UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
|
S
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
quarterly period ended
March 31,
2008
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
1-8086
GENERAL
DATACOMM INDUSTRIES, INC.
|
(Exact name of
registrant as specified in its
charter)
|
DELAWARE
|
06-0853856
|
(State
of other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification No.)
|
6
Rubber Avenue, Naugatuck, CT
|
06770
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code
203-729-0271
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.
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 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
S
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rue 12b-2
of the Exchange Act):
As of
March 31, 2008, there were outstanding the following number of shares of each of
the issuer’s classes of common equity:
3,487,473
shares of common stock, par value $0.01 per share
634,615
shares of Class B stock, par value $0.01 per share
GENERAL
DATACOMM INDUSTRIES, INC.
INDEX
TO QUARTERLY REPORT ON FORM 10-Q
PART
I
|
FINANCIAL
INFORMATION
|
Page
|
|
|
|
Item 1
.
|
Financial Statements
(unaudited):
|
|
|
|
3
|
|
|
4
|
|
|
5
|
|
|
6
|
|
|
|
Item 2
.
|
|
12
|
|
|
|
Item
3.
|
|
25
|
|
|
|
Item
4.
|
|
25
|
|
|
|
|
|
|
PART
II
|
OTHER
INFORMATION
|
|
|
|
|
|
|
|
Item 3
.
|
|
26
|
|
|
|
Item
5.
|
|
26
|
|
|
|
Item 6
.
|
|
26
|
PART
I. FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
General
DataComm Industries, Inc., and Subsidiaries
Condensed
Consolidated
Balance
Sheets
(in
thousands except shares)
|
|
March 31,
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007*
|
|
|
|
(Unaudited)
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
832
|
|
|
$
|
1,296
|
|
Accounts
receivable, less allowance for doubtful accounts of $272 at March 31, 2008
and $250 at September 30, 2007
|
|
|
1,734
|
|
|
|
1,711
|
|
Inventories
|
|
|
3,360
|
|
|
|
2,766
|
|
Other
current assets
|
|
|
791
|
|
|
|
676
|
|
Total
current assets
|
|
|
6,717
|
|
|
|
6,449
|
|
Property,
plant and equipment, net
|
|
|
3,612
|
|
|
|
3,687
|
|
Total
Assets
|
|
|
10,329
|
|
|
|
10,136
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Deficit:
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Current
portion of long-term debt ($2,079 and $2,332 owed to related parties at
March 31, 2008 and September 30, 2007, respectively)
|
|
|
21,683
|
|
|
|
2,355
|
|
Accounts
payable
|
|
|
2,352
|
|
|
|
2,810
|
|
Accrued
payroll and payroll-related costs
|
|
|
656
|
|
|
|
565
|
|
Accrued
interest
|
|
|
8,949
|
|
|
|
466
|
|
Other
current liabilities
|
|
|
2,111
|
|
|
|
3,051
|
|
Total
current liabilities
|
|
|
35,751
|
|
|
|
9,247
|
|
Long-term
debt, less current portion
|
|
|
4,500
|
|
|
|
23,953
|
|
Accrued
interest
|
|
|
42
|
|
|
|
7,946
|
|
Other
liabilities
|
|
|
715
|
|
|
|
722
|
|
Total
Liabilities
|
|
|
41,008
|
|
|
|
41,868
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
deficit:
|
|
|
|
|
|
|
|
|
9%
Preferred stock, par value $1.00 per share, 3,000,000 shares authorized;
781,996 shares issued and outstanding at March 31, 2008
and September 30, 2007; $33.2 million liquidation preference,
including $13.6 million of cumulative dividend arrearages at March 31,
2008
|
|
|
782
|
|
|
|
782
|
|
Class
B stock, par value $.01 per share, 5,000,000 shares
authorized; 634,615 and 647,715 shares issued and outstanding
at March 31, 2008 and September 30, 2007, respectively
|
|
|
6
|
|
|
|
6
|
|
Common
stock, par value $.01 per share, 25,000,000 shares authorized; 3,487,473
and 3,474,373 shares issued and outstanding at March 31, 2008 and
September 30, 2007, respectively
|
|
|
35
|
|
|
|
35
|
|
Capital
in excess of par value
|
|
|
199,145
|
|
|
|
199,021
|
|
Accumulated
deficit
|
|
|
(230,685
|
)
|
|
|
(231,601
|
)
|
Accumulated
other comprehensive income
|
|
|
38
|
|
|
|
25
|
|
Total
Stockholders’ Deficit
|
|
|
(30,679
|
)
|
|
|
(31,732
|
)
|
Total
Liabilities and Stockholders’ Deficit
|
|
$
|
10,329
|
|
|
$
|
10,136
|
|
* Derived
from the Company’s audited consolidated balance sheet at September 30,
2007.
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
General
DataComm Industries, Inc. and Subsidiaries
Condensed
Consolidated
Statements
of Operations (Unaudited)
(in
thousands except share data)
|
|
Three
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,656
|
|
|
$
|
2,489
|
|
|
$
|
5,075
|
|
|
$
|
5,454
|
|
Service
|
|
|
410
|
|
|
|
569
|
|
|
|
1,071
|
|
|
|
1,163
|
|
Total
|
|
|
2,066
|
|
|
|
3,058
|
|
|
|
6,146
|
|
|
|
6,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
|
889
|
|
|
|
1,054
|
|
|
|
2,349
|
|
|
|
2,197
|
|
Service
|
|
|
379
|
|
|
|
215
|
|
|
|
852
|
|
|
|
385
|
|
Total
|
|
|
1,268
|
|
|
|
1,269
|
|
|
|
3,201
|
|
|
|
2,582
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
margin
|
|
|
798
|
|
|
|
1,789
|
|
|
|
2,945
|
|
|
|
4,035
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
1,598
|
|
|
|
1,421
|
|
|
|
3,151
|
|
|
|
2,760
|
|
Research
and product development
|
|
|
823
|
|
|
|
615
|
|
|
|
1,506
|
|
|
|
1,223
|
|
|
|
|
2,421
|
|
|
|
2,036
|
|
|
|
4,657
|
|
|
|
3,983
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
(1,623
|
)
|
|
|
(247
|
)
|
|
|
(1,712
|
)
|
|
|
52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(737
|
)
|
|
|
(762
|
)
|
|
|
(1,514
|
)
|
|
|
(1,557
|
)
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
on sale of patents
|
|
|
3,891
|
|
|
|
--
|
|
|
|
3,891
|
|
|
|
--
|
|
Gain
on restructuring of debt
|
|
|
--
|
|
|
|
4,062
|
|
|
|
--
|
|
|
|
4,062
|
|
Other
,net
|
|
|
(12
|
)
|
|
|
60
|
|
|
|
106
|
|
|
|
104
|
|
|
|
|
3,142
|
|
|
|
3,360
|
|
|
|
2,483
|
|
|
|
2,609
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
1,519
|
|
|
|
3,113
|
|
|
|
771
|
|
|
|
2,661
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax provision
|
|
|
2
|
|
|
|
3
|
|
|
|
5
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
1,517
|
|
|
|
3,110
|
|
|
|
766
|
|
|
|
2,655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
applicable to preferred stock
|
|
|
(440
|
)
|
|
|
(440
|
)
|
|
|
(880
|
)
|
|
|
(880
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) applicable to common and Class B stock
|
|
$
|
1,077
|
|
|
$
|
2,670
|
|
|
$
|
(114
|
)
|
|
$
|
1,775
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
– common stock
|
|
$
|
0.27
|
|
|
$
|
0.66
|
|
|
$
|
(0.03
|
)
|
|
$
|
0.44
|
|
Diluted
– common stock
|
|
$
|
0.26
|
|
|
$
|
0.65
|
|
|
$
|
(0.03
|
)
|
|
$
|
0.43
|
|
Basic
– Class B stock
|
|
$
|
0.24
|
|
|
$
|
0.59
|
|
|
$
|
(0.03
|
)
|
|
$
|
0.39
|
|
Diluted
– Class B stock
|
|
$
|
0.24
|
|
|
$
|
0.59
|
|
|
$
|
(0.03
|
)
|
|
$
|
0.39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common and Class B shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
– common stock
|
|
|
3,483,010
|
|
|
|
3,473,542
|
|
|
|
3,478,668
|
|
|
|
3,472,163
|
|
Diluted
– common stock
|
|
|
4,122,088
|
|
|
|
4,122,088
|
|
|
|
3,478,668
|
|
|
|
4,122,088
|
|
Basic
– Class B stock
|
|
|
639,078
|
|
|
|
648,546
|
|
|
|
643,420
|
|
|
|
649,925
|
|
Diluted
- Class B stock
|
|
|
639,078
|
|
|
|
648,546
|
|
|
|
643,420
|
|
|
|
649,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these
condensed
consolidated financial statements.
General
DataComm Industries, Inc.
Condensed
Consolidated Statements of
Cash
Flows (Unaudited)
(In
thousands)
|
|
Six
Months Ended
|
|
|
|
March 31
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
income
|
|
$
|
766
|
|
|
$
|
2,655
|
|
Adjustments
to reconcile net income to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
139
|
|
|
|
186
|
|
Stock
compensation expense
|
|
|
123
|
|
|
|
149
|
|
Gain
on restructuring of debt
|
|
|
-
|
|
|
|
(4,062
|
)
|
Gain
on sale of patents
|
|
|
(3,891
|
)
|
|
|
--
|
|
Changes
in:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(23
|
)
|
|
|
2
|
|
Inventories
|
|
|
(594
|
)
|
|
|
207
|
|
Accounts
payable
|
|
|
(458
|
)
|
|
|
381
|
|
Accrued
payroll and payroll-related costs
|
|
|
91
|
|
|
|
(6
|
)
|
Accrued
interest
|
|
|
612
|
|
|
|
1,120
|
|
Other
net current liabilities
|
|
|
(897
|
)
|
|
|
(235
|
)
|
Other
net long-term assets
|
|
|
(18
|
)
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) operating activities
|
|
|
(4,150
|
)
|
|
|
405
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Acquisition
of property, plant and equipment, net
|
|
|
(71
|
)
|
|
|
(8
|
)
|
Net
proceeds from sale of patents
|
|
|
3,891
|
|
|
|
--
|
|
Net
cash provided by (used in) investing activities
|
|
|
3,820
|
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from notes payable to related parties
|
|
|
125
|
|
|
|
270
|
|
Principal
payments on notes payable to related parties
|
|
|
(395
|
)
|
|
|
-
|
|
Proceeds
from other notes payable
|
|
|
226
|
|
|
|
222
|
|
Principal
payments on other notes payable
|
|
|
(90
|
)
|
|
|
(83
|
)
|
Principal
payments on term obligation
|
|
|
-
|
|
|
|
(573
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(134
|
)
|
|
|
(164
|
)
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash
equivalents
|
|
|
(464
|
)
|
|
|
233
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
1,296
|
|
|
|
246
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
832
|
|
|
$
|
479
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
(including payments to related parties of $446)
|
|
$
|
763
|
|
|
$
|
192
|
|
Income
taxes
|
|
$
|
6
|
|
|
$
|
3
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these
condensed
consolidated financial statements.
GENERAL
DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
– Basis of Presentation and Liquidity
The
accompanying unaudited interim financial statements of General DataComm
Industries, Inc. (the “Company”) have been prepared on a going concern basis, in
accordance with generally accepted accounting principles in the United States
for interim financial information, the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for year end financial statements. In the opinion of management,
these statements include all adjustments, consisting of normal and recurring
adjustments, considered necessary for a fair presentation of the results for the
periods presented. The results of operations for the three and six
months ended March 31, 2008 are not necessarily indicative of results which may
be achieved for the entire fiscal year ending September 30, 2008. The
unaudited interim financial statements should be read in conjunction with the
consolidated financial statements and notes thereto contained in the Company’s
annual report on Form 10-KSB for the fiscal year ended September 30, 2007 as
filed with the Securities and Exchange Commission.
On
November 2, 2001, General DataComm Industries, Inc. and its domestic
subsidiaries filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware. The Company continued in possession of its properties and
the management of its business as debtors in possession.
The
Company emerged from Chapter 11 effective on September 15, 2003 pursuant to a
court-approved plan of reorganization. Under this plan, the Company
was to pay all creditors 100% of their allowed claims based upon a five year
business plan. Debentures were issued to unsecured creditors as part
of the plan of reorganization. However, the Company has not met its
business plan objectives since emerging from Chapter 11 and, therefore, there
can be no assurance that any such outstanding claims will be paid.
At March
31, 2008 the Company had a stockholders’ deficit of approximately $30.7
million, and a working capital deficit of approximately $29.0 million,
including debentures in the principal amount of $19.4 million,
together with accrued interest thereon ($8.8 million), which mature
on October 1, 2008. While a Subordinated Security Agreement signed by
the indenture trustee on behalf of the debenture holders provides that no
payments may be made to debenture holders while senior secured debt is
outstanding, in the absence of such payment restrictions the Company does not
presently have the ability to repay the debentures. A failure to pay
the debentures when due and payable could result in an event of default being
declared under the indenture governing the debentures.
The
conditions described above raise substantial doubt about the Company’s ability
to continue as a going concern.
Management
has responded to its liquidity and cash flow risks by replacing its senior debt
in 2007 on more favorable terms and by selling patents in February 2008 for
$4,000,000 while retaining rights to use the patented technologies (See Note 7).
In addition, management has implemented operational changes: reducing certain
salaries, restructuring the sales force, increasing factory shutdown
time, constraining expenses, and reducing and reallocating the employee
workforce. The Company also continues to pursue the sale or
lease of its headquarters land and building in Naugatuck, CT.
While the
Company is aggressively pursuing opportunities and corrective actions, there can
be no assurance that the Company will be successful in its efforts to generate
sufficient cash from operations or asset sales, or obtain additional funding
sources or resolve the repayment of the debentures. The accompanying
consolidated financial statements have been prepared assuming that the Company
will continue as a going concern and do not include any adjustments that may
result from the outcome of this uncertainty.
2.
– Earnings (Loss) Per Share
Basic
earnings per share is computed by allocating net income available to common
stockholders and to Class B shareholders based on their contractual
participation rights to share in such net income as if all the income for the
year had been distributed. Such allocation reflects that common stock
is entitled to cash dividends, if and when paid, 11.11% higher per share than
Class B stock. However, a net loss is allocated evenly to all
shares. The income (loss) allocated to each security is divided by
the respective weighted average number of common and Class B shares outstanding
during the period. Diluted earnings per common share assumes the
conversion of Class B stock into common stock. Diluted earnings per
share gives effect to all potential dilutive common shares outstanding during
the period. In computing diluted earnings per share, which only
applies in the event there is net income, the average price of the Company’s
common stock for the period is used in determining the number of shares assumed
to be purchased from exercise of stock options and
warrants. Dividends applicable to preferred stock represent
accumulating dividends that are not declared or accrued. The
following table sets forth the computation of basic and diluted earnings (loss)
applicable to common and Class B stock for the three and six months ended March
31, 2008 and 2007 (in thousands, except shares and per share data):
|
|
Three Months Ended
March 31,
|
|
|
Six Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,517
|
|
|
$
|
3,110
|
|
|
$
|
766
|
|
|
$
|
2,655
|
|
Dividends
applicable to preferred stock
|
|
|
(440
|
)
|
|
|
(440
|
)
|
|
|
(880
|
)
|
|
|
(880
|
)
|
Net
income (loss) applicable to common and Class B stock
|
|
$
|
1,077
|
|
|
$
|
2,670
|
|
|
$
|
(114
|
)
|
|
$
|
1,775
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) applicable to common stock-basic
|
|
$
|
924
|
|
|
$
|
2,286
|
|
|
$
|
(96
|
)
|
|
$
|
1,519
|
|
Net
income (loss) applicable to Class B stock-basic and
diluted
|
|
$
|
153
|
|
|
$
|
384
|
|
|
$
|
(18
|
)
|
|
$
|
256
|
|
|
|
Three Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
Common Stock
|
|
|
Class B Stock
|
|
Numerator
for basic earnings per share - net income
|
|
$
|
924
|
|
|
$
|
2,286
|
|
|
$
|
153
|
|
|
|
384
|
|
Reallocation
of net income for potential dilutive common shares
|
|
|
153
|
|
|
|
384
|
|
|
|
--
|
|
|
|
--
|
|
Numerator
for diluted earnings per share - net income
|
|
|
1,077
|
|
|
|
2,670
|
|
|
|
153
|
|
|
|
384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share - weighted average outstanding
shares
|
|
|
3,483,010
|
|
|
|
3,473,542
|
|
|
|
639,078
|
|
|
|
648,546
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class
B stock
|
|
|
639,078
|
|
|
|
648,546
|
|
|
|
--
|
|
|
|
--
|
|
Denominator
for diluted earnings per share
|
|
|
4,122,088
|
|
|
|
4,122,088
|
|
|
|
639,078
|
|
|
|
648,546
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
$
|
0.27
|
|
|
$
|
0.66
|
|
|
$
|
0.24
|
|
|
$
|
0.59
|
|
Diluted earnings
per share
|
|
$
|
0.26
|
|
|
$
|
0.65
|
|
|
$
|
0.24
|
|
|
$
|
0.59
|
|
|
|
Six Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
Common Stock
|
|
|
Class B Stock
|
|
Numerator
for basic earnings per share - net income
|
|
$
|
(96
|
)
|
|
$
|
1,519
|
|
|
$
|
(18
|
)
|
|
|
256
|
|
Reallocation
of net income for potential dilutive common shares
|
|
|
--
|
|
|
|
256
|
|
|
|
--
|
|
|
|
--
|
|
Numerator
for diluted earnings per share - net income
|
|
|
(96
|
)
|
|
|
1,775
|
|
|
|
(18
|
)
|
|
|
256
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share - weighted average outstanding
shares
|
|
|
3,478,668
|
|
|
|
3,472,163
|
|
|
|
643,420
|
|
|
|
649,925
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class
B stock
|
|
|
|
|
|
|
649,925
|
|
|
|
|
|
|
|
-
|
|
Denominator
for diluted earnings per share
|
|
|
3,478,668
|
|
|
|
4,122,088
|
|
|
|
643,420
|
|
|
|
649,925
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
$
|
(0.03
|
)
|
|
$
|
0.44
|
|
|
$
|
(0.03
|
)
|
|
$
|
0.39
|
|
Diluted earnings
per share
|
|
$
|
(0.03
|
)
|
|
$
|
0.43
|
|
|
$
|
(0.03
|
)
|
|
$
|
0.39
|
|
In the
six months ended March 31, 2008 and 2007, no effect has been given to certain
outstanding options and warrants, convertible securities and contingently
issuable shares in computing diluted income (loss) per share as their effect
would be antidilutive. Such share amounts which could potentially
dilute basic earnings per share are as follows:
|
|
No. of Shares
|
|
|
|
Six Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Stock
warrants
|
|
|
4,093,251
|
|
|
|
4,093,251
|
|
Stock
options
|
|
|
3,492,298
|
|
|
|
2,645,197
|
|
Convertible
preferred stock
|
|
|
143,223
|
|
|
|
143,223
|
|
Contingently
issuable shares*
|
|
|
-
|
|
|
|
2,200,752
|
|
Total
|
|
|
7,728,772
|
|
|
|
9,082,423
|
|
* Common
stock contingently issuable to the Company’s senior secured lenders in the event
of default or if certain payment terms were not met are excluded from the
computation of earnings per share because the contingency defined in the loan
agreement had not taken place. Such contingency was cancelled when
the senior loan to which that provision relates was paid off on July 30,
2007.
Inventories
consist of (in thousands):
|
|
March 31,
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
Raw
materials
|
|
$
|
636
|
|
|
$
|
665
|
|
Work-in-process
|
|
|
1,354
|
|
|
|
1,020
|
|
Finished
goods
|
|
|
1,370
|
|
|
|
1,081
|
|
|
|
$
|
3,360
|
|
|
$
|
2,766
|
|
Inventories
are stated at the lower of cost or market using a first-in, first-out
method. Reserves in the amount of $3,078,000 and
$2,883,000 were recorded at March 31, 2008 and September 30, 2007, respectively,
for excess and obsolete inventories.
Long-term
debt consists of (in thousands):
|
|
March 31
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Notes
Payable to Related Parties, net of debt discount of $19 at September 30,
2007
|
|
|
2,079
|
|
|
|
2,332
|
|
Other
Note Payable
|
|
|
151
|
|
|
|
23
|
|
Debentures
due October 1, 2008
|
|
|
19,453
|
|
|
|
19,453
|
|
Real
Estate Mortgage due July 31, 2009
|
|
|
4,500
|
|
|
|
4,500
|
|
|
|
|
26,183
|
|
|
|
26,308
|
|
Less
current portion
|
|
|
21,683
|
|
|
|
2,355
|
|
|
|
$
|
4,500
|
|
|
$
|
23,953
|
|
Long-term
debt has matured or will mature in amounts totaling $21,683,000 in the twelve
months ending March 31, 2009, of which $19,453,000 in debentures is due October
1, 2008. In the following twelve months, the real estate mortgage in
the amount of $4,500,000 is due July 31, 2009.
Notes
Payable to Related Parties
On
December 9, 2005, Mr. Howard S. Modlin, Chairman of the Board and Chief
Executive Officer, and Mr. John Segall, a Director, restructured existing loans
and entered into new senior secured loans with the Company in the principal
amounts of $1,198,418 and $632,527, respectively. Interest accrues at
the rate of 10% per annum. In connection with the transactions,
Mr. Modlin and Mr. Segall each received seven year warrants expiring December 8,
2012 to purchase common stock at $0.575 per share covering 2,084,204 shares and
1,100,047 shares, respectively.
On
February 17, 2006, the Company borrowed $250,000 from Mr. Modlin in the form of
a demand note which bore interest at the rate of 10% per annum. On
April 20, 2006, the Corporation entered into an amendment of its loan
arrangement with Mr. Modlin whereby the $250,000 demand loan made by Mr. Modlin
on February 17, 2006 was amended and restated into a term note, 50% of which was
payable February 17, 2007 and 50% of which was payable February 17, 2008 (such
payments were deferred indefinitely in agreement with Mr.
Modlin). Mr. Modlin received a seven year warrant expiring April 19,
2013 to purchase 909,000 shares of common stock at $0.275 per
share. The warrant, valued at $69,000, was recorded as debt discount
and was amortized as additional interest expense over the initial term of the
debt.
In the
quarters ended March 31, 2007 and December 31, 2007, Mr. Modlin made demand
loans to the Company totaling $270,000 and $125,000,
respectively. Such loans were paid off in the quarter ended March 31,
2008. See Note 11, “Subsequent Events” for reference to loans made by
Mr. Modlin to the Company after March 31, 2008.
Accrued
interest on all such loans amounted to $17,674 and $389,748 at March 31, 2008
and September 30, 2007, respectively. All loans made by Mr. Modlin
and Mr. Segall are collateralized by all the assets of the Company.
Debentures
Debentures
together with accrued interest mature on October 1, 2008. The
debentures were issued to unsecured creditors in 2003 as part of the Company’s
plan of reorganization. No principal or interest is payable on the
debentures until the senior secured lenders’ claims are paid in full and no
principal or interest has been paid through March 31, 2008. Interest
accrues at the annual rate of 10% and totaled $8,853,954 at March 31,
2008. While principal and/or interest on the debentures may not be
paid while senior secured debt, including such debt owed to Mr. Modlin and Mr.
Segall, is outstanding, in the absence of such payment restrictions the Company
does not presently have the ability to repay the debentures. A
failure to pay the debentures when due and payable, could result in an event of
default being declared under the indenture governing the debentures and the
Company’s business, financial condition, and results of operations could be
materially adversely affected thereby.
Real
Estate Mortgage
The real
estate mortgage entered into July 30, 2007 in the amount of $4,500,000 is
secured by the Company’s premises in Naugatuck, CT. The mortgage
requires monthly payments of interest at the rate of 30-day LIBOR plus 6% (such
interest rate was 9.12% at March 31, 2008). No principal payments are
required until the full amount of the mortgage matures on July 30,
2009. The mortgage contains no financial performance
covenants.
5.
|
Accounting
for Stock-Based Compensation
|
Effective
October 1, 2006, the Company adopted the fair value recognition provisions of
SFAS No. 123 (R) “Accounting for Stock-Based Compensation” (“SFAS No. 123R”)
using the modified prospective method. Under that transition method,
compensation cost recognized includes: (a) compensation cost for all share-based
payments (including stock options) granted prior to, but not yet vested as of
October 1, 2006, based on the grant date fair value estimated in accordance with
the original provisions of SFAS No. 123, and (b) compensation cost for all
share-based payments granted subsequent to October 1, 2006, based on the
grant-date fair value estimated in accordance with the provisions of
SFAS No. 123R. Results for prior periods were not
restated. Compensation cost is recorded over the stock options’
vesting periods. As a result of adopting SFAS No. 123R, compensation
cost recognized in the quarter ended March 31, 2008 and 2007 was $57,000 and
$58,000, respectively. Compensation cost recognized in the six months ended
March 31, 2008 and 2007 was $123,000 and $149,000,
respectively.
6.
|
Employee
Incentive Plans
|
The
Company has adopted a 2003 Stock and Bonus Plan (“2003 Plan”) reserving 459,268
shares of Class B stock and 459,268 shares of common stock and a 2005 Stock and
Bonus Plan (“2005 Plan”) reserving 2,400,000 shares of common
stock. No shares of Class B stock are authorized under the 2005 Plan
and no further shares of Class B are available under the 2003
Plan. Officers and key employees may be granted incentive stock
options at an exercise price equal to or greater than the market price on the
date of grant and non-incentive stock options at an exercise price equal to,
greater than or less than the market price on the date of
grant. While individual options can be issued under various
provisions, most options, once granted, generally vest in increments of 20% per
year over a five-year period and expire within ten years. At March 31,2008 there
were 465,856 options available for future issuance under the plans.
On
October 11, 2007, the Stock Option Committee of the Board of Directors granted
stock options pursuant to the Company’s 2005 Plan to purchase 312,900 shares of
common stock at the quoted market price of $.25 per share, including grants of
30,000 shares to Aletta Richards and John L. Segall, Directors, William G.
Henry, Vice President, Finance and Administration and Principal Financial
Officer and George Gray, Vice President, Operations and Chief Technology
Officer, and an aggregate of 192,900 of such options to all of its employees
other than its officers and directors. The Committee also granted to
Howard S. Modlin, Chairman and Chief Executive Officer, a stock option with
terms similar to options granted under the 2005 Plan to purchase 551,121 shares
at $.275 a share. All such options vest in increments of 20% per year
over a five year period and expire ten years after grant.
A summary
of stock options outstanding under the Company’s stock plans as of September 30,
2007 and changes during the six months ended March 31, 2008 are presented
below:
|
|
Shares
|
|
|
Weighted Average Exercise
Price
|
|
|
Weighted Average Remaining Contractual Term
(Yrs)
|
|
|
Aggregate Intrinsic Value
|
|
Options
outstanding, September 30, 2007
|
|
|
2,635,807
|
|
|
$
|
0.77
|
|
|
|
|
|
|
|
Options
granted
|
|
|
864,021
|
|
|
|
0.27
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
--
|
|
|
|
--
|
|
|
|
|
|
|
|
Options
cancelled or expired
|
|
|
(7,530
|
)
|
|
|
24.34
|
|
|
|
|
|
|
|
Options
outstanding, March 31, 2008
|
|
|
3,492,228
|
|
|
|
0.60
|
|
|
|
8.09
|
|
|
$
|
0
|
|
Vested
or expected to vest at March 31, 2008
|
|
|
3,157,700
|
|
|
|
0.56
|
|
|
|
8.10
|
|
|
|
0
|
|
Exercisable
at March 31, 2008
|
|
|
1,122,101
|
|
|
|
1.17
|
|
|
|
7.25
|
|
|
|
0
|
|
As of
March 31, 2008, there was $356,825 of total unrecognized compensation cost
related to nonvested options which is expected to be recognized over a
weighted-average period of 1.74 years.
The
weighted-average grant-date fair value of options granted during the six months
ended March 31, 2008 was $0.23 per share, which was estimated using the Black
Scholes model and the following weighted average assumptions:
Risk-free
interest rate (%)
|
|
|
3.76
|
%
|
Volatility
(%)
|
|
|
133
|
%
|
Expected
life (in years)
|
|
|
6.50
|
|
Dividend
yield rate
|
|
Nil
|
|
Expected
volatility is based on historical volatility in the Company’s stock price over
the expected life of the options. The risk-free interest rate is
based on the annual yield on the measurement date of a zero coupon U.S. Treasury
Bond, the maturity of which equals the options’ expected life. The
weighted average expected life of 6.50 years reflects the alternative simplified
method permitted by SEC Staff Accounting Bulletin No. 107, which defines the
expected life as the average of the contractual term of the options and the
weighted average vesting period for all option tranches. The dividend
yield assumption is based on the Company’s intent not to issue a
dividend.
7.
|
Gain
on Sale of Patents
|
On
February 5, 2008, the Company completed the sale of selected patents and patent
applications to Fournier Assets Limited Liability Company for proceeds of
$4,000,000. The patents and patent applications sold relate to the Company’s
product lines, and the Company retains a non-exclusive, royalty-free license
under the patents for all its product lines.
As a
result of the sale, the Company recorded a gain in the amount of $3,891,000 in
the quarter ended March 31, 2008. The Company used the funds for
general corporate purposes, including payment of debt and interest and for
working capital.
8.
|
Gain
on Restructuring of Debt
|
On
January 17, 2007, pursuant to an amendment to the senior loan agreement (“Loan
Agreement”), the Company and its senior lender agreed, among other matters, to
the following changes:
|
(a)
|
to
reduce and fix the outstanding amount of the PIK Obligation, including
principal and interest, at $3,000,000 as of January 16,
2007;
|
|
(b)
|
to
provide for certain affiliates of the senior lender to sell
debentures with a face value approximating $2,471,000 together
with accrued interest of $824,694 to the Company for consideration of
$1.00.
|
As a
result of the debenture purchase and the adjustment to the PIK Obligation, the
Company recorded a gain on restructuring of debt in the amount of $4,062,000 in
the quarter ended March 31, 2007.
On
December 19, 2007, a sole supplier of a proprietary component critical to one of
the Company’s products announced the discontinuation of the component and
rejected previously accepted orders that had been placed for the component by
the Company. Thereafter, the Company attempted to exercise its rights
to obtain the documentation necessary to allow the Company to manufacture the
component under its contracts with the supplier. The Company has been
unable to date to obtain this documentation and, as a result, on February 8,
2008 the Company filed a legal claim in Connecticut Superior Court against the
supplier.
The
Company believes that it has contingency plans in place to allow for a
transition to a new component without a disruption in customer
deliveries. However, the Company expects to incur increased costs in
the next six months by reason of such transition
plans. Furthermore, the Company has entered into a
non-cancelable purchase commitment in the amount of $128,700 for certain
electronic parts in anticipation of manufacturing the original
component. Such parts will not be required for the new component and
there is a limited resale market for such parts. In the event that
the Company is unable to transition to the new component in time to
meet its customer requirements and/or is unable to generate the liquidity
required to pay the increased costs or the purchase commitment, such events
could have a material adverse effect on the Company’s business, financial
condition and results of operations.
10.
|
Recent
Accounting Pronouncements
|
On
October 1, 2007, the Company adopted the provisions of FASB Interpretation No.
48 (“FIN 48”),
“Accounting for
Uncertainty in Income Taxes,”
which clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with FASB Statement No. 109,
“
Accounting for Income Taxes”
.
FIN 48 provides guidance
on the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures, and transition. Prior to implementation
of FIN 48, the Company had a liability for unrecognized foreign and state tax
benefits amounting to $313,000 provided in its balance sheet all of which, if
recognized, would affect the Company’s effective tax rate. In
adopting FIN 48, the liability for unrecognized tax benefits was reduced by
$180,000 and accrued interest through September 30, 2007 and penalties
aggregating $30,000 related to unrecognized tax benefits
were accrued resulting in a net reduction of $150,000 to the
accumulated deficit at October 1, 2007. The Company files a consolidated federal
income tax return with its subsidiaries. In addition, the Company and/or its
subsidiaries file in various states and foreign jurisdictions. The
Company is no longer subject to examinations by taxing authorities for fiscal
years before September 30, 2004. The Company classifies interest and
penalties as selling, general and administrative expenses. Interest
and penalties recognized in the three and six months ended March 31, 2008
amounted to $1,000 and $2,100, respectively, and accrued interest and penalties
included in the balance sheet at March 31, 2008 amounted to
approximately $152,100.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157,
“Fair Value
Measurements”
. SFAS No. 157 defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair
value. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of
this standard on the consolidated financial statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 159,
“The Fair
Value Option for Financial Assets and Financial
Liabilities”
, SFAS No. 159 provides an option to report
selected financial assets and financial liabilities using fair
value. The standard establishes required presentation and disclosures
to facilitate comparisons with companies that use different measurements for
similar assets and liabilities. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007, with early adoption allowed only if
SFAS No. 157 is also adopted. The Company is currently evaluating the
impact of this standard on the consolidated financial statements.
11. Subsequent
Events
On April
30 and May 13, 2008, Mr. Howard S. Modlin, Chairman of the Board and Chief
Executive Officer, made demand loans to the Company in the amount of $175,000
and $75,000, respectively, to be used for working capital purposes.
ITEM
2.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE
FOLLOWING DISCUSSION AND ANALYSIS OF THE COMPANY’S FINANCIAL CONDITION
AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND RELATED NOTES APPEARING ELSEWHERE IN THIS QUARTERLY
REPORT ON FORM 10-Q AND IN THE COMPANY’S ANNUAL REPORT ON FORM 10-KSB FOR THE
YEAR ENDED SEPTEMBER 30, 2007 AS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION.
THIS
REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. FOR
THIS PURPOSE, STATEMENTS CONTAINED HEREIN THAT ARE NOT STATEMENTS OF HISTORICAL
FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING
THE FOREGOING, THE WORDS “BELIEVES”, “ANTICIPATES”, “PLANS”, “EXPECTS” AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES AND ARE NOT GUARANTEES OF FUTURE PERFORMANCE. ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS INCLUDING, BUT NOT LIMITED TO, THOSE
SET FORTH UNDER THE HEADING “RISK FACTORS” BELOW. UNLESS REQUIRED BY
LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING
STATEMENTS OR REASONS WHY ACTUAL RESULTS MAY DIFFER.
Unless
otherwise stated, all references to “Notes” in the following discussion of
“Results of Operations” and “Liquidity and Capital Resources” are to the “Notes
to Condensed Consolidated Financial Statements included in Item 1 in this Form
10-Q.
RESULTS
OF OPERATIONS
Revenues
|
|
Three Months Ended
March 31
|
|
|
Six Months Ended
March 31,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,656
|
|
|
$
|
2,489
|
|
|
$
|
5,075
|
|
|
$
|
5,454
|
|
Service
|
|
|
410
|
|
|
|
569
|
|
|
|
1,071
|
|
|
|
1,163
|
|
Total
Revenues
|
|
$
|
2,066
|
|
|
$
|
3,058
|
|
|
$
|
6,146
|
|
|
$
|
6,617
|
|
Revenues
for the three months ended March 31, 2008 decreased $992,000, or 32.4%, to
$2,066,000 from $3,058,000 reported for the three months ended March 31, 2007.
Product revenues decreased $833,000, or 33.5%, while service revenues decreased
by $159,000, or 27.9%.
Sales of
high-end, multi-service switches declined in the quarter by approximately
$440,000 compared to the prior year. Such product sales tend to vary
significantly from quarter-to-quarter due to the dependency on timing of
customer project requirements and to long time cycles between bids and
awards. As an example, such product shipments had increased $580,000
in the prior quarter comparison.
Sales of
network access products declined in the quarter by approximately $501,000, where
increasing sales of the company’s newer SpectraComm IP products could not offset
the continued decline in sales of legacy products to large telecommunication
carriers and to integrators for specific projects.
The
decrease in service revenues in the quarter was due primarily to a specific
foreign contract for a one-time project in the prior year that did not repeat
itself in the current quarter.
Revenues
for the six months ended March 31, 2008 decreased $471,000, or 7.1%, to
$6,146,000 from $6,617,000 reported for the six months ended March 31,
2007. Product revenues decreased $379,000, or 6.9%, while service
revenues decreased by $92,000, or 7.9%.
Sales of
high-end, multi-service switches increased approximately $150,000, primarily due
to expansion of networks of existing customers in the first three months of the
period offset in part with lower sales in the second three months as noted
above. Furthermore, the Company realized increased sales of $227,000
from its line of security software products. These increases were
more than offset by a reduction of approximately $850,000 resulting from
continued net declines in sales of network access products to large
telecommunications carriers and to integrators for specific
projects.
The
decrease in service revenues was due primarily to a one-time project in the
prior year that did not repeat, offset in part by support services sold along
with the security software products.
Foreign
sales accounted for 36% and 45% of revenue for the six months ended March 31,
2008 and 2007, respectively.
The
Company anticipates that demand for its legacy network access products will
continue to decline and due to the “Risk Factors” mentioned below, there can be
no assurance that orders for new products and products with enhanced features
will increase to offset this decline. Accordingly, the ability to
forecast future revenue trends in the current environment is
difficult.
Gross
Margin
|
|
Three Months Ended
March 31
|
|
|
Six Months Ended
March 31,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Product
|
|
$
|
767
|
|
|
$
|
1,435
|
|
|
$
|
2,726
|
|
|
$
|
3,257
|
|
Service
|
|
|
31
|
|
|
|
354
|
|
|
|
219
|
|
|
|
778
|
|
Total
Gross Margin
|
|
$
|
798
|
|
|
$
|
1,789
|
|
|
$
|
2,945
|
|
|
$
|
4,035
|
|
Percentage
of Product Revenues
|
|
|
46.3
|
%
|
|
|
57.6
|
%
|
|
|
53.7
|
%
|
|
|
59.7
|
%
|
Percentage
of Service Revenues
|
|
|
7.6
|
%
|
|
|
62.2
|
%
|
|
|
20.4
|
%
|
|
|
66.9
|
%
|
Percentage
of Total Revenues
|
|
|
38.6
|
%
|
|
|
58.5
|
%
|
|
|
47.9
|
%
|
|
|
61.0
|
%
|
Gross
Margin as a percentage of revenues, in the three months ended March 31, 2008 was
38.6% as compared to 58.5% in the three months ended March 31, 2007, a decrease
of 19.9%.
Product
gross margin, as a percentage of product revenues, decreased
11.3%. This decrease was due to a reduction of the favorable impact
in the prior year of selling inventories previously written down (-14.4%) and of
selling high-margin products to a government contractor
(-4.4%). Offsetting these reductions was the Company’s successful
procurement of components at reduced prices (+8.0%) and other net items
contributed 0.5%.
Service
gross margin, as a percentage of service revenues, declined 54.6%. In
the prior quarter the Company started a new business venture in Texas
to target subcontract service work from major telecommunication
providers. These costs, with little revenue, reduced gross margin by
34.6%. The balance of the reduction (-20%) results from the lower
revenue level (-14.6%) and compensation and other cost increases
(-5.4%).
Gross
margin as a percentage of revenues, in the six months ended March 31, 2008 was
47.9% as compared to 61.0% in the six months ended March 31, 2007, a decrease of
13.1%.
Product
gross margin, as a percentage of product revenues, decreased
6.0%. This decrease was due primarily to the low margin sales of the
Company’s line of security software products (-3.6%), the favorable impact in
the prior year of selling inventories previously written down (-0.3%), of
selling high-margin products to a government
contractor (-1.5%) and other items (-0.6%).
Service
gross margin, as a percentage of revenues declined 46.5%. This
decrease was due to the impact of start up costs for the Texas operation
(-19.2%), and to low margin service support on security software
(-1.8%). The balance of the reduction (-19.2%) results from and the
lower revenue level (-6.3%), compensation, and additional strategic investments
made in the area of professional services.
In future
periods, the Company’s gross margin will vary depending upon a number of
factors, including the mix of products sold, the cost of products manufactured
at subcontract facilities, the channels of distribution, the price of products
sold, discounting practices, price competition, increases in material costs, the
costs of the service organization and changes in other components of cost of
sales. As and to the extent the Company introduces new products and
services, it is possible that such products and services may have lower gross
profit margins than other established products in higher volume production and
than traditional service offerings. Accordingly, gross margin as a
percentage of revenues is expected to vary.
Selling,
General and Administrative
|
|
Three Months Ended
March 31
|
|
|
Six Months Ended
March 31,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
$
|
1,598
|
|
|
$
|
1,421
|
|
|
$
|
3,151
|
|
|
$
|
2,760
|
|
Percentage
of revenues
|
|
|
77.3
|
%
|
|
|
46.5
|
%
|
|
|
51.3
|
%
|
|
|
41.7
|
%
|
The
Company’s selling, general and administrative expenses (“SG&A”) increased to
$1,598,000, or 77.3% of revenues in the three months ended March 31, 2008 from
$1,421,000, or 46.5% of revenues in the three months ended March 31,
2007. The increase in spending in the quarter of $177,000, or 12.4%
was primarily a result of higher compensation costs of $230,000 due to new hires
in the sales force and salary increases. In addition, increased legal
costs were primarily responsible for a $77,000 increase in professional fees and
results from an increased level of litigation. These items were
offset by a gain of $108,000 resulting from the favorable resolution of a
property tax liability. Other items were a net decrease of
$22,000.
For the
six months ended March 31, 2008, SG&A expenses increased to $3,151,000, or
51.3% of revenues from $2,760,000, or 41.7% of revenues in the six months ended
March 31, 2007. The increase in spending in the six months of
$391,000, or 14.2%, was due primarily to higher compensation costs of $395,000
and increased legal costs of $107,000, offset by the property tax gain of
$108,000 and other net reductions of $4,000.
Research
and Product Development
|
|
Three Months Ended
March 31
|
|
|
Six Months Ended
March 31,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and product development
|
|
$
|
823
|
|
|
$
|
615
|
|
|
$
|
1,506
|
|
|
$
|
1,223
|
|
Percentage
of revenues
|
|
|
39.8
|
%
|
|
|
20.1
|
%
|
|
|
24.5
|
%
|
|
|
18.5
|
%
|
Research
and product development (“R&D”) expenses increased to $823,000, or 39.8% of
revenues in the three months ended March 31, 2008 as compared to $615,000, or
20.1% of revenues in the three months ended March 31, 2007. The
increase of $208,000, or 33.8%, was due to additions to the staff and salary
adjustments which resulted in an increase in engineering compensation costs of
$161,000, an increase in the use of contract engineers of $46,000 and other net
increases of $1,000. Both the additions to staff and the contract
engineers were required to accelerate the completion of critical and strategic
product development programs.
R & D
expenses increased to $1,506,000, or 24.5% of revenues in the six months ended
March 31, 2008 as compared to $1,223,000, or 18.5% of revenues in the six months
ended March 31, 2007. The increase of $283,000, or 23.1%, was due to
an increase in engineering compensation costs of $244,000 and an increase in the
use of contract engineers of $40,000, offset by other net decreases of
$1,000.
Interest
Expense
Interest
expense decreased to $737,000 in the three months ended March 31, 2008 from
$762,000 in the three months ended March 31, 2007. Interest expense
decreased to $1,514,000 in the six months ended March 31, 2008 from $1,557,000
in the six months ended March 31, 2007. The lower interest charges
resulted primarily from a reduction in debt levels resulting from a repurchase
of debentures in 2007 and lower variable interest rates in 2008.
Other
Income (Expense)
Other
income (expense) for the three months ended March 31, 2008 and 2007 totaled
$3,879,000 and $4,122,000, respectively. The 2008 quarterly amount
includes $3,891,000 from the gain on the sale of patents (see Note 7) offset by
other net losses of $12,000 which includes $12,000 received from a tradename
license offset by $24,000 in other expense items. The 2007 quarterly
amount includes a gain of $4,062,000 from restructuring of debt with the
Company’s senior lender (see Note 8) and the net amount of $60,000 which
includes $18,000 in sales of components no longer used, $24,000 of foreign
exchange gains, $12,000 received from a tradename license and $6,000 of other
income items.
Other
income (expense) for the six months ended March 31, 2008 and 2007 totaled
$3,997,000 and $4,166,000, respectively. The 2008 amount includes
$3,891,000 from the gain on the sale of patents, $26,000 received from a
tradename license and $100,000 from a negotiated professional fee reduction
offset by $20,000 in other net losses. The 2007 amount includes
$4,062,000 from restructuring of debt, $45,000 received from a tradename
license, $40,000 in sales of components no longer used and $19,000 of other
income items.
Provision
for Income Taxes
Income
tax provisions for each of the three and six months ended March 31, 2008 and
2007 reflect current state tax provisions only. No federal income tax
provisions were provided in the three and six months ended March 31, 2008 and
2007 due to the utilization of net operating loss carry forwards. The
Company established a full valuation allowance against its net deferred tax
assets due to the uncertainty of realization of benefits of the net operating
loss carryforwards from prior years. The Company has federal tax
credit and net operating loss carryforwards of approximately $11.9 million and
$214.3 million, respectively, as of September 30, 2007.
Liquidity
and Capital Resources
|
|
March 31,
|
|
|
September 30,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
832
|
|
|
$
|
1,296
|
|
Working
capital (deficit)
|
|
|
(29,034
|
)
|
|
|
(2,798
|
)
|
Total
assets
|
|
|
10,329
|
|
|
|
10,136
|
|
Long-term
debt, including current portion
|
|
|
26,183
|
|
|
|
26,308
|
|
Total
liabilities
|
|
|
41,008
|
|
|
|
41,868
|
|
|
|
Six Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in):
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
(4,150
|
)
|
|
$
|
405
|
|
Investing
activities
|
|
|
3,820
|
|
|
|
(8
|
)
|
Financing
activities
|
|
|
(134
|
)
|
|
|
(164
|
)
|
Note: Significant
risk factors exist due to the Company’s limited financial resources and its
present inability to repay its debentures which mature on October 1,
2008. See “Risk Factors” below for further
discussion.
Cash
Flows
Net cash
used in operating activities totaled $4,150,000 in the six months ended March
31, 2008. Net income in the quarter was $766,000. Included
in this net income were a net gain of $3,891,000 related to the sale of patents
and non-cash expenses for depreciation and amortization of $139,000 and stock
compensation expense of $123,000. A net increase of accrued
interest resulted from additional interest charges of $1,375,000 reduced by
interest payments to related parties of $446,000 and to others of
$317,000. Inventories increased due to purchases of materials
required to meet product delivery requirements and resulted in a use of cash of
$594,000. Other net uses of cash included a reduction in accounts
payable and accrued expenses of $539,000 due to payments made to professionals,
suppliers and others, a reduction in deferred income on service contracts of
$250,000 due to older contracts expiring and not being renewed, annual cash
payments of pre-petition tax claims of $178,000, property tax payments of
$189,000, favorable resolution of a property tax liability of $108,000 and other
uses of $36,000.
Net cash
provided by operating activities totaled $405,000 in the six months ended March
31, 2007. The net income in the period was
$2,655,000. Included in this net income were a non-cash gain of
$4,062,000 resulting from an amendment of the Company’s senior loan agreement,
and non-cash expenses for depreciation and amortization of $186,000 and stock
compensation expense of $149,000. Inventories were lower by $207,000
as the Company was able to achieve shipments of on-hand inventories to satisfy
new customer orders and generate a source of cash through reduced
purchasing. Unpaid interest which accrued on the Company’s debt
increased $1,120,000 as a source of cash. The Company received the
proceeds of a prior year legal settlement ($213,000) and a final settlement of
claims in a subsidiary liquidation ($137,000). The Company paid the
third of six installments of prior year tax claims in the amount of
$223,000. All other changes net to a source of funds of
$23,000.
Net cash
provided by investing activities in the six months ended March 31, 2008 was
$3,820,000 and net cash used by investing activities was of $8,000 in
2007. The 2008 six month period included net proceeds from the sale
of patents of $3,891,000.
Net cash
used in financing activities in the six months ended March 31, 2008 was
$134,000. Proceeds from notes payable of $226,000 and proceeds of
notes payable to related parties of $125,000 were offset by payments on notes to
related parties of $395,000 and payments of notes payable of
$68,000.
Cash used
in financing activities in the six months ended March 31, 2007 of $164,000 is
comprised of payments on notes payable of $83,000 and on secured debt of
$573,000, offset in part by proceeds from notes payable to related parties of
$270,000 and proceeds from notes payable of $222,000.
Liquidity
The
Company has no current ability to borrow additional funds. It must,
therefore, fund operations from cash balances, cash generated from operating
activities and any cash that may be generated from the sale of non-core assets
such as real estate and others. The Company has approximately $28
million of debentures including accrued interest which mature on October 1, 2008
which it is presently unable to pay.
The
potential liquidity risks described above, raise substantial doubt about the
Company’s ability to continue as a going concern.
Management
has responded to its liquidity and cash flow risks in 2007 by replacing its
senior debt with mortgage debt on more favorable terms. Such mortgage
financing requires payments of interest (only) and contains no financial
covenants. In addition, management has implemented operational
changes: reducing certain salaries, restructuring the sales force,
increasing factory shutdown time, constraining expenses, and reducing and
reallocating the employee workforce. The Company also continues to
pursue the sale or lease of its headquarters land and building in Naugatuck,
CT. Furthermore, on February 5, 2008 the Company completed the sale
of certain patents for proceeds of $4,000,000 and received a royalty-free
license to continue to use the patented technologies in its
products.
Critical
Accounting Policies
The
Company’s financial statements and accompanying notes are prepared in accordance
with generally accepted accounting principles in the United States, the
instructions to Form 10-Q and Article 8 of Regulation S-X. Preparing
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and
expenses. Management bases its estimates and judgements on historical
experience and on various other factors that are believed to be reasonable under
the circumstances. Due to the inherent uncertainty involved in making
estimates, actual results reported in future periods might be based upon amounts
that differ from those estimates. The following represent what the
Company believes are among the critical accounting policies most affected by
significant management estimates and judgements. See Note 2 in Notes
to Consolidated Financial Statements in Item 7 in Form 10-KSB for the year ended
September 30, 2007 as filed with the Securities and Exchange Commission for a
summary of the Company’s significant accounting policies.
Revenue
Recognition
. The Company recognizes a sale when the product is
shipped and the following four criteria are met upon shipment: (1)
persuasive evidence of an arrangement exists; (2) title and risk of loss
transfers to the customer; (3) the selling price is fixed or determinable; and
(4) collectibility is reasonably assured. A reserve for future
product returns is established at the time of the sale based on historical
return rates and return policies including stock rotation for sales to
distributors that stock the Company’s products. Service revenue is
recognized either when the service is performed or, in the case of maintenance
contracts, on a straight-line basis over the term of the
contract.
Warranty Reserves.
The
Company offers warranties of various lengths to its customers depending on the
specific product and the terms of its customer purchase
agreements. Standard warranties require the Company to repair or
replace defective product returned during the warranty period at no cost to the
customer. An estimate for warranty related costs is recorded based on
actual historical return rates and repair costs at the time of
sale. On an on-going basis, management reviews these estimates
against actual expenses and makes adjustments when necessary. While
warranty costs have historically been within expectations of the provision
established, there is no guarantee that the Company will continue to experience
the same warranty return rates or repair costs as in the past. A
significant increase in product return rates or the costs to repair our products
would have a material adverse impact on the Company’s operating
results.
Allowance for Doubtful
Accounts.
The Company estimates losses resulting from the
inability of its customers to make payments for amounts billed. The
collectability of outstanding invoices is continually
assessed. Assumptions are made regarding the customers ability and
intent to pay, and are based on historical trends, general economic conditions
and current customer data. Should our actual experience with respect
to collections differ from these assessments, there could be adjustments to our
allowance for doubtful accounts.
Inventories
. The
Company values inventory at the lower of cost or market. Cost is
computed using standard cost, which approximates actual cost on a first-in,
first-out basis. Agreements with certain customers provide for return
rights. The Company is able to reasonably estimate these returns and
they are accrued for at the time of shipment. Inventory quantities on
hand are reviewed on a quarterly basis and a provision for excess and obsolete
inventory is recorded based primarily on product demand for the
preceding twelve months. Historical product demand may prove to be an
inaccurate indicator of future demand in which case the Company may increase or
decrease the provision required for excess and obsolete inventory in future
periods. Furthermore, if the Company is able to sell inventory in the
future that has been previously written down or off, such sales will result in
higher than normal gross margin.
Deferred Tax
Assets.
The Company has provided a full valuation allowance
related to its deferred tax assets. In the future, if sufficient
evidence of the Company’s ability to generate sufficient future taxable income
in certain tax jurisdictions becomes apparent, the Company will be required to
reduce its valuation allowances, resulting in income tax benefits in the
Company’s consolidated statement of operations. Management evaluates
the realizability of the deferred tax assets and assesses the need for the
valuation allowance each period.
Impairment of Long-Lived
Assets
. The Company assesses the impairment of long-lived
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable under the guidance prescribed by SFAS No.
144. The Company's long-lived assets consist of real estate, property
and equipment. At both March 31, 2008 and September 30, 2007, real
estate represented the only significant remaining long-lived asset that has not
been fully written down for impairment.
Recent
Accounting Pronouncements
On
October 1, 2007, the Company adopted the provisions of FASB Interpretation No.
48 (“FIN 48”),
“Accounting for
Uncertainty in Income Taxes,”
which clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with FASB Statement No. 109,
“
Accounting for Income Taxes”
.
FIN 48 provides guidance
on the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures, and transition. Prior to implementation
of FIN 48, the Company had a liability for unrecognized foreign and state tax
benefits amounting to $313,000 provided in its balance sheet all of which, if
recognized, would affect the Company’s effective tax
rate. . In adopting FIN 48, the liability for unrecognized
tax benefits was reduced by $180,000 and accrued interest through September 30,
2007 and penalties aggregating $30,000 related to
unrecognized tax benefits were accrued resulting in a net reduction
of $150,000 to the accumulated deficit at October 1, 2007. The
Company files a consolidated federal income tax return with its subsidiaries. In
addition, the Company and/or its subsidiaries file in various states and foreign
jurisdictions. The Company is no longer subject to examinations by
taxing authorities for fiscal years before September 30, 2004. The
Company classifies interest and penalties as selling, general and administrative
expenses. Interest and penalties recognized in the six months ended
March 31, 2008 amounted to approximately $1,000 and accrued interest and
penalties included in the balance sheet amounted to approximately $152,100 at
such date.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157,
“Fair Value
Measurements”
. SFAS No. 157 defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair
value. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of
this standard on the consolidated financial statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 159,
“The Fair
Value Option for Financial Assets and Financial
Liabilities”
, SFAS No. 159 provides an option to report
selected financial assets and financial liabilities using fair
value. The standard establishes required presentation and disclosures
to facilitate comparisons with companies that use different measurements for
similar assets and liabilities. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007, with early adoption allowed only if
SFAS No. 157 is also adopted. The Company is currently evaluating the
impact of this standard on the consolidated financial statements.
RISK FACTORS
GDC Negative Operating History Since
Emerging from Bankruptcy.
The Company emerged from Bankruptcy on
September 15, 2003. The Company had voluntarily filed for protection under
Chapter 11 of the US Bankruptcy Code on November 2, 2001, after incurring seven
consecutive years of losses and selling three of its four operating divisions in
2001. Accordingly, an investor in the Company’s common stock must evaluate
the risks, uncertainties, and difficulties frequently encountered by a company
emerging from Chapter 11 and that operates in rapidly evolving markets such as
the telecommunications equipment industry.
Due to
the Company’s limited and negative operating history and poor performance since
emergence, the Company may not successfully implement any of its strategies or
successfully address these risks and uncertainties. As described by the
following factors, past financial performance should not be considered to be a
reliable indicator of future performance, and investors should not use
historical trends to anticipate results or trends in future
periods.
Potential Default on
Debentures.
The Company has no current ability to borrow
additional funds. It must, therefore, fund operations from cash
balances, cash generated from operating activities and any cash that may be
generated from the sale of non-core assets such as real estate and
others. The Company has approximately $28 million of debentures
including accrued interest which mature on October 1, 2008 which it is presently
unable to pay. Therefore, the Company anticipates that a
restructuring, including extension of the payment terms, of the debenture debt
will be required. However, no such restructuring has occurred to date
and there can be no assurance that such restructuring will be completed or
completed on terms acceptable to the Company. While principal and/or
interest on the debentures may not be paid while senior secured debt, including
debt owed to Mr. Modlin and Mr. Segall, is outstanding, in the absence of such
payment restrictions the Company does not presently have the ability to repay
the debentures. A failure to pay the debentures when due and payable,
could result in an Event of Default being declared under the Indenture governing
the debentures and the Company’s business, financial condition, and results of
operations could be materially adversely affected thereby.
Dependence on Legacy and Recently
Introduced Products and New Product Development.
The Company’s future
results of operations are dependent on market acceptance of existing and future
applications for the Company’s current products and new products in development.
Sales of the Company’s legacy products, primarily the digital service unit and
V.34 lines, declined to approximately 30% of product sales in fiscal 2007 from
44% in fiscal 2006. The Company anticipates that net sales from legacy products
will decline over the next several years and net sales of new products will
increase at the same time, with significant quarterly fluctuations possible, and
without assurance that sales of new products will increase at the same
time.
Market
acceptance of the Company’s recently introduced and future product lines is
dependent on a number of factors, not all of which are in the Company’s control,
including the continued growth in the use of bandwidth intensive applications,
continued deployment of new telecommunication services, market acceptance of
multiservice access devices, the availability and price of competing products
and technologies, and the success of the Company’s sales and marketing efforts.
Failure of the Company’s products to achieve market acceptance would have a
material adverse effect on the Company’s business, financial condition and
results of operations. Failure to introduce new products in a timely manner in
order to replace sales of legacy products could cause customers to purchase
products from competitors and have a material adverse effect on the Company’s
business, financial condition and results of operations.
New
products under development may require additional development work, enhancement
and testing or further refinement before the Company can make them commercially
available. The Company has in the past experienced delays in the introduction of
new products, product applications and enhancements due to a variety of internal
factors, such as reallocation of priorities, financial constraints, difficulty
in hiring sufficient qualified personnel, and unforeseen technical obstacles, as
well as changes in customer requirements. Such delays have deferred the receipt
of revenue from the products involved. If the Company’s products have
performance, reliability or quality shortcomings, then the Company may
experience reduced
orders, higher
manufacturing costs, delays in collecting accounts receivable, and additional
warranty and service expenses.
Customer Concentration.
The
Company’s customers include the former Regional Bell Operating Companies, long
distance service providers, wireless service providers, and resellers who sell
to these customers. The market for the services provided by the majority of
these service providers has been influenced largely by the passage and
interpretation of the Telecommunications Act of 1996 (the “1996 Act”). Service
providers require substantial capital for the development, construction, and
expansion of their networks and the introduction of their services. The
ability of service providers to fund such expenditures often depends on their
ability to budget or obtain sufficient capital resources. In the
past, resources made available by these customers for capital
acquisitions have declined, particularly due to recent negative market
conditions in the United States. If the Company’s current or potential
service provider customers cannot successfully raise the necessary funds, or if
they experience any other adverse effects with respect to their operating
results or profitability, their capital spending programs may be adversely
impacted which could materially adversely affect the Company’s business,
financial condition and results of operations.
A small number of customers have
historically accounted for a majority of the Company’s sales. Sales
to the Company’s top five customers accounted for approximately 67% and 45% of
revenues in fiscal 2007 and 2006, respectively, and one customer accounted for
approximately 30% of revenues in fiscal 2007. There can be no
assurance that the Company’s current customers will continue to place orders
with the Company, that orders by existing customers will continue at the levels
of previous periods, or that the Company will be able to obtain orders from new
customers. The Company expects the economic climate and conditions in the
telecommunication equipment industry to remain unpredictable in fiscal 2008, and
possibly beyond. The loss of one or more service provider customers, such as
occurred during past years through industry consolidation or otherwise, could
have a material adverse effect on our sales and operating results. A bankruptcy
filing by one or more of the Company’s major customers could materially
adversely affect the Company’s business, financial condition and results of
operations
.
Dependence on Key Personnel.
The Company’s future success will depend to a large extent on the
continued contributions of its executive officers and key management, sales, and
technical personnel. Each of the Company’s executive officers, and key
management, sales and technical personnel would be difficult to replace. The
Company does not have employment contracts with its key employees. The Company
implemented significant cost and staff reductions in recent years, which may
make it more difficult to attract and retain key personnel. The loss of the
services of one or more of the Company’s executive officers or key personnel, or
the inability to attract qualified personnel, could delay product development
cycles or otherwise could have a material adverse effect on the Company’s
business, financial condition and results of operations.
Dependence on Key Suppliers and
Component Availability.
The Company generally relies upon several
contract manufacturers to assemble finished and semi-finished goods. The
Company’s products use certain components, such as microprocessors, memory chips
and pre-formed enclosures that are acquired or available from one or a limited
number of sources. Component parts that are incorporated into board
assemblies are sourced directly by the Company from suppliers. The
Company has generally been able to procure adequate supplies of these components
in a timely manner from existing sources.
On
December 19, 2007, a sole supplier of a proprietary component critical to one of
the Company’s products announced the discontinuation of the component and
rejected previously accepted orders that had been placed for the component by
the Company. Thereafter, the Company attempted to exercise its rights
to obtain the documentation necessary to allow the Company to manufacture the
component under its contracts with the supplier. The Company has been
unable to date to obtain this documentation and, as a result, on February 8,
2008 the Company filed a legal claim in Connecticut Superior Court against the
supplier.
The
Company believes that it has contingency plans in place to allow for a
transition to a new component without a disruption in customer
deliveries. However, the Company expects to incur increased costs in
the next six months by reason of such transition
plans. Furthermore, the Company has entered into a
non-cancelable purchase commitment in the amount of $128,700 for certain
electronic parts in anticipation of manufacturing the original
component. Such parts will not be required for the new component and
there is a limited resale market for such parts. In the event that
the Company is unable to transition to the new component in time to
meet its customer requirements and/or is unable to generate the liquidity
required to pay the increased costs or the purchase commitment, such events
could have a material adverse effect on the Company’s business, financial
condition and results of operations.
While
most other components are standard items, certain application-specific
integrated circuit chips used in many of the Company’s products are customized
to the Company’s specifications. Except for the sole supplier noted above, none
of the suppliers of components operate under contract. Additionally,
availability of some standard components may be affected by market shortages and
allocations. The Company’s inability to obtain a sufficient quantity
of components when required, or to develop alternative sources due to lack of
availability or degradation of quality, at acceptable prices and within a
reasonable time, could result in delays or reductions in product shipments which
could materially affect the Company’s operating results in any given
period. In addition, as referenced above the Company relies heavily
on outsourcing subcontractors for production. The inability of such
subcontractors to deliver products in a timely fashion or in accordance with the
Company’s quality standards could materially adversely affect the Company’s
operating results and business.
The
Company uses internal forecasts to manage its general finished goods and
components requirements. Lead times for materials and components may vary
significantly, and depend on factors such as specific supplier performance,
contract terms, and general market demand for components. If orders vary from
forecasts, the Company may experience excess or inadequate inventory of certain
materials and components, and suppliers may demand longer lead times and higher
prices. From time to time, the Company has experienced shortages and allocations
of certain components, resulting in delays in fulfillment of customer orders.
Such shortages and allocations may occur in the future, and could have a
material adverse effect on the Company’s business, financial condition and
results of operations.
Fluctuations in Quarterly Operating
Results.
The Company’s sales are subject to quarterly and annual
fluctuations due to a number of factors resulting in more variability and less
predictability in the Company’s quarter-to-quarter sales and operating results.
As a small number of customers have historically accounted for a majority of the
Company’s sales, order volatility by any of these major customers has had and
may have an impact on the Company in the prior, current and future fiscal
years.
Most of
the Company’s sales require short delivery times. The Company’s ability to
affect and judge the timing of individual customer orders is limited. Large
fluctuations in sales from quarter-to-quarter could be due to a wide variety of
factors, such as delay, cancellation or acceleration of customer projects, and
other factors discussed below. The Company’s sales for a given quarter may
depend to a significant degree upon planned product shipments to a single
customer, often related to specific equipment or service deployment projects.
The Company has experienced both acceleration and slowdown in orders related to
such projects, causing changes in the sales level of a given quarter relative to
both the preceding and subsequent quarters.
Delays or
lost sales can be caused by other factors beyond the Company’s control,
including late deliveries by the third party subcontractors the Company is using
to outsource its manufacturing operations and by vendors of components used in a
customer’s products, slower than anticipated growth in demand for the Company’s
products for specific projects or delays in implementation of projects by
customers and delays in obtaining regulatory approvals for new services and
products. Delays and lost sales have occurred in the past and may occur in the
future. The Company believes that sales in the past have been adversely impacted
by merger and restructuring activities by some of its top customers. These and
similar delays or lost sales could materially adversely affect the Company’s
business, financial condition and results of operations
.
See “Customer Concentration”
and “Dependence on Key Suppliers and Component Availability”.
The
Company’s backlog at the beginning of each quarter typically is not sufficient
to achieve expected sales for that quarter. To achieve its sales objectives, the
Company is dependent upon obtaining orders in a quarter for shipment in that
quarter. Furthermore, the Company’s agreements with certain of its customers
typically provide that they may change delivery schedules and cancel orders
within specified timeframes, typically up to 30 days prior to the scheduled
shipment date, without significant penalty. Some of the Company’s customers have
in the past built, and may in the future build, significant inventory in order
to facilitate more rapid deployment of anticipated major projects or for other
reasons. Decisions by such customers to reduce their inventory levels could lead
to reductions in purchases from the Company in certain periods. These
reductions, in turn, could cause fluctuations in the Company’s operating results
and could have an adverse effect on the Company’s business, financial condition
and results of operations in the periods in which the inventory is
reduced.
Operating
results may also fluctuate due to a variety of factors, including market
acceptance of the Company’s new lines of products, delays in new product
introductions by the Company, market acceptance of new products and feature
enhancements introduced by the Company, changes in the mix of products and or
customers, the gain or loss of a significant customer, competitive price
pressures, changes in expenses related to operations, research and development
and marketing associated with existing and new products, and the general
condition of the economy.
All of
the above factors are difficult for the Company to forecast, and these or other
factors can materially and adversely affect the Company’s business, financial
condition and results of operations for one quarter or a series of quarters. The
Company’s expense levels are based in part on its expectations regarding future
sales and are fixed in the short term to a certain extent. Therefore, the
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected shortfall in sales. Any significant decline in demand relative to
the Company’s expectations or any material delay of customer orders could have
a
material adverse effect on the
Company’s business, financial condition, and results of operations
. There
can be no assurance that the Company will be able to sustain profitability on a
quarterly or annual basis. In addition, the Company has had, and in some future
quarter may have operating results below the expectations of public market
analysts and investors. In
such event, the price of
the Company’s common stock would likely be materially and adversely affected.
See “Potential Volatility of Stock Price”.
Competition.
The markets for
telecommunications network access and multi-service equipment addressed by the
Company’s products can be characterized as highly competitive, with
intensive equipment price pressure. These markets are subject to rapid
technological change, wide-ranging regulatory requirements, the entrance of low
cost manufacturers and the presence of formidable competitors that have greater
name recognition and financial resources. Certain technology such as the V.34
and digital service units portion of the SpectraComm line are not considered new
and the market has experienced decline in recent years.
Industry
consolidation could lead to competition with fewer, but stronger competitors. In
addition, advanced termination products are emerging, which represent both new
market opportunities, as well as a threat to the Company’s current products.
Furthermore, basic line termination functions are increasingly being integrated
by competitors, such as Cisco, Alcatel/Lucent, and Nortel Networks, into other
equipment such as routers and switches. To the extent that current or potential
competitors can expand their current offerings to include products that have
functionality similar to the Company’s products and planned products, the
Company’s business, financial condition and results of operations could be
materially adversely affected. Many of the Company’s current and
potential competitors have substantially greater technical, financial,
manufacturing and marketing resources than the Company. In addition, many of the
Company’s competitors have long-established relationships with network service
providers. There can be no assurance that the Company will have the financial
resources, technical expertise, manufacturing, marketing, distribution and
support capabilities to compete successfully in the future.
Rapid Technological Change.
The network access and telecommunications equipment markets are
characterized by rapidly changing technologies and frequent new product
introductions. The rapid development of new technologies increases the risk that
current or new competitors could develop products that would reduce the
competitiveness of the Company’s products. The Company’s success will depend to
a substantial degree upon its ability to respond to changes in technology and
customer requirements. This will require the timely selection, development and
marketing of new products and enhancements on a cost-effective basis. The
development of new, technologically advanced products is a complex and uncertain
process, requiring high levels of innovation. The Company may need to supplement
its internal expertise and resources with specialized expertise or intellectual
property from third parties to develop new products.
Furthermore,
the communications industry is characterized by the need to design products that
meet industry standards for safety, emissions and network interconnection. With
new and emerging technologies and service offerings from network service
providers, such standards are often changing or unavailable. As a result, there
is a potential for product development delays due to the need for compliance
with new or modified standards. The introduction of new and enhanced products
also requires that the Company manage transitions from older products in order
to minimize disruptions in customer orders, avoid excess inventory of old
products and ensure that adequate supplies of new products can be delivered to
meet customer orders. There can be no assurance that the Company will be
successful in developing, introducing or managing the transition to new or
enhanced products, or that any such products will be responsive to technological
changes or will gain market acceptance. The Company’s business, financial
condition and results of operations would be materially adversely affected if
the Company were to be unsuccessful, or to incur significant delays in
developing and introducing such new products or enhancements. See “Dependence on
Legacy and Recently Introduced Products and New Product
Development”.
Compliance with Regulations and
Evolving Industry Standards.
The market for the Company’s products is
characterized by the need to meet a significant number of communications
regulations and standards, some of which are evolving as new technologies are
deployed. In the United States, the Company’s products must comply with various
regulations defined by the Federal Communications Commission and standards
established by Underwriters Laboratories and Bell Communications Research and
certain new products introduced, for example in the SpectraComm line, will need
to be NEBS Certified. As standards continue to evolve, the Company will be
required to modify its products or develop and support new versions of its
products. The failure of the Company’s products to comply, or delays in
compliance, with the various existing and evolving industry standards, could
delay introduction of the Company’s products, which could have a material
adverse effect on the Company’s business, financial condition and results of
operations.
GDC Will Require Additional Funding
to Sustain Operations.
The Company emerged from Chapter 11 bankruptcy on
September 15, 2003. Under the plan of reorganization, the Company was to pay all
creditors 100% of their allowed claims based upon a five year business plan.
However, the company has not met its business plan objectives since emerging
from Chapter 11. The ability to meet the objectives of this business
plan is directly affected by the factors described in this “Risk Factors”
section. The Company cannot assure investors that it will be able to obtain new
customers or to generate the increased revenues required to meet our business
plan objectives. In addition, in order to execute the business plan, the Company
may need to seek additional funding through public or private equity offerings,
debt financings or commercial partners. The Company cannot assure investors that
it will obtain funding on acceptable terms, if at all. If the Company is unable
to generate sufficient revenues or access capital on acceptable terms, it may be
required to (a) obtain funds on unfavorable terms that may require the Company
to relinquish rights to certain of our technologies or that would significantly
dilute our stockholders and/or (b) significantly scale back current operations.
Either of these two possibilities would have a material adverse effect on the
Company’s business, financial condition and results of operations.
Risks Associated with Entry into
International Markets
. The Company has limited experience in
international markets with the exception of a few direct customers and
resellers/integrators and sales into Western Europe through its subsidiary in
France, which was acquired by the Company on June 30, 2005. The
Company intends to expand sales of its products outside of North America and to
enter certain international markets, which will require significant management
attention and financial resources. Conducting business outside of
North America is subject to certain risks, including longer payment cycles,
unexpected changes in regulatory requirements and tariffs, difficulty in
supporting foreign customers, greater difficulty in accounts receivable
collection and potentially adverse tax consequences. To the extent
any Company sales are denominated in foreign currency, the Company’s sales and
results of operations may also be directly affected by fluctuation in foreign
currency exchange rates. In order to sell its products
internationally, the Company must meet standards established by
telecommunications authorities in various countries, as well as recommendations
of the Consultative Committee on International Telegraph and
Telephone. A delay in obtaining, or the failure to obtain,
certification of its products in countries outside the United States, could
delay or preclude the Company’s marketing and sales efforts in such countries,
which could have a material adverse effect on the Company’s business, financial
condition and results of operations.
Risk of Third Party Claims of
Infringement.
The network access and telecommunications equipment
industries are characterized by the existence of a large number of patents and
frequent litigation based on allegations of patent infringement. From time to
time, third parties may assert exclusive patent, copyright, trademark and other
intellectual property rights to technologies that are important to the Company.
The Company has not conducted a formal patent search relating to the technology
used in its products, due in part to the high cost and limited benefits of a
formal search. In addition, since patent applications in the United States are
not publicly disclosed until the related patent is issued and foreign patent
applications generally are not publicly disclosed for at least a portion of the
time that they are pending, applications may have been filed which, if issued as
patents, could relate to the Company’s products. Software comprises a
substantial portion of the technology in the Company’s products. The scope of
protection accorded to patents covering software-related inventions is evolving
and is subject to a degree of uncertainty which may increase the risk and cost
to the Company if the Company discovers third party patents related to its
software products or if such patents are asserted against the Company in the
future.
The
Company may receive communications from third parties asserting that the
Company’s products infringe or may infringe the proprietary rights of third
parties. In its distribution agreements, the Company typically agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In the
event of litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company’s
technical and management personnel from productive tasks. In the event of an
adverse ruling in such litigation, the Company might be required to discontinue
the use and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses from third parties. There can be no
assurance that licenses from third parties would be available on acceptable
terms, if at all. In the event of a successful claim against the Company and the
failure of the Company to develop or license a substitute technology, the
Company’s business, financial condition, and results of operations could be
materially adversely affected.
Limited Protection of Intellectual
Property.
The Company relies upon a combination of patent, trade secret,
copyright, and trademark laws and contractual restrictions to establish and
protect proprietary rights in its products and technologies. The Company has
been issued certain U.S., Canadian and European technology
patents. Most of these patents were sold in February 2008 and the
Company retained a royalty-free right to continue to use the patent
technologies. There can be no assurance that third parties have
not or will not develop equivalent technologies or products without infringing
the Company’s patents and licensed patents or that a court having jurisdiction
over a dispute involving such patents would hold the Company’s patents and
licensed patents valid, enforceable and infringed. The Company also typically
enters into confidentiality and invention assignment agreements with its
employees and independent contractors, and non-disclosure agreements with its
suppliers, distributors and appropriate customers so as to limit access to and
disclosure of its proprietary information. There can be no assurance that these
statutory and contractual arrangements will deter misappropriation of the
Company’s technologies or discourage independent third-party development of
similar technologies. In the event such arrangements are insufficient, the
Company’s business, financial condition and results of operations could be
materially adversely affected. The laws of certain foreign countries in which
the Company’s products are or may be developed, manufactured or sold may not
protect the Company’s products or intellectual property rights to the same
extent as do the laws of the United States and thus, make the possibility of
misappropriation of the Company’s technology and products more
likely.
Potential Volatility of Stock Price.
The trading price of the Company’s common stock may be subject to wide
fluctuations in response to quarter-to-quarter variations in operating results,
announcements of technological innovations or new products by the Company or its
competitors, developments with respect to patents or proprietary rights, general
conditions in the telecommunication network access and equipment industries,
changes in earnings estimates by analysts, or other events or factors. In
addition, the stock market has experienced extreme price and volume
fluctuations, which have particularly affected the market prices of many
technology companies and which have often been unrelated to the operating
performance of such companies. Company-specific factors or broad market
fluctuations may materially adversely affect the market price of the Company’s
common stock. The Company has experienced significant fluctuations in its stock
price and share trading volume in the past and may continue to do
so.
The Company is Controlled by a Small
Number of Stockholders and Certain Creditors
. In particular,
Mr. Howard Modlin, Chairman of the Board and Chief Executive Officer, and
President of Weisman Celler Spett & Modlin, P.C., legal counsel for the
Company, owns approximately 71% of the Company’s outstanding shares of Class B
stock and has out of the money (above market) stock options and warrants that
would allow him to acquire approximately 57% of the Company’s common
stock. Furthermore, Mr. Modlin is also trustee for the benefit of the
children of Mr. Charles P. Johnson, the former Chairman of the Board and Chief
Executive Officer, and such trust holds approximately 12% of the outstanding
shares of Class B stock. Class B stock under certain circumstances
has 10 votes per share in the election of Directors. The Board of
Directors is to consist of no less than three and no more than thirteen
directors, one of which was designated by the Creditors Committee (and
thereafter may be designated by the Debenture Trustee). The holders
of the 9% Preferred Stock are presently entitled to designate two directors
until all arrears on the dividends on such 9% Preferred Stock are paid in
full. In the event of a payment default under the Debentures which is
not cured within 60 days after written notice, the Debenture Trustee shall be
entitled to select a majority of the Board of Directors. Accordingly,
in absence of a default under the Debentures, Mr. Modlin may be able to elect
all members of the Board of Directors not designated by the holders of the 9%
Preferred Stock and the Debenture Trustee and determine the outcome of certain
corporate actions requiring stockholder approval, such as mergers and
acquisitions of the Company. This level of ownership by such persons
and entities could have the effect of making it more difficult for a third party
to acquire, or of
discouraging a third party
from attempting to acquire, control of the Company. Such provisions
could limit the price that certain investors might be willing to pay in the
future for shares of Company’s common stock, thereby making it less likely that
a stockholder will receive a premium in any
sales of
shares. To date, the holders of the 9% Preferred Stock have not
designated any directors.
ITEM
3.
|
QUANTITATIVE
AN QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
The
Company is exposed to certain market risks, including foreign currency
fluctuations and interest rate fluctuations.
The
Company is exposed to foreign currency exchange risk primarily through
transactions denominated in foreign currencies. The vast majority of
the Company’s foreign transactions are denominated in U. S. dollars and,
therefore, an adverse change in foreign currency exchange rates is
not expected to have a direct material effect on the Company’s results of
operations, financial position or cash flows. However, there could be
a negative impact on future sales orders if, as a result of such a change in
foreign exchange rates, customers determined that the Company’s sales prices
were not competitive. The Company cannot quantify the impact on
orders or reduced margins thereon in the event customers object to such
prices.
The
Company is exposed to interest rate fluctuations on its variable rate,
LIBOR-based mortgage loan. A one-percent increase or decrease in
30-day LIBOR would result in an increase or decrease in interest expense of
$45,000 on an annualized basis.
ITEM
4.
|
CONTROLS
AND
PROCEDURES
|
For the
period covered by this report, the Company carried out an evaluation, under the
supervision and with the participation of the Company’s management, including
the Company’s Chairman and Chief Executive Officer, and Vice President and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon that evaluation, the Company’s Chairman and Chief
Executive Officer, and Vice President and Chief Financial Officer, have
concluded that the Company’s disclosure controls and procedures are effective to
ensure the information required to be disclosed in reports filed or submitted
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms. There have been no significant changes in the
Company’s internal controls over financial reporting that occurred during the
period covered by this quarterly report on Form 10-Q that has materially
affected, or is reasonably likely to materially affect, the Company’s internal
control over financial reporting.
PART
II. OTHER
INFORMATION
ITEM
3.
|
DEFAULTS
UPON SENIOR
SECURITIES
|
Payment
of dividends on the 9% Cumulative Convertible Exchangeable Preferred Stock were
suspended June 30, 2000. Such dividend arrearages total
$13,636,055.25 as of March 31, 2008.
ITEM
5.
|
OTHER
INFORMATION
|
See Note
11, "Subsequent Events", included in the Notes to Condensed Consolidated
Financial Statements included in Part 1 of this Form 10-Q regarding demand loans
made by the Chairman of the Board.
(a) Exhibits
Index:
Exhibit
Number
|
Description
of Exhibit
|
|
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of
1934.
|
|
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of
1934
|
|
Certification
of Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted 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.
|
|
GENERAL
DATACOMM INDUSTRIES INC.
|
|
|
|
|
|
|
May 15,
2008
|
/s/ William G.
Henry
|
|
|
William
G. Henry
|
|
|
Vice
President, Finance and Administration
|
|
|
Chief
Financial Officer
|
26
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