product

   $ 2,806       $ 3,280   

Service

     5,410         5,443   

Other

     4,742         3,265   
  

 

 

    

 

 

 

Total

   $ 12,958       $ 11,988   
  

 

 

    

 

 

 

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

 

     Three Months Ended Sept. 30,      Nine Months Ended Sept. 30,  

(in thousands)

   2011      2010      2011      2010  

United States

   $ 5,714       $ 5,537       $ 17,081       $ 20,713   

International

     981         777         2,840         2,381   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,695       $ 6,314       $ 19,921       $ 23,094   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

(in thousands)

   September 30,
2011
     December 31,
2010
 

United States

   $ 1,781       $ 1,277   

International

     1,330         1,297   
  

 

 

    

 

 

 

Total

   $ 3,111       $ 2,574   
  

 

 

    

 

 

 

International long-lived assets include goodwill of $0.8 million as of September 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 nine months ended September 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 September 30, 2011, we recorded net income of $214,000, or $0.03 per diluted share, versus net income of $1,673,000, or $0.21 per diluted share, for the prior year quarter (including a $1.3 million net tax benefit related to the reversal of most of our deferred tax asset valuation allowance). During the nine months ended September 30, 2011, we recorded net income of $949,000, or $0.12 per diluted share (including $0.3 million related to research and development tax credit adjustments), versus net income of $2,282,000, or $0.29 per diluted share, for the prior year period (including the $1.3 million valuation allowance reversal benefit noted above). See below for further discussion of consolidated and reportable segment results of operations for the three and nine months ended September 30, 2011 and 2010.

We reviewed our net deferred tax assets as of September 30, 2009 to assess the need to establish a valuation allowance due to the continuing uncertain economic environment and our pre-tax loss for the nine months ended September 30, 2009. At that time, our net deferred tax assets primarily consisted of temporary differences related to inventory reserves and federal net operating loss (“NOL”) carryforwards. Based on our analysis and application of the GAAP framework, we established a valuation allowance of $1.6 million against our net deferred tax assets.

During the third quarter of 2010, we concluded that our operations had demonstrated sustainable profitability, and that future taxable income would more likely than not allow for realization of benefits from existing deferred income tax assets. Accordingly, we reversed substantially all of our deferred tax asset valuation allowance. As a result, the year-to-date U.S. effective tax rate for the third quarter of 2010 was approximately 34%, versus an effective rate of approximately 22% applied in the first six months of 2010. The combined impact of the valuation allowance reversal and the adjustment of the year-to-date U.S. effective tax rate resulted in a $1.3 million net non-cash benefit.

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. 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 and third quarters of 2011, we recorded net tax expense of $0.1 million and a net benefit of $0.1 million, respectively, 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

Third Quarter – 2011 Compared to 2010

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

 

(dollars in thousands)

   2011      % of
Sales
    2010     % of
Sales
    %
Change
 

Sales

   $ 6,695         100.0   $ 6,314        100.0     6

Cost of sales

     4,479         66.9     4,088        64.7     10
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     2,216         33.1     2,226        35.3     0

Operating expenses

     1,981         29.6     1,732        27.4     14
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     235         3.5     494        7.8     -52

Other expense

           

Interest expense

     —           0.0     4        0.1     -100
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     235         3.5     490        7.8     -52

Income tax expense

     21         0.3     (1,183     -18.7     NM   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 214         3.2   $ 1,673        26.5     -87
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

12


Table of Contents

The decrease in net income for the third quarter of 2011 compared to the prior year quarter primarily was due to a $1.3 million net tax benefit recorded during the third quarter of 2010 associated with the aforementioned reversal of most of our valuation allowance against deferred tax assets. This partially was offset by the previously described $0.1 million tax benefit in the third quarter of 2011 related to the finalization of amended tax returns for prior years impacted by the R&D tax credit study. Furthermore, higher operating expenses in the current year quarter reflect investments in personnel necessary to grow and support the business. Overall gross profit was flat with strong Service segment sales growth offsetting lower Product segment results. Service segment sales increased 14% due to 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 third quarter of 2011.

For the third quarter of 2011, we had three customers that generated $1.9 million, $1.5 million and $1.0 million, or 28%, 22% and 15%, respectively, of total sales. Of the revenues from these customers, 27% and 73% were included in Product and Service segment sales, respectively. For the third quarter of 2010, we had two customers that generated $2.2 million and $1.1 million, or 35% and 18%, respectively, of total sales. Of the revenues from these customers, 27% and 73% 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. We continue to work toward developing a more diversified customer revenue base across both our Product and Service segments.

Year-to-Date – 2011 Compared to 2010

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

 

(dollars in thousands)

   2011     % of
Sales
    2010     % of
Sales
    %
Change
 

Sales

   $ 19,921        100.0   $ 23,094        100.0     -14

Cost of sales

     13,378        67.2     16,484        71.4     -19
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     6,543        32.8     6,610        28.6     -1

Operating expenses

     5,700        28.6     5,295        22.9     8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     843        4.2     1,315        5.7     -36

Other expense

          

Interest expense

     1        0.0     45        0.2     -98
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     842        4.2     1,270        5.5     -34

Income tax expense (benefit)

     (107     -0.5     (1,012     -4.4     NM   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 949        4.8   $ 2,282        9.9     -58
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Lower net income for the first nine months of 2011 compared to the prior year period primarily was due to the reversal of most of our deferred tax asset valuation allowance as discussed above, resulting in a $1.3 million net tax benefit during the third quarter of 2010. Net tax benefits of $0.3 million related to R&D tax credit adjustments recorded during the first three quarters of 2011 also impacted the comparison between periods. Increased operating expenses in 2011 primarily reflect investments in personnel necessary to grow and support the business. Overall gross profit as a percentage of sales rose to 33% in 2011 from 29% in 2010 driven by the shift in mix toward higher margin Service segment business, which helped mitigate the impact on gross margin of lower sales in the Product segment. Service segment gross profit increased 28% primarily due to a 29% 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 reduced to virtually zero due to minimal usage of the Company’s line of credit over the first nine months of 2011.

For the first nine months of 2011, we had three customers that generated $4.9 million, $4.3 million and $3.2 million, or 25%, 22% and 16%, respectively, of total sales. Of the revenues from these customers, 29% and 71% were included in Product and Service segment sales, respectively. For the first nine months of 2010, we had three customers that generated $7.6 million, $2.8 million and $2.4 million, or 33%, 12% and 10%, respectively, of total sales. Of the revenues from these customers, 47% and 53% were included in Product and Service segment sales, respectively.

 

13


Table of Contents

Segment Operations

Product

Third Quarter – 2011 Compared to 2010

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

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 2,151         100.0   $ 2,343         100.0     -8

Cost of sales

     1,826         84.9     1,968         84.0     -7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit

   $ 325         15.1   $ 375         16.0     -13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Lower Product segment gross profit reflects an 8% decline in sales primarily attributable to the ramp down of certain legacy programs, partially offset by growth in sales to defense and imaging OEMs. Reduced operating leverage on lower sales levels resulted in a slight decline to a 15% gross margin in the third quarter of 2011 compared to 16% in the comparable quarter of 2010.

Year-to-Date – 2011 Compared to 2010

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

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 7,041         100.0   $ 13,112         100.0     -46

Cost of sales

     5,866         83.3     10,682         81.5     -45
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit

   $ 1,175         16.7   $ 2,430         18.5     -52
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

A 46% 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. The continued shift in sales mix to higher margin products and management of manufacturing overhead costs to levels consistent with lower Product revenues helped to reduce the negative impact on gross margins, which fell to 17% for the first nine months of 2011 compared to 19% in the comparable period of 2010 due to reduced operating leverage on 46% lower revenue.

Service

Third Quarter – 2011 Compared to 2010

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

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 4,544         100.0   $ 3,971         100.0     14

Cost of sales

     2,653         58.4     2,120         53.4     25
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit

   $ 1,891         41.6   $ 1,851         46.6     2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit in the Service segment increased due to a 14% increase in sales fueled by business growth in the U.S. and Europe for both new customers and new programs within existing customers. A shift in mix toward lower margin programs, as well as investments in overhead to add capability and support future growth, drove a decline in gross profit as a percentage of sales to 42% in the third quarter of 2011 from 47% in the comparable quarter of 2010, despite the overall trend toward higher margin programs.

 

14


Table of Contents

Year-to-Date – 2011 Compared to 2010

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

 

(dollars in thousands)

   2011      % of
Sales
    2010      % of
Sales
    %
Change
 

Sales

   $ 12,880         100.0   $ 9,982         100.0     29

Cost of sales

     7,512         58.3     5,802         58.1     29
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit

   $ 5,368         41.7   $ 4,180         41.9     28
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

The improvement in Service segment gross profit was driven by a 29% increase in 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 was flat at 42% in the first nine months of 2011 and 2010, with gains in operating leverage offsetting a third quarter 2011 shift in mix toward lower margin programs and investments in overhead to add capability and support future growth. However, the overall trend within the Service segment continued toward higher margin programs.

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 stockholders’ equity with a line of credit available to provide supplemental liquidity. The following table summarizes the Company’s capital structure as of the dates indicated:

 

(in thousands)

   September 30,
2011
    December 31,
2010
 

Line of credit

   $ —        $ 273   
  

 

 

   

 

 

 

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

     9,772        8,751   

Accumulated other comprehensive income (loss)

     (101     (90
  

 

 

   

 

 

 

Total stockholders’ equity

     9,671        8,661   
  

 

 

   

 

 

 

Total capital

   $ 9,671      $ 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 nine months ended September 30:

 

(in thousands)

   2011     2010  

Net cash provided by operating activities

   $ 1,558      $ 1,793   

Net cash used in investing activities

     (366     (110

Net cash used in financing activities

     (132     (1,881

Effect of exchange rate on cash

     4        (1
  

 

 

   

 

 

 

Increase (decrease) in cash

     1,064        (199

Cash at beginning of period

     465        323   
  

 

 

   

 

 

 

Cash at end of period

   $ 1,529      $ 124   
  

 

 

   

 

 

 

 

15


Table of Contents

Operating Activities

Net cash provided by operating activities was $1.6 million and $1.8 million for the nine months ended September 30, 2011 and 2010, respectively. Net income adjusted for the effects of non-cash items, which primarily include deferred income taxes, depreciation expense and inventory reserves, resulted in cash inflows of $1.2 million and $1.8 million in the first nine months of 2011 and 2010, respectively. Changes in working capital resulted in $0.4 million in cash provided for the first nine months of 2011 compared to a net neutral impact 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 $0.1 million and $1.9 million for the first nine 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.

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 Company was in compliance with all financial covenants as of September 30, 2011.

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.

 

16


Table of Contents

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.

 

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 third 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 September 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 September 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 September 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 September 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: October 28, 2011

    

/s/    John D. Bair

    

John D. Bair

    

Chief Executive Officer

Date: October 28, 2011

    

/s/    Nicholas J. Tomashot

    

Nicholas J. Tomashot

    

Chief Financial Officer

 

19