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PAR TECHNOLOGY CORP - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statement(Edgar Glimpses Via Acquire Media NewsEdge) This document contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. Any statements in this document that do not describe historical facts are forward-looking statements. Forward-looking statements in this document (including forward-looking statements regarding the continued health of the Hospitality industry, future information technology outsourcing opportunities, changes in contract funding by the U.S. Government, the impact of current world events on our results of operations, the effects of inflation on our margins, and the effects of interest rate and foreign currency fluctuations on our results of operations) are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When we use words such as "intend," "anticipate," "believe," "estimate," "plan," "will," or "expect", we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable based on information available to us on the date hereof, but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we presently may be planning. We have disclosed certain important factors that could cause our actual future results to differ materially from our current expectations, including a decline in the volume of purchases made by one or a group of our major customers; risks in technology development and commercialization; risks of downturns in economic conditions generally, and in the quick-service sector of the hospitality market specifically; risks associated with government contracts; risks associated with competition and competitive pricing pressures; and risks related to foreign operations. Forward-looking statements made in connection with this report are necessarily qualified by these factors. We are not undertaking to update or revise publicly any forward-looking statements if we obtain new information or upon the occurrence of future events or otherwise. Overview PAR's technology solutions for the Hospitality segment feature software, hardware and support services tailored for the needs of restaurants, luxury hotels, resorts and spas, casinos, cruise lines, movie theatres, theme parks and retailers. The Company's Government segment provides technical expertise in the contract development of advanced systems and software solutions for the U.S. Department of Defense and other federal agencies, as well as information technology and communications support services to the U.S. Department of Defense. The Company's products sold in the Hospitality segment are utilized in a range of applications by thousands of customers. The Company faces competition across all of its markets within the Hospitality segment, competing on the basis of product design, features and functionality, quality and reliability, price, customer service, and delivery capability. PAR's global infrastructure and reach as a technology solutions provider to hospitality customers is an important competitive advantage, as it allows the Company to provide innovative systems, with significant global deployment capability, to its multinational customers. PAR's continuing strategy is to provide complete integrated technology solutions and services with excellent customer service in the markets in which it participates. The Company conducts its research and development efforts to create innovative technology offerings that meet and exceed customer requirements and also have a high probability for broader market appeal and success. The Company is focused on expanding four distinct parts of its Hospitality businesses. First, it is investing in the market introduction and deployment of ATRIO, its next generation, cloud-based property management software for the Hotel/Resort/Spa market. Second, we are investing in the enhancement of existing software and the development of the Company's SureCheck™ product for food safety and task management applications. Third, the Company continues to work on building more robust and extensive third-party distribution channels. Fourth, as the Company's customers continue to expand in international markets, PAR has created an international infrastructure focused on that expansion. 13-------------------------------------------------------------------------------- The QSR market, our primary market, continues to perform well for the majority of large, international companies, despite worldwide macroeconomic uncertainty. However, the Company has seen an impact of current economic conditions on smaller, regional QSR organizations, whose business is slowing because of higher unemployment and lack of consumer confidence in certain regions. The Company is continuing to reassess the alignment of its product and service offerings to support improved operational efficiency and profitability going forward. These conditions could have a material adverse impact on the Company's significant estimates, specifically the fair value of its assets related to its legacy products. Approximately 39% of the Company's revenues are generated by its Government business. The Company's focus is to expand two separate aspects of its Government business: services and solutions. Through outstanding performance of existing service contracts and investing in enhancing its business development staff and processes, the Company is able to consistently win the renewal of expiring contracts, extend existing contracts, and win new efforts. With its intellectual property and investment in new technologies, the Company provides solutions to the U.S. Department of Defense and other federal/state agencies with systems integration, products and highly-specialized services. The general uncertainty in U.S. defense total workforce policies (military, civilian and contract), procurement cycles and spending levels for the next several years may impact the performance of this business segment. Results of Operations - Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011 During the first quarter of fiscal year 2012, the Company sold substantially all of the assets of its Logistics Management business, PAR Logistics Management Systems Corporation (LMS) to ORBCOMM Inc., including but not limited to accounts receivable, inventory, equipment, intellectual property, and customer contracts. The transaction closed on January 12, 2012. The results of operations of LMS for fiscal years 2012 and 2011 have been recorded as discontinued operations in accordance with Accounting Standards Codification (ASC) 205-20, Presentation of Financial Statements - Discontinued Operations. All prior period amounts have been reclassified to conform to the current period presentation. Refer to Note 2 "Discontinued Operations" in the Notes to the Consolidated Financial Statements for further discussion. The Company reported revenues of $61.1 million for the quarter ended September 30, 2012, an increase of 4% from the $58.7 million reported for the quarter ended September 30, 2011. The Company's net income from continuing operations was $1.3 million or $0.09 per diluted share for the third quarter of 2012 versus $1.6 million or $0.11 per diluted share for the same period in 2011. During the quarter, the Company reported a net income from discontinued operations of $50,000 versus a net loss from discontinued operations of $394,000 or $0.03 loss per diluted share for the same period in 2011. Product revenues were $22.3 million for the quarter ended September 30, 2012, a decrease of 8.5% from the $24.4 million recorded in 2011. This decrease was the result of a decline in domestic sales to McDonald's as their significant technology upgrade program was completed in fiscal year 2011. Partially offsetting this decrease was an increase in sales to YUM! Brands and Subway, commensurate with new store rollouts, as well as hardware in support of the Company's SureCheck solution. Further offsetting this decline was an increase in international product revenue, which increased 8% versus the third quarter of 2011 as a result of increases in Central America, China and the Middle East. Service revenue primarily includes installation, software maintenance, training, twenty-four hour help desk support and various depot and on-site service options. Service revenues were $16.7 million for the quarter ended September 30, 2012, a decrease of 9.7% from the $18.5 million reported for the same period in 2011. This decrease was associated with a decline in installation revenue commensurate with the related decline of product revenue in the Company's Hospitality businesses as well as a decline in call center revenue resulting from a modification to existing service contracts. These decreases were partially offset by an increase in software maintenance and professional services revenue associated with the deployment of the Company's SureCheck product. Contract revenues were $22.0 million for the quarter ended September 30, 2012, compared to $15.8 million reported for the same period in 2011. This increase is mostly attributable to the Company's new Intelligence, Surveillance, and Reconnaissance (ISR) systems integration contract with the U.S. Army. Product margins for the quarter ended September 30, 2012 were 34.3 %, a decrease from 35.5% for the same period in 2011. This decrease was driven by an unfavorable product mix resulting from a decrease in the amount of terminals sold relative to lower margin peripheral devices. 14-------------------------------------------------------------------------------- Service margins were 29.6% for the quarter ended September 30, 2012, an increase from the 28.8% recorded for the same period in 2011 as a result of favorable margin earned on the Company's depot repair business. Contract margins were 6.4% for the quarter ended September 30, 2012, compared to 6.9% for the same period in 2011. This decrease was due to a less favorable contract mix as a result of the beginning of certain fixed price contracts. The most significant components of contract costs in 2012 and 2011 were labor and fringe benefits. For the third quarter of 2012, labor and fringe benefits were $9.6million or 46.4% of contract costs compared to $11.2 million or 76% of contract costs for the same period in 2011. This decrease is mostly attributable to the amount of subcontract pass through revenue associated with the Company's new ISR systems integration contract with the U.S. Army. Selling, general and administrative expenses for the quarter ended September 30, 2012 were $9.4 million, an increase from the $8.7 million recorded for the same period in 2011 attributable to an increase in costs associated primarily with international sales and marketing initiatives executed within the Company's Hospitality businesses. Research and development expenses were $3.3 million for the quarter ended September 30, 2012, relatively flat with the $3.4 million recorded for the same period in 2011. This slight decrease was associated with a reduction in the expense incurred in support of developers utilized towards the Company's hospitality software products combined with an increased in software development costs capitalized following the Company's establishment of technological feasibility in accordance with the related accounting guidance. Amortization of identifiable intangible assets was $138,000 for the quarter ended September 30, 2012, compared to $257,000 for the same period in 2011. This decrease was due to certain intangible assets that were fully amortized in 2011. Other income, net was $233,000 for the quarter ended September 30, 2012 compared to income of $23,000 for the same period in 2011. Other income primarily includes losses on the Company's investments, rental income, finance charges and foreign currency gains and losses. This increase was partially associated with foreign currency gains recognized during the quarter. Interest expense primarily represents interest charged on the Company's short-term borrowing requirements from banks and from long-term debt. Interest expense was $22,000 for the quarter ended September 30, 2012 as compared to $48,000 for the same period in 2011. This reduction is associated with a lower outstanding borrowing in 2012 as compared to the same period in 2011, combined with a favorable fair value adjustment on the Company's interest rate swap. For the quarter ended September 30, 2012, the Company's expected effective income tax rate was 4.5 %, compared to a benefit of 40.8% for the same period in 2011. The variance from the federal statutory rate in 2012 was due to an adjustment of the Company's tax accrual during the period, commensurate with the filing of its 2011 income tax return. The variance from the federal statutory rate in 2011 was primarily due to state income taxes and various non-deductible expenses. 15-------------------------------------------------------------------------------- Back to Table of Contents Results of Operations - Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011 During the first quarter of fiscal year 2012, the Company sold substantially all of the assets of its Logistics Management business, PAR Logistics Management Systems Corporation (LMS) to ORBCOMM Inc., including but not limited to accounts receivable, inventory, equipment, intellectual property, and customer contracts. The transaction closed on January 12, 2012. The results of operations of LMS for fiscal years 2012 and 2011 have been recorded as discontinued operations in accordance with Accounting Standards Codification (ASC) 205-20, Presentation of Financial Statements - Discontinued Operations. All prior period amounts have been reclassified to conform to the current period presentation. Refer to Note 2 "Discontinued Operations" in the Notes to the Consolidated Financial Statements for further discussion. The Company reported revenues of $178.7 million for the nine months ended September 30, 2012, an increase of 5.6% from the $169.3 million reported for the same period in 2011. The Company's net income from continuing operations was $1.8 million or $0.12 per diluted share for 2012 versus a net loss from continuing operations of $15.2 million or $1.01 loss per diluted share for the same period in 2011. During the nine months, the Company reported income from discontinued operations of $1.5 million or $0.10 per diluted share versus a loss of $1.1 million or $0.07 loss per diluted share for the same period in 2011. Results of the nine months ended September 30, 2012 include a gain on the sale of LMS of $2.6 million, recorded as a component of income from discontinued operations for the period. The results of 2011 include pre-tax non-recurring charges of $29.4 million. Of this amount, $20.8 million was a non-cash charge related to the impairment of the Company's goodwill and intangible assets. The remaining $8.6 million in charges was related to the write-down of certain inventory associated with discontinued products, as well as severance and office closure costs. Product revenues were $62.7 million for the nine months ended September 30, 2012, a decrease of 9% from the $68.9 million recorded in 2011. This decrease was the result of a decline in domestic sales to McDonald's as their significant technology upgrade program was completed in fiscal year 2011. Partially offsetting this decrease was an increase in sales of the Company's SureCheck™ product to a significant launch customer during the year, as well increases in product sales to YUM! Brands and Subway, commensurate with new store rollouts and upgrades. In addition, international product sales grew 9.6% primarily to Yum! Brands in Europe as well as an increase in sales to restaurants in Australia Central America, China and, the Middle East. Service revenue primarily includes installation, software maintenance, training, twenty-four hour help desk support and various depot and on-site service options. Service revenues were $48.1 million for the nine months ended September 30, 2012, a decrease of 6.7% from the $51.6 million reported for the same period in 2011. This decrease was associated with a decline in installation revenue commensurate with the related decline of product revenue in the Company's Hospitality businesses as well as a decline in call center revenue resulting from a modification to existing service contracts. These decreases were partially offset by an increase in software maintenance and professional services revenue associated with the deployment of the Company's SureCheck product. Contract revenues were $68.0 million for the nine months ended September 30, 2012, compared to $48.8 million reported for the same period in 2011. This increase is mostly attributable to the Company's new Intelligence, Surveillance, and Reconnaissance (ISR) systems integration contract with the U.S. Army. 16-------------------------------------------------------------------------------- Product margins for the nine months ended September 30, 2012 were 36.6%, a decrease from the 37.7% recorded for the same period in 2011. This decrease was the result of an unfavorable mix in product sales resulting from a decrease in the amount of terminals sold relative to lower margin peripheral devices, partially offset by an increase in software revenue driven by the Company's launch of its EverServ software. Service margins were 29.7% for the nine months ended September 30, 2012, an increase from the 14.4% for the same period in 2011. Results for the nine months ended September 30, 2011 included a charge of $7.7 million recorded towards the write down of service parts inventory related to discontinued products during 2011. Exclusive of the aforementioned charges, service margins were relatively flat at 29.4%. Contract margins were 5.6% for the nine months ended September 30, 2012, compared to 6.2% for the same period in 2011. This decrease was due to a less favorable contract mix as a result of the beginning of certain fixed price contracts. The most significant components of contract costs in 2012 and 2011 were labor and fringe benefits. For the nine months ended September 30, 2012, labor and fringe benefits were $30.1 million or 47% of contract costs compared to $36.7 million or 79% of contract costs for the same period in 2011. This decrease is mostly attributable to the amount of subcontract pass through revenue associated with the Company's new ISR systems integration contract with the U.S. Army. Selling, general and administrative expenses for the nine months ended September 30, 2012 were $28.8 million, an increase from the $27.7 million recorded for the same period in 2011. This increase was due to an increase in commission expense associated with the increase in software sales in the first quarter, as well as an increase in sales and marketing effort associated with the Company's Hospitality products. During the nine months ended September 30, 2011, the Company recorded a non-cash impairment charge of $20.2 million to its goodwill, which was the result of the reduction in PAR's stock price through the second quarter of 2011. As a result of this reduction, the Company determined an impairment of goodwill had occurred and in accordance with the relevant accounting rules, recorded the aforementioned charge. In addition to the aforementioned goodwill impairment charge, as part of this analysis, the Company recorded an impairment charge of $580,000 associated with its indefinite lived intangible assets. Research and development expenses were $9.9 million for the nine months ended September 30, 2012, a decrease from the $10.4 million for the same period in 2011. This decrease was associated with a reduction in the expense incurred in support of developers utilized towards the Company's hospitality software products, combined with an increased in software development costs capitalized following the Company's establishment of technological feasibility in accordance with the related accounting guidance. Amortization of identifiable intangible assets was $441,000 for the nine months ended September 30, 2012, compared to $667,000 for the same period in 2011. This decrease was due to certain intangible assets that were fully amortized in 2011. Other income, net was $440,000 for the nine months ended September 30, 2012 compared to other expense of $106,000 for the same period in 2011. Other income primarily includes unrealized gains on the Company's investments, rental income, finance charges and foreign currency gains and losses. The increase in 2012 was due to foreign currency gains and finance charges associated with the Company's Hospitality businesses. 17-------------------------------------------------------------------------------- Interest expense primarily represents interest charged on the Company's short-term borrowing requirements from banks and from long-term debt. Interest expense was $64,000 for the nine months ended September 30, 2012, as compared to $163,000 for the same period in 2011. This reduction is associated with a lower outstanding borrowing in 2012 as compared to the same period in 2011. For the nine months ended September 30, 2012, the Company's expected effective income tax rate was 17.3%, compared to a benefit of 35.4% for the same period in 2011. The variance from the federal statutory rate in 2012 was due to an adjustment of the Company's tax accrual during the period, commensurate with the filing of its 2011 income tax return. The variance from the federal statutory rate in 2011 was primarily due to state income taxes and various non-deductible expenses. Liquidity and Capital Resources The Company's primary sources of liquidity have been cash flow from operations and its bank line of credit. Cash provided by operating activities of continuing operations was $13.7 million for the nine months ended September 30, 2012 compared to $4.3 million for the same period in 2011. In 2012, cash was generated by the Company's net income plus the add back of non-cash charges, offset by reductions to changes in operating assets and liabilities. The most significant changes to the Company's operating assets and liabilities were the decrease in accounts receivable primarily due to the timing of collections associated with the Company's ISR contract with the U.S. Government, as well as an increase in deferred service revenue due to the timing of billing of customer service contracts. These were partially offset by an increase in inventory due planned shipments that were delayed until the fourth quarter. In 2011, cash was generated by the Company's net loss plus the add back of non-cash charges, offset by reductions to changes in operating assets and liabilities. The most significant changes to the Company's operating assets and liabilities were associated with a decrease in accounts payable based on the timing of vendor payments, partially offset by an increase in deferred service revenue associated with the timing of contract billings. Cash provided by investing activities from continuing operations was $717,000 for the nine months ended September 30, 2012 versus cash used in investing activities of $7.8 million for the same period in 2011. In 2012, the Company received cash proceeds of $4 million related to the sale of its Logistics Management business, and generated $1.9 million from the maturity of its investments. In addition, $956,000 of the proceeds generated from the Company's sale of its investment remains in escrow commensurate with the terms of the Company's agreement relative to the January 2012 sale of its Logistics Management business. Capital expenditures were $1.7 million and were primarily for tooling associated with the Company's new hardware products, as well as for purchases of office and computer equipment. Capitalized software was $2.5 million and was associated with the Company's next generation Hospitality software platforms. In 2011, capital expenditures were $651,000 and were primarily for office and computer equipment. Capitalized software was $7.0 million and was associated with the Company's next generation Hospitality software platforms. Cash used in financing activities from continuing operations was $1.4 million for the nine months ended September 30, 2012 versus cash provided of $406,000 in 2011. In 2012, the Company decreased its long-term debt by $1.5 million and benefited $25,000 from the exercise of employee stock options. In 2011, the Company increased its short-term borrowings by $1.5 million in support of its operating cash needs, and decreased its long-term debt by $1.2 million. The Company also benefited $132,000 from the exercise of employee stock options. The Company maintains a credit facility which provides it with borrowing availability up to $20 million (with the option to increase to $30 million) in the form of a line of credit. This agreement allows the Company, at its option, to borrow funds at the LIBOR rate plus the applicable interest rate spread (1.38% at September 30, 2012) or at the bank's prime lending rate (3.25 % at September 30, 2012). This agreement expires in June 2014. At September 30, 2012, the Company did not have any outstanding balance on this line of credit, nor did it borrow against this line at anytime during the nine months. This agreement contains certain loan covenants including leverage and fixed charge coverage ratios. In July 2011, this agreement was amended to exclude specific non-recurring charges recorded by the Company in the second quarter of 2011 from all debt covenant calculations in 2011 and through September 30, 2012. The Company is in compliance with these amended covenants at September 30, 2012. This credit facility is secured by certain assets of the Company. 18 --------------------------------------------------------------------------------The Company has a $1.3 million mortgage, collateralized by certain real estate. This mortgage matures on November 1, 2019. In May 2012, the Company amended its mortgage to reduce the fixed interest rate to 4.05% through October 1, 2014. Beginning on October 1, 2014 and through the maturity date of the loan, the fixed rate will be converted to a new rate equal to the then-current five year fixed advanced rate charged by the New York Federal Home Loan bank, plus 225 basis points. The annual mortgage payment including interest through October 1, 2014 totals $207,000. During fiscal year 2012, the Company anticipates that its capital requirements will not exceed approximately $3 million. The Company does not usually enter into long term contracts with its major Hospitality segment customers. The Company commits to purchasing inventory from its suppliers based on a combination of internal forecasts and actual orders from customers. This process, along with good relations with suppliers, minimizes the working capital investment required by the Company. Although the Company lists two major customers, McDonald's and Yum! Brands, it sells to hundreds of individual franchisees of these corporations, each of which is individually responsible for its own debts. These broadly made sales substantially reduce the impact on the Company's liquidity if one individual franchisee reduces the volume of its purchases from the Company in a given year. The Company, based on internal forecasts, believes its existing cash, line of credit facilities and its anticipated operating cash flow will be sufficient to meet its cash requirements through the next twelve months. However, the Company may be required, or could elect, to seek additional funding prior to that time. The Company's future capital requirements will depend on many factors including its rate of revenue growth, the timing and extent of spending to support product development efforts, potential growth through strategic acquisition, expansion of sales and marketing, the timing of introductions of new products and enhancements to existing products, and market acceptance of its products. The Company cannot assure additional equity or debt financing will be available on acceptable terms or at all. The Company's sources of liquidity beyond twelve months, in management's opinion, will be its cash balances on hand at that time, funds provided by operations, funds available through its lines of credit and the long-term credit facilities that it can arrange. Recently Issued Accounting Pronouncements Not Yet Adopted On July 27, 2012, the FASB issued Accounting Standards Update 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 is intended to reduce the cost and complexity of the annual indefinite-lived intangible assets impairment testing by providing entities an option to perform a "qualitative" assessment to determine whether further impairment testing is necessary. As such, there is the possibility that quantitative assessments would not need to be performed if it is more likely than not that no impairment exists. The Company is required to adopt the provisions of ASU 2012-02, which is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of ASU 2012-02 is not expected to have a significant impact on the Company's financial position or results of operations. Recently Adopted Accounting Pronouncements In September 2011, FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other: Testing Goodwill for Impairment, which amends FASB Topic ASC 350, Intangible Assets-Goodwill and Other. Under ASU No. 2011-08, an entity may elect the option to assess qualitative factors to determine whether it is necessary to perform the first step in the two-step impairment testing process. ASU No. 2011-08 was effective on January 1, 2012. The adoption of ASU No. 2011-08 did not have a material impact on the Company's consolidated financial statements. In May 2011, FASB issued ASU No. 2011-04, Amendment to Achieve Common Fair Value Measurement and Disclosure Requirements, in U.S. GAAP and International Financial Reporting Standards (IFRS), which amends FASB Topic ASC 820, Fair value measurement. ASU No. 2011-04 modifies the existing standard to include disclosure of all transfers between Level 1 and Level 2 asset and liability fair value categories. In addition, ASU No. 2011-04 provides guidance on measuring the fair value of financial instruments managed within a portfolio and the application of premiums and discounts on fair value measurements. ASU No. 2011-04 requires additional disclosure for Level 3 measurements regarding the sensitivity of fair value to changes in unobservable inputs and any interrelationships between those inputs. ASU No. 2011-04 was effective on January 1, 2012. The adoption of ASU No. 2011-04 did not have a material impact on the Company's consolidated financial statements. Critical Accounting Policies In our Annual Report on Form 10-K for the year ended December 31, 2011, we disclose accounting policies, referred to as critical accounting policies, that require management to use significant judgment or that require significant estimates. Management regularly reviews the selection and application of our critical accounting policies. There have been no updates to the critical accounting policies contained in our Annual Report on Form 10-K for the year ended December 31, 2011. Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements. 19-------------------------------------------------------------------------------- Back to Table of Contents |