UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2009
Or
oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File Number: 001-08048
TII NETWORK TECHNOLOGIES, INC. |
(Exact name of registrant as specified in its charter) |
State of incorporation: Delaware | IRS Employer Identification No: 66-0328885 |
141 Rodeo Drive, Edgewood, New York 11717 |
(Address and zip code of principal executive office) |
(631) 789-5000 |
(Registrant’s telephone number, including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 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 o
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 o No o
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. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | 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).
Yeso No x
The number of shares of the registrant’s Common Stock, $.01 par value, outstanding as of May 4, 2009 was 13,917,792.
TII NETWORK TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TII NETWORK TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
| | March 31, | | December 31, | |
| | 2009 | | 2008 | |
| | (unaudited) | | | |
ASSETS | | | | | | | |
| Current assets: | | | | | | | |
Cash and cash equivalents | | $ | 9,535 | | $ | 8,282 | |
Accounts receivable, net of allowance of $98 and $88 at
March 31, 2009 and December 31, 2008, respectively | | | 2,831 | | | 3,906 | |
Inventories, net | | | 8,353 | | | 9,031 | |
Deferred tax assets, net | | | 613 | | | 697 | |
Other current assets | | | 156 | | | 175 | |
Total current assets | | | 21,488 | | | 22,091 | |
| | | | | | | |
Property, plant and equipment, net | | | 8,545 | | | 8,877 | |
Deferred tax assets, net | | | 8,642 | | | 8,599 | |
Other assets, net | | | 185 | | | 154 | |
Total assets | | $ | 38,860 | | $ | 39,721 | |
| | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | |
Current liabilities: | | | | | | | |
Accounts payable | | $ | 1,150 | | $ | 2,090 | |
Accrued liabilities | | | 769 | | | 652 | |
Total current liabilities and total liabilities | | | 1,919 | | | 2,742 | |
| | | | | | | | |
| Commitments and contingencies | | | | | | | |
| | | | | | | | |
Stockholders' equity: | | | | | | | |
Preferred stock, par value $1.00 per share; 1,000,000 shares authorized,
including 30,000 shares of series D junior participating at December 31, 2008; no shares outstanding | | | — | | | — | |
Common stock, par value $.01 per share; 30,000,000 shares authorized;
13,787,429 shares issued and 13,769,792 shares outstanding as of
March 31, 2009, and December 31, 2008 | | | 138 | | | 138 | |
Additional paid-in capital | | | 42,456 | | | 42,262 | |
Accumulated deficit | | | (5,372 | ) | | (5,140 | ) |
| | | 37,222 | | | 37,260 | |
Less: Treasury shares, at cost, 17,637 common shares at
March 31, 2009 and December 31, 2008 | | | (281 | ) | | (281 | ) |
Total stockholders' equity | | | 36,941 | | | 36,979 | |
| | | | | | | |
Total liabilities and stockholders' equity | | $ | 38,860 | | $ | 39,721 | |
See notes to unaudited condensed consolidated financial statements
TII NETWORK TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
| | Three months ended
March 31, | |
| | 2009 | | 2008 | |
Net sales | | $ | 5,749 | | $ | 8,851 | |
Cost of sales | | | 3,622 | | | 5,599 | |
Gross profit | | | 2,127 | | | 3,252 | |
| | | | | | | |
Operating expenses: | | | | | | | |
Selling, general and administrative | | | 1,884 | | | 2,407 | |
Research and development | | | 439 | | | 622 | |
Total operating expenses | | | 2,323 | | | 3,029 | |
| | | | | | | |
Operating (loss) income | | | (196 | ) | | 223 | |
| | | | | | | |
Interest income | | | 3 | | | 17 | |
| | | | | | | |
(Loss) income before income taxes | | | (193 | ) | | 240 | |
| | | | | | | |
Income tax provision | | | 39 | | | 89 | |
| | | | | | | |
Net (loss) income | | $ | (232 | ) | $ | 151 | |
| | | | | | | |
Net (loss) income per common share: | | | | | | | |
Basic and Diluted | | $ | (0.02 | ) | $ | 0.01 | |
| | | | | | | |
Weighted average common shares outstanding: | | | | | | | |
Basic | | | 13,560 | | | 13,493 | |
Diluted | | | 13,560 | | | 13,750 | |
See notes to unaudited condensed consolidated financial statements
TII NETWORK TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
(Unaudited)
| | Common Stock
Shares | | Common
Stock
Amount | | Additional
Paid-In
Capital | | Accumulated
Deficit | | Treasury
Stock | | Total
Stockholders'
Equity | |
Balance December 31, 2008 | | 13,769,792 | | $ | 138 | | $ | 42,262 | | $ | (5,140 | ) | $ | (281 | ) | $ | 36,979 | |
Share-based compensation | | — | | | — | | | 194 | | | — | | | — | | | 194 | |
Net loss for the three months
ended March 31, 2009 | | — | | | — | | | — | | | (232 | ) | | — | | | (232 | ) |
Balance March 31, 2009 | | 13,769,792 | | $ | 138 | | $ | 42,456 | | $ | (5,372 | ) | $ | (281 | ) | $ | 36,941 | |
See notes to unaudited condensed consolidated financial statements
TII NETWORK TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
| | Three months ended | |
| | March 31, | |
| | 2009 | | 2008 | |
Cash Flows from Operating Activities | | | | | | | |
Net (loss) income | | $ | (232 | ) | $ | 151 | |
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: | | | | | | | |
Depreciation and amortization | | | 451 | | | 419 | |
Share-based compensation | | | 194 | | | 172 | |
Deferred income taxes | | | 41 | | | 53 | |
Loss on write-offs and disposals of capital assets | | | 19 | | | 1 | |
Changes in operating assets and liabilities: | | | | | | | |
Accounts receivable | | | 1,075 | | | 2,556 | |
Inventories | | | 678 | | | (3,487 | ) |
Other assets | | | (24 | ) | | 189 | |
Accounts payable and accrued liabilities | | | (823 | ) | | (1,142 | ) |
Net cash provided by (used in) operating activities | | | 1,379 | | | (1,088 | ) |
| | | | | | | |
Cash Flows Used in Investing Activities | | | | | | | |
Capital expenditures | | | (126 | ) | | (168 | ) |
| | | | | | | |
Cash Flows Provided by Financing Activities | | | | | | | |
Proceeds from exercise of stock options | | | — | | | 28 | |
| | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 1,253 | | | (1,228 | ) |
| | | | | | | |
Cash and cash equivalents, at beginning of period | | | 8,282 | | | 3,261 | |
| | | | | | | |
Cash and cash equivalents, at end of period | | $ | 9,535 | | $ | 2,033 | |
| | | | | | | |
Non-Cash Investing and Financing Activities | | | | | | | |
Capital additions included in accounts payable | | $ | — | | $ | 19 | |
| | | | | | | |
Supplemental Cash Flow Information | | | | | | | |
Cash paid during the period for interest | | $ | — | | $ | — | |
Cash paid during the period for income taxes | | $ | 8 | | $ | 12 | |
| | | | | | | |
See notes to unaudited condensed consolidated financial statements
TII NETWORK TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 – Basis of Presentation
The unaudited interim condensed consolidated financial statements presented herein have been prepared by TII Network Technologies, Inc. and Subsidiaries (together “Tii,” the “company,” “we,” “us,” or “our”) in accordance with U.S. generally accepted accounting principles for interim financial statements and in accordance with the instructions to Form 10-Q and Regulation S-X pertaining to interim financial statements. Accordingly, they do not include all information and notes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The unaudited interim condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments and accruals which, in the opinion of management, are considered necessary for a fair presentation of our consolidated financial position, results of operations and cash flows for the interim periods presented. The condensed consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2008. In addition, the December 31, 2008 balance sheet was derived from the audited consolidated financial statements, but does not include all disclosures required by GAAP.
Results of operations for interim periods presented are not necessarily indicative of results of operations that might be expected for future interim periods or for the full fiscal year ending December 31, 2009.
Reclassifications
Certain reclassifications have been made to the prior period financial statements presented herein to conform to the 2009 presentation.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our more significant estimates include the valuation of accounts receivable, inventory and deferred income taxes and the fair value of share-based payments. Actual results could differ from such estimates.
Recently Adopted Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS 157 indicates, among other things, that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. SFAS 157 defines fair value based upon an exit price model. In February 2008, the FASB issued FASB Staff Positions (“FSP”) SFAS No. 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Its Related Interpretive Accounting Pronouncements That Address Leasing Transactions,” and FSP SFAS No. 157-2, “Effective Date of FASB Statement No. 157.” FSP SFAS 157-1 removes leasing transactions from the scope of SFAS No. 157, while SFAS No. 157-2 deferred the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. It did not defer recognition and disclosure requirements for financial assets and financial liabilities or for nonfinancial assets and nonfinancial liabilities that are remeasured at least annually. Effective January 1, 2008, we adopted SFAS 157, with the exception of the application of the statement to non-recurring nonfinancial assets and nonfinancial liabilities, which we adopted effective January 1, 2009. The adoption of SFAS 157 did not impact our financial position or results of operations.
In November 2007, the FASB Emerging Issues Task Force (“EITF”) issued EITF 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock.” As a result of EITF 07-5, freestanding warrants containing protective features, which provide for adjustments to the exercise or conversion price if the entity subsequently issues shares or other equity-related contracts to a new investor with more favorable pricing, will no longer be eligible to be recorded in equity. EITF 07-5 became effective for us on January 1, 2009. EITF 07-5 has not impacted us to date as we have no outstanding instruments that contain these protective features. We will assess the impact of EITF 07-5 if and when we issue instruments that contain these protective features.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141(R) also established disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141(R) became effective for us on January 1, 2009. SFAS No. 141(R) has not impacted us to date. We will assess the impact of SFAS 141(R) if and when a future acquisition occurs.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” (“SFAS 160”) which will require noncontrolling interests, previously referred to as minority interests, to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. SFAS 160 became effective for us on January 1, 2009. SFAS No. 160 has not impacted us to date as there are no such controlling interests. We will assess the impact of SFAS 160 if and when any noncontrolling interests should arise.
Note 2 – Comprehensive (loss) income
We do not have any items of comprehensive (loss) income. Accordingly, for all periods presented, comprehensive (loss) income equaled net (loss) income.
Note 3 – Puerto Rico Facility Closing
In June 2007, our Board of Directors approved a plan to consolidate the operations of our Puerto Rico leased facility into our new headquarters in Edgewood, New York, resulting in the closure of the Puerto Rico facility. No costs related to this plan were incurred during the quarter ended March 31, 2009. During the three months ended March 31, 2008, we incurred costs of $70,000 related to this plan. Cumulative costs incurred through December 31, 2008 to close the Puerto Rico facility were $1,146,000. All of these costs were included in cost of sales for the respective periods incurred.
Upon adoption of the provisions of Financial Accounting Standards Board Interpretation No. 47, “Accounting for Asset Retirement Obligations,” in 2005, we recorded an asset retirement obligation of $109,000 for the estimated cost to restore the then leased facility in Puerto Rico to its original condition at the end of the lease. Based upon an updated assessment of the final restoration costs, we recorded additional charges of $70,000 and settled liabilities of $80,000 during the three months ended March 31, 2008. Restoration was completed in April 2008 and there were no liabilities related to this plan thereafter.
Note 4 – Share–Based Payment and Stockholder’s Equity
Share-based payment compensation is attributable to the granting of stock options and awarding of shares of restricted stock, and vesting of these options and shares of restricted stock over the remaining requisite service period. Compensation expense attributable to share-based compensation during the three months ended March 31, 2009 and 2008 was $194,000 and $172,000, respectively.
We are authorized to issue up to 1,000,000 shares of preferred stock in series, with each series having such powers, rights, preferences, qualifications and restrictions as determined by our Board of Directors. No shares of preferred stock were outstanding at March 31, 2009 and December 31, 2008.
In May 2008, our Stockholder Rights Plan under which we could have issued Series D junior participating preferred stock expired. In March 2009, registration of the Series D junior participating preferred stock was terminated.
Note 5 - Net income per common share
Basic earnings per share (“EPS”) is computed by dividing income available to common stockholders (which equals our net income) by the weighted average number of common shares outstanding, and dilutive EPS adds the dilutive effect of stock options and other common stock equivalents. Due to the net loss for the three months ended March 31, 2009, all potentially dilutive common stock equivalents of approximately 2,500,000 stock options were excluded because their inclusion would have been anti-dilutive. During the three months ended March 31, 2008, outstanding options to purchase an aggregate of approximately 2,397,000 shares of common stock were excluded from the computation of diluted earnings per share because their inclusion would have been anti-dilutive.
The following table sets forth the amounts used in the computation of basic and diluted EPS:
| | Three months ended March 31, | |
| | 2009 | | 2008 | |
Numerator for diluted EPS calculation: | | | | | | | |
Net income (loss) | | $ | (232,000 | ) | $ | 151,000 | |
| | | | | | | |
Denominator for diluted EPS calculation: | | | | | | | |
Weighted average shares outstanding - Basic | | | 13,560,000 | | | 13,493,000 | |
Effect of dilutive stock options | | | — | | | 257,000 | |
| | | 13,560,000 | | | 13,750,000 | |
| | | | | | | |
Basic and Diluted EPS | | $ | (0.02 | ) | $ | 0.01 | |
Note 6 – Inventories
The following table sets forth the cost basis of each major class of inventory as of March 31, 2009 and December 31, 2008:
| | March 31, | | December 31, | |
| | 2009 | | 2008 | |
Raw material and subassemblies | | $ | 1,294,000 | | $ | 1,459,000 | |
Work in progress | | | 52,000 | | | — | |
Finished goods | | | 7,007,000 | | | 7,572,000 | |
| | $ | 8,353,000 | | $ | 9,031,000 | |
Inventories are net of a reserve of $989,000 and $980,000 at March 31, 2009 and December 31, 2008, respectively.
Note 7 – Property, Plant and Equipment
Property, plant and equipment is recorded at cost and depreciated using the straight-line method over the estimated useful life of the related asset. The following table sets forth the amounts of each major class of property, plant and equipment as of March 31, 2009 and December 31, 2008:
| | March 31, | | December 31, | |
| | 2009 | | 2008 | |
Land | | $ | 1,244,000 | | $ | 1,244,000 | |
Building and building improvements | | | 4,303,000 | | | 4,303,000 | |
Construction in progress | | | 118,000 | | | 118,000 | |
Machinery and equipment | | | 7,672,000 | | | 7,865,000 | |
Computer hardware and software | | | 804,000 | | | 802,000 | |
Office furniture, fixtures, equipment and other | | | 711,000 | | | 764,000 | |
| | $ | 14,852,000 | | $ | 15,096,000 | |
Less: accumulated depreciation and amortization | | | (6,307,000 | ) | | (6,219,000 | ) |
| | $ | 8,545,000 | | $ | 8,877,000 | |
Depreciation and amortization of plant and equipment was $439,000 and $410,000 for the three months ended March 31, 2009 and 2008, respectively. These amounts included accelerated depreciation of $64,000 and $7,000 for the three months ended March 31, 2009 and 2008, respectively, resulting from a revision to the estimate of the useful life of certain machinery and equipment, which was accounted for in accordance with SFAS 154 “Accounting Changes and Error Corrections.” Of these amounts, $58,000 was included in cost of sales and $6,000 was included in research and development expenses for the three months ended March 31, 2009, and $7,000 was included in cost of sales for the three months ended March 31, 2008.
We recorded a loss on disposal of capital assets of approximately $19,000 and $1,000 for the three months ended March 31, 2009 and March 31, 2008, respectively, related to disposals of obsolete equipment. These charges are included in selling, general and administrative expenses.
During 2008, we capitalized $102,000 of costs incurred for the development of machinery and equipment and $16,000 of costs incurred for the license fees of stock option accounting software. These costs are classified as construction in progress at March 31, 2009 and December 31, 2008 as neither the machinery and equipment nor the software were in service at these dates.
Note 8 – Credit Facility
In December 2008, we entered into an amended credit agreement with JP Morgan Chase Bank, N.A. (the “amended agreement”) which replaced a $5,000,000 credit facility that was expiring. Under the amended agreement, we are entitled to borrow from the bank up to $5,000,000 in the aggregate at any one time outstanding, but limited to a borrowing base, in general, equal to 80% of eligible accounts receivable (as defined), plus the lesser of 30% of eligible inventory (as defined, generally to include, with certain exceptions, inventories at the Company’s continental United States warehouse), after certain reserves, or $1,500,000. As of March 31, 2009, our borrowing base was $3,700,000. Loans under the amended agreement mature on December 31, 2010. We had no borrowings outstanding under the credit agreement as of March 31, 2009.
Outstanding loans under the amended agreement bear interest, at our option, either at (a) the bank’s prime rate plus 2.75% per annum, provided that the prime rate shall not be less than an adjusted one-month London Interbank Offered Rate (“LIBOR”) (as defined in the amended agreement), or (b) under a formula based on LIBOR plus 4.5% per annum. We also pay a commitment fee equal to 0.25% per annum on the average daily unused portion of the credit facility.
Our obligations under the amended agreement are collateralized, pursuant to a Continuing Security Agreement, by all of our accounts receivable and inventory, and are also guaranteed by one of our subsidiaries.
The amended agreement contains various covenants, including financial covenants and covenants that prohibit or limit a variety of actions without the bank’s consent. These include, among other things, covenants that prohibit our payment of dividends and limit our ability to repurchase stock, incur or guarantee indebtedness, create liens, purchase all or a substantial part of the assets or stock of another entity, other than certain permitted acquisitions, create or acquire any subsidiary, or substantially change our business. The amended agreement requires us to maintain, as of the end of each fiscal quarter, tangible net worth and subordinated debt of at least $35,300,000, a ratio of net income before interest expense and taxes for the 12-month period ending with such fiscal quarter to interest expense for the same period of at least 2.25 to 1.00, and a ratio of total liabilities, excluding accounts payable in the ordinary course of business, accrued expenses or losses and deferred revenues or gains, to net income before interest expense, income taxes, depreciation and amortization for the 12-month period ending with the fiscal quarter for which compliance is being determined of not greater than 2.5 to 1.0. As of March 31, 2009, we were in compliance with all financial covenants in the amended agreement.
Note 9 – Income Taxes
For the three months ended March 31, 2009 and 2008, our income tax provision consisted of amounts necessary to align our year-to-date tax provision with the effective tax rate we expect for the full year. That rate differs from the U.S. statutory rate primarily as a result of the non-deductibility of certain share-based compensation expense for income tax purposes that has been expensed for financial statement purposes, state taxes and additionally, in the current period, an increase in the valuation allowance against deferred tax assets for our estimate of state net operating losses that will expire unutilized.
We do not expect that our unrecognized tax benefits will significantly change within the next twelve months. We file a consolidated U.S. income tax return and tax returns in certain state and local jurisdictions. There have not been any past tax examinations nor are there any current tax examinations in progress. Accordingly, as of March 31, 2009, we remain subject to examination in applicable tax jurisdictions for the relevant statute of limitations periods.
Note 10- Significant Customers
The following customers accounted for 10% or more of our consolidated net sales during at least one of the periods presented below:
| Three months ended March 31, |
| 2009 | | 2008 |
Customer A | 25% | | 36% |
Customer B | 12% | | 17% |
Customer C | 10% | | * |
Customer D | 27% | | * |
* Amounts are less than 10%
As of March 31, 2009, three customers accounted for approximately 23%, 15%, and 18% of accounts receivable, and as of December 31, 2008, the same three customers accounted for approximately 32%, 16% and 14% of accounts receivable, respectively.
Note 11 – Litigation
In February 2009, a lawsuit was filed in Puerto Rico by a former sales representative against us. The complaint alleges that we terminated our relationship with the former sales representative without just cause and is seeking $1,400,000 in damages, plus attorney’s fees and costs. We believe this case is without merit and we intend to defend this case vigorously.
From time to time, we are subject to legal proceedings or claims which arise in the ordinary course of business. While the outcome of such matters can not be predicted with certainty, we believe that such matters will not have a material adverse effect on our financial condition or liquidity.
12
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the foregoing unaudited Condensed Consolidated Financial Statements and related notes thereto appearing elsewhere in this Report.
Overview
Business
TII Network Technologies, Inc. and subsidiaries (together, “Tii,” the “company,” “we,” “us” or “our”) design, manufacture and sell products to service providers in the communications industry for use in their networks. Our products are typically found outdoors in the service provider’s distribution network, at the interface where the service provider’s network connects to the user’s network, and inside the user’s home or apartment, and are critical to the successful delivery of voice and broadband communication services.
We sell our products through a network of sales channels, principally to telephone operating companies (“Telcos”), multi-system operators (“MSOs��) of communications services, including cable and satellite service providers, and original equipment manufacturers (“OEMs”).
Results of Operations
The following table sets forth certain statement of operations information as a percentage of net sales for the periods indicated (except “Income tax provision,” which is stated as a percentage of “(Loss) income before income taxes”):
| | Three months ended March 31, | | | | | | | |
| | 2009 | | 2008 | | | | | | | |
| | Amount | | % of
Net sales | | Amount | | % of
Net sales | | Dollar increase (decrease) | | Percent
increase (decrease) |
Net sales | | $ | 5,749 | | | 100.0 | % | | $ | 8,851 | | 100.0 | % | | $ | (3,102 | ) | | (35.0 | %) |
Cost of sales | | | 3,622 | | | 63.0 | % | | | 5,599 | | 63.3 | % | | | (1,977 | ) | | (35.3 | %) |
Gross profit | | | 2,127 | | | 37.0 | % | | | 3,252 | | 36.7 | % | | | (1,125 | ) | | (34.6 | %) |
| | | | | | | | | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | | | | | | | | |
Selling, general and administrative | | | 1,884 | | | 32.8 | % | | | 2,407 | | 27.2 | % | | | (523 | ) | | (21.7 | %) |
Research and development | | | 439 | | | 7.6 | % | | | 622 | | 7.0 | % | | | (183 | ) | | (29.4 | %) |
Total operating expenses | | | 2,323 | | | 40.4 | % | | | 3,029 | | 34.2 | % | | | (706 | ) | | (23.3 | %) |
| | | | | | | | | | | | | | | | | | | | |
Operating (loss) income | | | (196 | ) | | -3.4 | % | | | 223 | | 2.5 | % | | | (419 | ) | | (187.9 | %) |
| | | | | | | | | | | | | | | | | | | | |
Interest income | | | 3 | | | 0.1 | % | | | 17 | | 0.2 | % | | | (14 | ) | | (82.4 | %) |
| | | | | | | | | | | | | | | | | | | | |
(Loss) income before income taxes | | | (193 | ) | | -3.4 | % | | | 240 | | 2.7 | % | | | (433 | ) | | (180.4 | %) |
Income tax provision | | | 39 | | | -20.2 | % | | | 89 | | 37.1 | % | | | (50 | ) | | (56.2 | %) |
Net (loss) income | | $ | (232 | ) | | -4.0 | % | | $ | 151 | | 1.7 | % | | $ | (383 | ) | | (253.6 | %) |
Net sales for the three months ended March 31, 2009 were $5,749,000 compared to $8,851,000 for the comparable prior year period, a decrease of $3,102,000 or 35.0%. The decline was due to the sharp downturn in economic activity which has negatively impacted the markets for our connectivity, network interface device and overvoltage surge protection products. This decrease was partially offset by an increase in sales of our broadband products.
Gross profit for the three months ended March 31, 2009 was $2,127,000 compared to $3,252,000 for the comparable prior year period, a decrease of $1,125,000 or 34.6%, which was primarily due to lower sales volume. Gross profit margin remained virtually consistent at 37.0% and 36.7% for the three months ended March 31, 2009 and 2008, respectively. Though the margins have been flat with lower sales, we are under increasing pressure from customers to reduce prices.
Selling, general and administrative expenses for the three months ended March 31, 2009 were $1,884,000 compared to $2,407,000 for the comparable prior year period, a decrease of $523,000 or 21.7%. The decrease in the 2009 period was primarily attributable to the following:
Salary and related benefits - headcount decreases | | $ | 189,000 | |
SOX 404 and ERP implementation consulting fees | | | 131,000 | |
Travel and entertainment expenses | | | 57,000 | |
Professional and consulting fees | | | 48,000 | |
Advertising | | | 47,000 | |
Sales commissions as a result of decreased sales | | | 39,000 | |
Other, net | | | 12,000 | |
| | $ | 523,000 | |
Research and development expenses for the three months ended March 31, 2009 were $439,000 compared to $622,000 for the comparable prior year period, a decrease of $183,000 or 29.4%. The decrease was primarily attributable to a decrease in salary and related benefits of $101,000 as a result of decreases in headcount and a decrease of $53,000 in product development activities during the current year period.
Interest income for the three months ended March 31, 2009 was $3,000 compared to $17,000 for the comparable prior year period, a decrease of $14,000 or 82.4%. The decrease was due to lower interest earned as a result of lower interest rates in the 2009 period than the 2008 period.
During the three months ended March 31, 2009 and 2008, we recorded a provision for income taxes of $39,000 and $89,000, respectively. Our income tax provision for each period consists of amounts necessary to align our year-to-date tax provision with the effective tax rate we expect to achieve for the full year. That rate differs from the U.S. statutory rate primarily as a result of the non-deductibility of certain share-based compensation expense for income tax purposes that has been recognized for financial statement purposes, state taxes and additionally, in the current year period, an increase in the valuation allowance against deferred tax assets for our estimate of state net operating losses that will expire unutilized.
Impact of Inflation
We do not believe our business is affected by inflation to a greater extent than the general economy. Our products contain a significant amount of plastic that is petroleum based. We import most of our products from contract manufacturers, principally in Malaysia and China, and fuel costs are, therefore, a significant component of transportation costs to obtain delivery of products. Accordingly, an increase in petroleum prices can potentially increase the cost of our products. Increased labor costs in the countries in which our contract manufacturers produce products for us and a continuing increase in the cost of precious metals could also increase the cost of our products. We monitor the impact of inflation and attempt to adjust prices where market conditions permit, except that we may not increase prices under our general supply agreement with Verizon Services Corp. Inflation has not had a significant effect on our operations during any of the reported periods.
Liquidity and Capital Resources
As of March 31, 2009, we had $19,569,000 of working capital, which included $9,535,000 of cash and cash equivalents, and our current ratio was 11.2 to 1.
The primary reason for the $1,379,000 of cash provided by operating activities in the first three months of 2009 compared to the $1,088,000 cash used in operating activities in the first three months of 2008 was a $678,000 reduction in inventories in the 2009 period compared to a $3,487,000 temporary build-up of inventories in the 2008 period to fulfill anticipated sales. This $4,165,000 variation was partially offset by a reduction in accounts receivable in the 2009 period of $1,075,000 compared to a reduction in the 2008 period of $2,556,000. This was due to a significantly lower accounts receivable balance at January 1, 2009 of $3,906,000 than at January 1, 2008 of $6,994,000, as a result of a decrease in sales volume of $4,042,000 from the quarter ended December 31, 2007 to the quarter ended December 31, 2008.
Investing activities in the 2009 three month period used cash of $126,000, for capital expenditures, primarily for machinery and equipment used in the development of new products, which was slightly less than the $168,000 used for this purpose in the similar 2008 period. There was no cash provided by financing activities in the first three months of 2009, while the exercise of stock options provided $28,000 of cash in the similar period of 2008.
In December 2008, we entered into an amended credit agreement with JP Morgan Chase Bank, N.A. (the “amended agreement”) which replaced a $5,000,000 credit facility that was expiring. Under the amended agreement, we are entitled to borrow from the bank up to $5,000,000 in the aggregate at any one time outstanding, but limited to a borrowing base, in general, equal to 80% of eligible accounts receivable (as defined), plus the lesser of 30% of eligible inventory (as defined, generally to include, with certain exceptions, inventories at the Company’s continental United States warehouse), after certain reserves, or $1,500,000. As of March 31, 2009, our borrowing base was $3,700,000. Loans under the amended agreement mature on December 31, 2010. We had no borrowings outstanding under the amended agreement as of March 31, 2009.
Outstanding loans under the amended agreement bear interest, at our option, either at (a) the bank’s prime rate plus 2.75% per annum, provided that the prime rate shall not be less than an adjusted one-month London Interbank Offered Rate (“LIBOR”) (as defined in the amended agreement), or (b) under a formula based on LIBOR plus 4.5% per annum. We also pay a commitment fee equal to 0.25% per annum on the average daily unused portion of the credit facility.
Our obligations under the amended agreement are collateralized, pursuant to a Continuing Security Agreement, by all of our accounts receivable and inventory, and are also guaranteed by one of our subsidiaries.
The amended agreement contains various covenants, including financial covenants and covenants that prohibit or limit a variety of actions without the bank’s consent. These include, among other things, covenants that prohibit our payment of dividends and limit our ability to repurchase stock, incur or guarantee indebtedness, create liens, purchase all or a substantial part of the assets or stock of another entity, other than certain permitted acquisitions, create or acquire any subsidiary, or substantially change our business. The amended agreement requires us to maintain, as of the end of each fiscal quarter, tangible net worth and subordinated debt of at least $35,300,000, a ratio of net income before interest expense and taxes for the 12-month period ending with such fiscal quarter to interest expense for the same period of at least 2.25 to 1.00, and a ratio of total liabilities, excluding accounts payable in the ordinary course of business, accrued expenses or losses and deferred revenues or gains, to net income before interest expense, income taxes, depreciation and amortization for the 12-month period ending with the fiscal quarter for which compliance is being determined of not greater than 2.5 to 1.0. As of March 31, 2009, we were in compliance with all financial covenants in the amended agreement.
We believe that existing cash, together with internally generated funds and the available line of credit, will be sufficient for our working capital requirements and capital expenditure needs for at least the next twelve months.
Seasonality
Our operations are subject to seasonal variations primarily due to the fact that our principal products, NIDs, are typically installed on the side of homes. During the hurricane season, sales may increase depending upon the severity and location of hurricanes and the number of NIDs that are damaged and need replacement. Conversely, during winter months when severe weather hinders or delays the Telco’s installation and maintenance of their outside plant network, NID sales have been adversely affected until replacements can be installed (at which time sales increase).
Off Balance Sheet Financing
We have no off-balance sheet contractual arrangements, as that term is defined in Item 303(a)(4) of Regulation S-K.
Critical Accounting Policies, Estimates and Judgments
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and judgments. A summary of our most critical accounting policies can be found in the Management’s Discussion and Analysis of Financial Condition and Results of Operation section of our Annual Report on Form 10-K for year ended December 31, 2008. We regularly evaluate items which may impact our critical accounting estimates and judgments. During the three months ended March 31, 2009, we did not update our critical accounting policies.
Recently Adopted Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS 157 indicates, among other things, that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. SFAS 157 defines fair value based upon an exit price model. In February 2008, the FASB issued FASB Staff Positions (FSP) SFAS No. 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Its Related Interpretive Accounting Pronouncements That Address Leasing Transactions,” and FSP SFAS No. 157-2, “Effective Date of FASB Statement No. 157.” FSP SFAS 157-1 removes leasing transactions from the scope of SFAS No. 157, while SFAS No. 157-2 deferred the effective date of SFAS 157 to the fiscal year beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. It did not defer recognition and disclosure requirements for financial assets and financial liabilities, or for nonfinancial assets and nonfinancial liabilities that are remeasured at least annually. Effective January 1, 2008, we adopted SFAS 157, with the exception of the application of the statement to non-recurring nonfinancial assets and nonfinancial liabilities, which we adopted effective January 1, 2009. The adoption of SFAS 157 did not impact our financial position or results of operations.
In November 2007, the FASB Emerging Issues Task Force (“EITF”) issued EITF 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock.” As a result of EITF 07-5, freestanding warrants containing protective features, which provide for adjustments to the exercise or conversion price if the entity subsequently issues shares or other equity-related contracts to a new investor with more favorable pricing, will no longer be eligible to be recorded in equity. EITF 07-5 became effective for us on January 1, 2009. EITF 07-5 has not impacted us to date as we have no outstanding instruments that contain these protective features. We will assess the impact of EITF 07-5 if and when we issue instruments that contain these protective features.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141(R) also established disclosure requirements to enable the evaluation of the nature and financial effects of the
business combination. SFAS 141(R) became effective for us on January 1, 2009. SFAS No. 141(R) has not impacted us to date. We will assess the impact of SFAS 141(R) if and when a future acquisition occurs.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” (“SFAS 160”) which will require noncontrolling interests, previously referred to as minority interests, to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. SFAS 160 became effective for us on January 1, 2009. SFAS No. 160 has not impacted us to date as there are no such noncontrolling interests. We will assess the impact of SFAS 160 if and when any noncontrolling interests should arise.
Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this Report, words such as “may,” “should,” “seek,” “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” “strategy” and similar expressions are intended to identify forward-looking statements regarding events, conditions and financial trends that may affect our future plans, operations, business strategies, operating results and financial position. Forward-looking statements are subject to a number of known and unknown risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those described or implied in the forward-looking statements as a result of several factors, including, but not limited to, those factors discussed below and elsewhere in this document. We undertake no obligation to update any forward-looking statement to reflect events after the date of this Report. Among those factors are:
| • | general economic and business conditions, especially as they pertain to the telecommunications industry; |
| • | potential changes in customers’ spending and purchasing policies and practices, which are effected by customers’ internal budgetary allotments that may be impacted by the current economic climate, particularly in the United States; |
| • | pressure from customers to reduce pricing without achieving a commensurate reduction in costs; |
| • | the ability to market and sell products to new markets beyond our principal copper-based telephone operating company (“Telco”) market which has been declining over the last several years, due principally to the impact of alternate technologies; |
| • | exposure to increases in the cost of our products, including increases in the cost of our petroleum-based plastic products and precious metals; |
| • | the ability to timely develop products and adapt our existing products to address technological changes, including changes in our principal market; |
| • | competition in our traditional Telco market and new markets into which we have been seeking to Ex; |
| • | dependence on, and ability to retain, our “as-ordered” general supply agreements with our largest customer and our ability to win new contracts; |
| • | dependence on third parties for certain product development; |
| • | dependence for products and product components from Pacific Rim contract manufacturers, including on-time delivery that could be interrupted as a result of third party labor disputes, political factors or shipping disruptions, quality control and exposure to changes in costs and changes in the valuation of the Chinese Yuan; |
| • | weather and similar conditions, including the effect of typhoons on our assembly facilities in the Pacific Rim, the effect of hurricanes on our warehouse in the United States which can increase the demand for our products and harsh winter conditions which can temporarily disrupt the installation of certain of our products by Telcos; |
| • | the ability to attract and retain technologically qualified personnel; and |
| • | the availability of financing on satisfactory terms. |
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks, including changes in interest rates. The interest payable under our credit facility, under which there were no borrowings outstanding as of March 31, 2009, is based on a specified bank’s prime interest rate and, therefore, is affected by changes in market interest rates. Historically, the effects of movements in the market interest rates have been immaterial to our consolidated operating results, as we have not borrowed to any significant degree.
Our products contain a significant amount of plastic that is petroleum based. We import most of our products from contract manufacturers, principally in Malaysia and China. The increased cost of petroleum can potentially increase the cost of our products.
We require foreign sales to be paid in U.S. currency, and we are billed by our contract manufacturers in U.S. currency. Since one of our Pacific Rim suppliers is based in China, the cost of our products could be affected by changes in the valuation of the Chinese Yuan.
Historically, we have not purchased or entered into interest rate swaps or future, forward, option or other instruments designed to hedge against changes in interest rates, the price of materials we purchase or the value of foreign currencies.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Report, our management, with the participation of our President and Principal Executive Officer and our Vice President-Finance and Principal Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures,” as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based on that evaluation, these officers concluded that, as of March 31, 2009, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our periodic filings under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including those officers, to allow timely decisions regarding required disclosure. It should be noted that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within us to disclose material information otherwise required to be set forth in our periodic reports.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the quarter covered by this Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
On February 19, 2009, a former sales representative filed a lawsuit against us in the Puerto Rico Court of First Instance, San Juan Region. The complaint alleges that we terminated our relationship with the former sales representative without just cause and is seeking $1,400,000 in damages, plus attorney’s fees and costs. We believe this case is without merit and we intend to defend this case vigorously.
Item 6. Exhibits
31(a) | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31(b) | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32(a) | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32(b) | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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.
| TII NETWORK TECHNOLOGIES, INC.
|
Date: May 5, 2009 | By: | /s/ Jennifer E. Katsch |
| | Jennifer E. Katsch
Vice President-Finance, Treasurer and
Chief Financial Officer |
Exhibit Index
