U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the Quarterly Period Ended June 30, 2002. [ ] 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: 0-17893
TELTRONICS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
59-2937938
(I.R.S. Employer Identification Number)
2150 WHITFIELD INDUSTRIAL WAY
SARASOTA, FLORIDA 34243
(Address of principal executive offices, including zip code)
941-753-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
As of August 14, 2002 there were 5,513,354 shares of the Registrant's Common Stock outstanding.
INDEX
PAGE
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (Unaudited) Condensed Consolidated Balance Sheets at June 30, 2002 and
December 31, 2001.3-4 Condensed Consolidated Statements of Operations for the three months
and six months ended June 30, 2002 and 2001.5 Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001.6 Notes to Condensed Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
16-20
PART II.
OTHER INFORMATION21 ITEM 1. LEGAL PROCEEDINGS 21 ITEM 2. CHANGES IN SECURITIES 21 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 21 ITEM 5. OTHER INFORMATION 21 ITEM 6A. EXHIBITS 21 ITEM 6B. REPORTS ON FORM 8-K 21
SIGNATURES22
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
2002December 31,
2001(Unaudited) Current assets: Cash and cash equivalents $ 324,292 $ 63,307 Accounts receivable, net of allowance for doubtful accounts
of $542,961 at June 30, 2002 and $469,860 at
December 31, 20019,979,089 10,021,731 Costs and estimated earnings in excess of billings on
uncompleted contracts1,030,459 638,119 Inventories, net 7,904,028 9,175,567 Prepaid expenses and other current assets 527,680 314,363
Total current assets19,765,548 20,213,087
Property and equipment, net4,395,938 5,163,007 Goodwill, net 241,371 241,371 Other intangible assets, net 302,445 335,814 Other assets 281,982 339,569 Total assets $ 24,987,284 $ 26,292,848
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS - ContinuedLIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
June 30,
2002December 31,
2001(Unaudited) Current liabilities: Current portion of long-term debt $ 4,606,429 $ 4,550,645 Current portion of capital lease obligations 25,969 79,497 Accounts payable 5,313,047 6,181,434 Billings in excess of costs and estimated earnings
on uncompleted contracts348,905 125,783 Accrued expenses and other current liabilities 2,750,380 2,783,532 Deferred revenue 1,861,277 1,755,421 Total current liabilities 14,906,007 15,476,312 Long-term liabilities: Long-term debt, net of current portion 8,840,010 9,034,748 Capital lease obligations, net of current portion --- 963 Other long-term liability --- 3,744,355 Total long-term liabilities 8,840,010 12,780,066 Commitments and contingencies Shareholders' equity (deficiency): Common stock, $.001 par value, 40,000,000 shares
authorized, 5,366,386 and 5,105,844 issued and
outstanding at June 30, 2002 and December 31, 2001,
respectively5,366 5,106 Non-voting common stock, $.001 par value, 5,000,000 shares
authorized, zero shares issued and outstanding--- --- Preferred Series A stock, $.001 par value, 100,000 shares
authorized, 100,000 shares issued and outstanding100 100 Preferred Series B Convertible stock, $.001 par value, 25,000
shares authorized, 12,625 shares issued and outstanding13 13 Preferred Series C Convertible stock, $.001 par value, 50,000
shares authorized, 40,000 shares issued and outstanding40 --- Additional paid-in capital 23,628,424 19,277,099 Accumulated other comprehensive loss (19,074) (2,941) Accumulated deficit (22,373,602) (21,242,907) Total shareholders' equity (deficiency) 1,241,267 (1,963,530) Total liabilities and shareholders' equity (deficiency) $ 24,987,284 $ 26,292,848
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)
Three Months Ended June 30, Six Months Ended June 30, 2002 2001 2002 2001 Net sales Product sales and installation $ 14,629,664 $ 24,204,010 $ 26,389,529 $ 40,801,670 Maintenance and service 2,032,128 1,623,558 3,945,281 3,276,368 16,661,792 25,827,568 30,334,810 44,078,038 Cost of goods sold 10,751,207 17,898,822 19,256,008 30,115,073 Gross profit 5,910,585 7,928,746 11,078,802 13,962,965 Operating expenses: General and administrative 1,307,768 1,509,158 2,745,989 3,068,542 Sales and marketing 2,491,409 3,167,733 5,657,423 6,241,390 Research and development 934,042 1,615,828 2,049,413 3,153,604 Depreciation and amortization 338,081 396,535 687,867 794,682 5,071,300 6,689,254 11,140,692 13,258,218 Income (loss) from operations 839,285 1,239,492 (61,890) 704,747 Other income (expense): Interest (291,370) (379,679) (661,697) (801,077) Financing (118,954) (96,473) (164,552) (175,124) Litigation costs --- --- (15,500) --- Other (9,444) 14,325 (11,806) 6,849 (419,768) (461,827) (853,555) (969,352) Income (loss) before income taxes 419,517 777,665 (915,445) (264,605) Income taxes (7,181) (6,413) (14,072) (11,564) Net income (loss) 412,336 771,252 (929,517) (276,169) Dividends on Preferred Series
B and C Convertible stock
158,919
37,875
201,178
75,750Net income (loss) available to
common shareholders
$ 253,417
$ 733,377
$ (1,130,695)
$ (351,919)Net income (loss) per share: Basic $ 0.05 $ 0.15 $ (0.21) $ (0.07) Diluted $ 0.05 $ 0.14 $ (0.21) $ (0.07)
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)
Six Months Ended June 30, 2002 2001 OPERATING ACTIVITIES: Net loss $ (929,517) $ (276,169) Adjustments to reconcile net loss to net cash
provided by operating activities:Provision for doubtful accounts 102,106 (22,500) Provision for obsolete inventories 1,116,049 173,972 Depreciation and amortization 1,056,214 1,122,550 Amortization of other intangible assets and goodwill 33,369 51,508 Amortization of deferred financing costs and other assets 121,018 92,379 Shares issued for 401(k) match 117,334 127,343 Gain on sale of property and equipment (25,020) --- Changes in operating assets and liabilities: Accounts receivable (59,464) (4,489,161) Net increase in costs and estimated earnings in excess
of billings on uncompleted contracts(169,218) --- Inventories 155,490 727,683 Prepaid expenses and other current assets (146,185) (80,711) Decrease in other assets 29,637 63,961 Accounts payable (868,387) 5,030,771 Accrued expenses and other current liabilities 163,394 937,856 Deferred revenue 105,856 1,019,487 Net cash flows provided by operating activities 802,676 4,478,969 INVESTING ACTIVITIES: Acquisition of property and equipment (289,145) (965,965) Proceeds from sale of property and equipment 25,020 899 Net cash flows used in investing activities (264,125) (965,066) FINANCING ACTIVITIES: Net borrowings (repayments) on line of credit 13,699 (2,601,669) Net repayments on loans, notes and capital leases (207,144) (930,235) Proceeds from issuance of common stock 74,091 132,887 Dividends paid on Preferred Series B and C Convertible stock (142,079) (75,750) Net cash flows used in financing activities (261,433) (3,474,767) Effect of exchange rate changes on cash (16,133) (1,065) Net increase in cash 260,985 38,071 Cash and cash equivalents - beginning of period 63,307 35,292 Cash and cash equivalents - end of period $ 324,292 $ 73,363
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued(Unaudited)
Six Months Ended June 30, 2002 2001 Supplemental noncash financing and investing activities: Conversion of other long-term liability to Preferred
Series C Convertible stock$ 3,744,355 $ --- Conversion of certain accrued expenses to Preferred
Series C Convertible stock255,645 --- Unpaid dividends on Preferred Series C Convertible stock
included in accrued expenses59,099 --- Deferred financing fee of $160,200 less amortization
expense of $93,068, included in prepaid expenses and
other current assets67,132 ---
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TELTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION
Teltronics, Inc. ("Teltronics" or "Company"), a Delaware corporation, designs, develops, installs, manufactures and markets electronic hardware and application software products, and engages in contract manufacturing for the telecommunication industry.
The accompanying condensed consolidated financial statements include the accounts of the Company and is comprised of its wholly-owned subsidiaries TTG Acquisition Corp. and Teltronics, S.A. de C.V. and its 85% owned subsidiary Interactive Solutions, Inc. ("ISI"). All significant intercompany transactions and balances have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.
The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and notes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2001.
Certain amounts in our prior period financial statements have been reclassified to conform to the current period presentation.
NOTE 2 - COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) is as follows:
Three Months Ended June 30, Six Months Ended June 30, 2002 2001 2002 2001 Net income (loss) $ 412,336 $ 771,252 $ (929,517) $ (276,169) Foreign currency translation (15,888) (625) (16,133) (1,065) Total comprehensive income (loss) $ 396,448 $ 770,627 $ (945,650) $ (277,234)
NOTE 3 - NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income (loss), adjusted for preferred stock dividends, by the weighted average number of issued common shares outstanding during the applicable period. Diluted net income (loss) per share is computed by dividing net income (loss), adjusted for preferred stock dividends, by the weighted average number of issued common shares and potential common shares. Potential common shares consist of convertible preferred stock, stock options (vested and unvested) and warrants and are computed using the treasury stock method. Certain potential common shares for 2002 and 2001 were anti-dilutive and were not included in the calculation of diluted net income (loss) per share.
8
The following table sets forth the unaudited computation of basic and diluted net income (loss) per share:
Three Months Ended June 30, Six Months Ended June 30, 2002 2001 2002 2001 Basic Net income (loss) $ 412,336 $ 771,252 $ (929,517) $ (276,169) Preferred dividends (158,919) (37,875) (201,178) (75,750) Net income (loss) available to
common shareholders
$ 253,417
$ 733,377
$ (1,130,695)
$ (351,919)Weighted average shares outstanding 5,347,463 4,840,860 5,289,052 4,821,487 Net income (loss) per share $ 0.05 $ 0.15 $ (0.21) $ (0.07) Diluted Net income (loss) $ 412,336 $ 771,252 $ (929,517) $ (276,169) Preferred dividends --- --- (201,178) (75,750) Net income (loss) available to
common shareholders
$ 412,336
$ 771,252
$ (1,130,695)
$ (351,919)Weighted average shares outstanding 5,347,463 4,840,860 5,289,052 4,821,487 Effect of dilutive securities Employee stock options --- 261,108 --- --- Convertible preferred stock 2,175,974 459,091 --- --- Dilutive potential common shares 7,523,437 5,561,059 5,289,052 4,821,487 Net income (loss) per share $ 0.05 $ 0.14 $ (0.21) $ (0.07)
NOTE 4 - INVENTORIES
The major classes of inventories are as follows:
June 30,
2002December 31,
2001(Unaudited) Raw materials $ 5,521,709 $ 5,963,289 Work-in-process 1,255,927 1,136,911 Finished goods 1,126,392 2,075,367 $ 7,904,028 $ 9,175,567
The reserve for slow moving and obsolete inventories was $1,924,000 and $1,235,000 as of June 30, 2002 and December 31, 2001, respectively.
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NOTE 5 - DEBT
Debt consists of the following:
June 30,
2002December 31,
2001(Unaudited) Secured promissory note - payable in monthly installments of $96,805 with interest at 8% commencing May 1, 2002 with a balloon payment of $7,196,801 due May 2006.
$ 9,089,611 $ 9,196,801
Bank line of credit - On December 22, 1998, the Company's principal lender, The CIT Group/Credit Finance, Inc. ("CIT") entered into an Amendment to the Company's existing Line of Credit Facility and Term Loan. Under the Amendment, the interest rate is 2.0% above prime rate, maximum availability is $5,500,000 and a prepayment penalty is assessed at 1.5%. On October 28, 2000, the Line of Credit Facility was extended to October 28, 2002. Substantially all of the Company's present and future assets, except for fixed assets, are pledged as collateral with borrowings limited to certain gross availability formulas based on accounts receivable and inventory as defined in the agreement. The facility provides for minimum loan fees, unused line fees and renewal term fees. The outstanding borrowings are classified as a current liability. The Company incurred renewal loan fees of $55,000 during 1999. A director of the Company has personally guaranteed a portion of the facility. At June 30, 2002 and December 31, 2001, the Company had $2,327,811 and $2,341,510 available respectively, pursuant to this facility. The availability of this unused line of credit is restricted based on availability formulas.3,172,189 3,158,490
Senior Secured Loan - initially payable in quarterly payments at 12% and due April 30, 2000. In May 2000, the Company amended and restated the loan to revise the maturity date to February 13, 2002. The loan was subsequently amended in May 2002 with a revised maturity date of August 13, 2002 with monthly payments of $35,000 commencing May 1, 2002.909,443 1,000,000
Notes payable to finance companies, payable in monthly installments of $4,200 with interest at 5%. The notes mature through May 2007 and are collateralized by vehicles.203,025 160,752
Notes payable - officer, payable upon demand with interest accruing at 8% per annum.
72,171
69,350
Total
13,446,439
13,585,393
Less current portion
4,606,429
4,550,645
Long-term portion
$ 8,840,010
$ 9,034,748
The Company maintains a promissory note to Harris Corporation ("Harris") related to the acquisition of the 20-20® Product Line, which was restructured on March 27, 2002, under a Master Restructuring Agreement. Under this restructuring, the principal and capitalized interest total was stated at $9,196,801. The Company made principal payments of $500,000 during the three month period ended March 31, 2002. This amount was classified within accrued expenses and other current liabilities as of December 31, 2001. Monthly payments of $96,805 in principal and interest commenced in May 2002 and continue until May 2006 at which time a balloon payment of the remaining unpaid balance of $7,196,801 will be due. The interest is 8%. In conjunction with the restructuring, Harris agreed to convert $4,000,000 of accrued expenses owed by the Company for additional inventory and services provided in connection with the transition of the 20-20® Switching Product Line to the Company, to 40,000 shares of Preferred Series C Convertible stock.
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The Note is secured by a first lien on certain of the acquired assets and a lien on the Company's other assets.
The Preferred Series C Convertible stock provides for a $10 per share annual dividend payable quarterly beginning May 15, 2002. The dividend increases to $20 beginning April 1, 2007. The holder of the Preferred Series C Convertible stock has the right at its option to convert the shares of the Preferred Series C to the Company's Common stock at $2.75 per share subject to adjustment. The Company has the right to redeem all or a portion of the then outstanding Preferred Series C Convertible stock at any time at 100% of the face value plus accrued and unpaid dividends.
On February 25, 1998, the Company entered into senior Secured Loans ("Loans") for $1,000,000 and $280,000. Interest was initially paid quarterly starting May 15, 1998. On May 12, 2000, the Company amended and restated the $1,000,000 Loan Agreement originally entered into on February 25, 1998 with Finova Mezzanine Capital Corp. ("Finova") and originally due February 25, 1999 to extend the maturity to February 13, 2002. On May 1, 2002, Finova and the Company entered into a Third Amended and Restated Senior Secured Promissory Note ("Note"). Under the terms of the Note, monthly principal and interest payments of $35,000 are required commencing May 1, 2002 until August 13, 2002 at which time all outstanding principal and interest is due. The interest rate remained unchanged at 12%. The Company is in discussions with Finova regarding restructuring the Note. The Holder of the Loans previously received 890,000 warrants to purchase the Company's Common stock at an exercise price of $2.75 per share. These warrants were exercisable in whole, or in part, at any time during a five-year holding period beginning on the date of issuance. In connection with the Note, Finova and the Company entered into an Amended and Restated Stock Purchase Warrant ("Warrant") that modified the terms of the 890,000 previously issued warrants to change the exercise price to $1.00 per share and extend the exercise period to February 26, 2004. The Note contains certain covenants.
As a result of modifying the exercise price and extending the exercise period of the 890,000 warrants, the Company recorded a deferred financing fee of approximately $160,000 in May 2002. This fee will be expensed as a financing cost in our condensed consolidated statements of operations commencing May 1, 2002 through August 13, 2002.
The covenants in the Secured Promissory Note, Loan and Security Agreement and the Senior Secured Loans restrict certain sales of assets; mergers and acquisitions; borrowings and guarantees; dividends and redemptions; creation of liens; investments; issuance of subsidiary shares; and transactions with affiliates.
NOTE 6 - SHAREHOLDERS' EQUITY
The total number of shares of all classes of capital stock, which the Company has the authority to issue is 50,000,000 shares divided into three classes of which 5,000,000 shares, par value $.001 per share are designated Preferred stock, 40,000,000 shares, par value $.001 per share are designated Common stock and 5,000,000 shares, par value $.001 per share, are designated Non-Voting Common stock.
(A) Preferred Stock - The Preferred Series A stock are restricted securities owned by the Company's Director and Senior Vice President of Business Development and subject to resale restrictions including the right of the Company to approve or disapprove any sale, transfer or disposition to any third party not controlled by the Director. Each share is entitled to 400 votes and is not entitled to any dividends. Accordingly, this would give the Senior Vice President voting control of the Company.
The Preferred Series B Convertible stock provided for a $12 per share annual dividend, payable quarterly and increasing to $20 in May 2002. On April 22, 2002, the terms of the Preferred Series B Convertible stock were modified. Commencing February 26, 2002, the annual dividend rate increased from $12 per share to $16 per share, payable quarterly. The annual dividend rate will increase to $18 per share on February 27, 2004 and to $20 per share on February 27, 2005. The holder of the Preferred Series B Convertible stock initially had the right at its option to convert to the Company's Common stock at $2.75 per share. The Company adjusted the conversion price on April 22, 2002 for the Preferred Series B Convertible stock from $2.75 to $1.75 per share in conjunction with the amendment and restatement of the Note. The Preferred Series B Convertible stock can be called by the Company only if the twenty-day average bid price of the Company's common stock exceeds $5.50 per share. Beginning May 2002, the Company has the right to redeem the Preferred Series B Convertible stock in full at 100% of the face value plus accrued and unpaid dividends. The Preferred Series B Convertible stock contains certain financial covenants.
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The Company issued 40,000 shares of Preferred Series C Convertible stock to Harris Corporation in March 2002 in connection with the Master Restructuring Agreement. The Preferred Series C Convertible stock provides for a $10 per share annual dividend, payable quarterly beginning May 15, 2002. The annual dividend increases to $20 per share beginning April 1, 2007. The holder of the Preferred Series C Convertible stock has the right at its option to convert to the Company's Common stock at $2.75 per share subject to adjustment. The Company has the right to redeem all or a portion of the then outstanding Preferred Series C Convertible stock at any time at 100% of the face value plus accrued and unpaid dividends.
(B) Warrants - In connection with the Note, Finova and the Company entered into an Amended and Restated Stock Purchase Warrant ("Warrant") that modified the terms of the 890,000 previously issued warrants to change the exercise price to $1.00 per share and extend the exercise period to February 26, 2004.
NOTE 7 - COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
June 30,
2002December 31,
2001(Unaudited)
Costs incurred on uncompleted contracts
$
3,322,135
$
770,551Estimated earnings 1,754,468 534,505 5,076,603 1,305,056 Less: Billings to date 4,395,049 792,720 $ 681,554 $ 512,336 Included in accompanying condensed consolidated balance
sheets under the following captions:Costs and estimated earnings in excess of billings on
uncompleted contracts
$
1,030,459
$
638,119Billings in excess of costs and estimated earnings on
uncompleted contracts
(348,905)
(125,783)$ 681,554 $ 512,336
NOTE 8 - GOODWILL
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized but instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values. The Company fully adopted the provisions of SFAS No. 142 effective January 1, 2002.
Under SFAS No. 142, the Company is required to perform a transitional impairment test for its goodwill as of the date of adoption. Step one of the transitional goodwill impairment test, which compares the fair values of the Company's reporting units to their respective carrying values, has been completed by June 30, 2002. The Company has concluded that no impairment is required as of January 1, 2002. As required by SFAS No. 142, the Company will perform its annual goodwill impairment test during the fourth quarter of 2002.
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The following is a summary of net income (loss) and net income (loss) per share for the three months and six months ended June 30, 2001 as adjusted to remove the amortization of goodwill:
Three Months Ended
June 30, 2001Six Months Ended
June 30, 2001Net income (loss) - as reported $ 771,252 $ (276,169) Goodwill amortization 5,457 10,914 Net income (loss) - adjusted $ 776,709 $ (265,255) Basic income (loss) per share of common stock: Net income (loss) - as reported $ 0.15 $ (0.07) Goodwill amortization --- --- Net income (loss) - adjusted $ 0.15 $ (0.07) Diluted income (loss) per share of common stock: Net income (loss) - as reported $ 0.14 $ (0.07) Goodwill amortization --- --- Net income (loss) - adjusted $ 0.14 $ (0.07)
Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values. The following is a summary of intangible assets at December 31, 2001 and June 30, 2002:
December 31, 2001 Gross
Carrying
AmountAccumulated
AmortizationTotal Definite useful lives Customer list $ 232,332 $ 76,917 $ 155,415 Patent 239,899 59,500 180,399 Total $ 472,231 $ 136,417 $ 335,814
June 30, 2002 Gross
Carrying
AmountAccumulated
AmortizationTotal Definite useful lives Customer list $ 232,332 $ 103,031 $ 129,301 Patent 239,899 66,755 173,144 Total $ 472,231 $ 169,786 $ 302,445
Amortization expense related to intangible assets was $16,685 and $20,297 for the three months ended June 30, 2002 and 2001, respectively. Amortization expense related to intangible assets was $33,369 and $40,594 for the six months ended June 30, 2002 and 2001, respectively. Estimated amortization expense related to intangible assets for each of the years in the five year period ending December 31, 2006 and thereafter is: 2002 - $66,740; 2003 - $66,740; 2004 - $50,396; 2005 - $29,580; 2006 - $14,510; thereafter - $107,848.
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NOTE 9 - SEGMENT INFORMATION
The Company's operations are classified into three reportable segments, Teltronics, ISI and Mexico. Each reportable segment is staffed separately, requires different technology and marketing strategies and sells to different customers.
The accounting policies of the Segments are the same. Intersegment sales and transfers are recorded at Teltronics' cost plus a normal margin for electronic manufacturing. Company management evaluates performance based on segment profit, which is net income (loss) before taxes, excluding nonrecurring gains or losses.
The following table presents unaudited information about reportable segment operations and assets.
Three Months Ended
June 30,Six Months Ended
June 30,2002 2001 2002 2001 Net sales Teltronics $ 16,458,000 $ 25,270,000 $ 29,769,000 $ 43,410,000 Mexico 120,000 3,000 407,000 3,000 ISI 84,000 555,000 159,000 665,000 Total sales $ 16,662,000 $ 25,828,000 $ 30,335,000 $ 44,078,000 Depreciation and amortization Teltronics $ 515,000 $ 526,000 $ 1,038,000 $ 1,083,000 Mexico 1,000 2,000 4,000 2,000 ISI 6,000 18,000 14,000 38,000 Total depreciation and amortization $ 522,000 $ 546,000 $ 1,056,000 $ 1,123,000 Interest and financing costs Teltronics $ 410,000 $ 476,000 $ 826,000 $ 976,000 Mexico --- --- --- --- ISI --- --- --- --- Total interest and financing costs $ 410,000 $ 476,000 $ 826,000 $ 976,000 Segment profit (loss) Teltronics $ 443,000 $ 962,000 $ (959,000) $ 305,000 Mexico (59,000) (179,000) (3,000) (268,000) ISI 36,000 (5,000) 47,000 (302,000) Income (loss) before income taxes $ 420,000 $ 778,000 $ (915,000) $ (265,000) Segment assets Teltronics $ 24,647,000 $ 32,339,000 $ 24,647,000 $ 32,339,000 Mexico 262,000 199,000 262,000 199,000 ISI 78,000 357,000 78,000 357,000 Total segment assets $ 24,987,000 $ 32,895,000 $ 24,987,000 $ 32,895,000 Acquisition of property and equipment Teltronics $ 142,000 $ 629,000 $ 288,000 $ 862,000 Mexico --- 76,000 --- 90,000 ISI 1,000 7,000 1,000 14,000 Total acquisition of property and
equipment
$ 143,000
$ 712,000
$ 289,000
$ 966,000
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NOTE 10 - SUBSEQUENT EVENT
In July 2002, the Company transferred seventy percent ownership of its ISI subsidiary and converted all debt and obligations owed to the Company by ISI to 50,000 shares of Series A Preferred Stock of ISI. The Series A Preferred Stock are non-voting, non-convertible shares with a stated value of $5,000,000 in the event of liquidation of ISI. The owners of ISI, including the Company as owner of the Series A Preferred Stock and fifteen percent of the voting common stock of ISI, entered into a Stockholder Agreement under which certain transactions involving ISI require the approval of the Company. The Series A Preferred Stock are subject to redemption in certain circumstances at prices based upon percentages of the valuation of ISI from time to time at the time of redemption.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
A number of statements contained in this Quarterly Report on Form 10-Q are forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of risks and uncertainties, including the timely development and market acceptance of products and technologies, competitive market conditions, successful integration of acquisitions, the ability to secure additional sources of financing, the ability to reduce operating expenses, the ability to comply with the rules for continued quotation on the Over the Counter Bulletin Board and other factors described in the Company's filings with the Securities and Exchange Commission. The actual results that the Company achieves may differ materially from any forward-looking statements due to such risks and uncertainties.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements that have been prepared under generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could materially differ from those estimates because the estimates represent judgments made at specific dates for events that are ongoing. Critical accounting policies have the potential to have the most significant impact on the consolidated financial statements.
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.
Our critical accounting policies and estimates are as follows:
Revenue recognition. Teltronics generates revenues through different sources.
Contract Manufacturing. Revenues from sales of product including our contract manufacturing business are recognized when the product is shipped. The Company's policy is to recognize revenue and related costs when the order has been shipped from our facilities, which is also the same point that title passes under the terms of the purchase order. Based on the Company's history of providing contract manufacturing services, we believe that collectibility is reasonably assured.
Performance of Construction-Type Contracts. The Company's policy is to recognize revenue and related costs on the construction-type contracts in accordance with Statement of Position 81-1 Accounting for Performance of Construction-Type and Certain Production-Type Contracts (SOP 81-1).
Our primary construction-type contracts are with the Board of Education of the City of New York. We accepted the assignment of a contract from Harris Corporation in connection with the Company's acquisition of Harris Corporation's 20-20® Switching Product Line in June 2000. This contract, with the Board of Education of the City of New York ("the Board"), specified that the Contractor (Teltronics) would provide telephone systems and peripheral equipment and cabling including systems maintenance and support.
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Installation is awarded on a fixed price and a school-by-school basis and maintenance is awarded for a group of schools. The term is segmented between installation and maintenance and is of a two year and 10 year period, respectively. Installation of each school requires between 4 to 16 weeks. The requirements agreement also provides for the transfer of risk of loss for each school at the date that systems are operational with title passing upon final acceptance.
In applying this policy, estimates of project installation cost and the percentage of work completed are updated on a monthly basis for each school. To the extent that billings exceed recognized revenues, deferred revenue is established. To the extent actual costs incurred are less than or greater than recognized expenses, accrual or prepaid balances are established.
- Maintenance and service. Revenue from support and maintenance activities is recognized ratably over the term of the maintenance period and the unrecognized portion is included in deferred revenue.
Allowance for doubtful accounts. A considerable amount of judgment is required when we assess the ultimate realization of receivables, including assessing the probability of collection and the current credit-worthiness of each customer. For all customers, we recognize reserves for bad debts based on the length of time the receivables are past due. We have evaluated our reserves based on the recent downturn in the economy and have increased them as necessary. We may record additional changes to our allowance for doubtful accounts in the future.
Slow moving and obsolete inventory. We write down our slow moving and obsolete inventory equal to the difference between the carrying value of the inventory and the estimated market value based on assumptions about future product life cycles, product demand and market conditions. If actual product life cycles, product demand or market conditions are less favorable than those projected by management, additional inventory write-down may be required.
Impairment of Intangible and Long Lived Assets. Intangibles and long-lived assets consist primarily of goodwill and fixed assets. We periodically evaluate the recovery of intangible and long lived assets when impairment indicators are present. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and the operational performance of our business. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible or long lived assets associated with our business are impaired. Beginning in 2002, the methodology for assessing potential impairments of intangible and long lived assets changed based on new accounting rules issued by the Financial Accounting Standards Board, and related practice implementation issues. The Company has determined there is no effect of adopting the new accounting rules on its results of operations and financial position.
Warranty and Service. The Company provides a limited warranty on most of its products, for a period of 3 to 15 months (depending on the product), under which the Company agrees to repair or replace, at the Company's sole discretion, units defective in material or workmanship, provided the equipment has not been subjected to alteration or abuse. The Company's technical service and engineering staff provide support services over the telephone to customers with installation or operational questions. Warranty and other repair services are provided by the Company at its facility in Sarasota, Florida.
Contingencies and Litigation. We are subject to proceedings, lawsuits and other claims related to class action lawsuits and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of loss accrual required, if any, for these contingencies are made after careful review of each individual issue. The required accruals may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters.
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RESULTS OF OPERATIONS
The following unaudited tables set forth certain data, expressed as a percentage of net sales, from the Company's unaudited condensed consolidated Statements of Operations for the three and six month periods ended June 30, 2002 and 2001.
Three Months Ended
June 30,Six Months Ended
June 30,2002 2001 2002 2001 Net sales 100.0% 100.0% 100.0% 100.0% Cost of goods sold 64.5% 69.3% 63.5% 68.3% Gross profit 35.5% 30.7% 36.5% 31.7% Operating expenses: General and administrative 7.8% 5.8% 9.0% 7.0% Sales and marketing 15.0% 12.3% 18.7% 14.1% Research and development 5.6% 6.3% 6.7% 7.2% Depreciation and amortization 2.0% 1.5% 2.3% 1.8% 30.4% 25.9% 36.7% 30.1% Income (loss) from operations 5.1% 4.8% (0.2%) 1.6% Other income (expense): Interest (1.8%) (1.5%) (2.2%) (1.8%) Financing (0.7%) (0.4%) (0.6%) (0.4%) Litigation costs --- --- (0.1%) --- Other (0.1%) 0.1% --- --- (2.6%) (1.8%) (2.9%) (2.2%) Income (loss) before income taxes 2.5% 3.0% (3.1%) (0.6%) Income taxes --- --- --- --- Net income (loss) 2.5% 3.0% (3.1%) (0.6%)
Net Sales
Net sales decreased 35% and 31% for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001. The decrease in net sales for both periods was primarily related to a $20 million project with the City of New York Board of Education (the "Board") that commenced in early 2001 and was substantially completed by June 30, 2001. We have had combined sales to the Board and IBM during the three month period and six month period ended June 30, 2002 of $7.3 million and $11.1 million, respectively.
Gross Profit Margin
Gross profit margin improved by 4.8 percentage points for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001. The projects with the Board in 2001 included both cabling and switching that resulted in lower margins due to the overall duration of the projects and the project management required. We have been able to improve our management by separating the two components within a project, which has improved our margins.
Operating Expenses
Operating expenses decreased $1.6 million and $2.1 million for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001.
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General and administrative expenses decreased $201,000 and $323,000 for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001. The decreases were primarily related to a reduction in the transition expenses related to the 20-20 Switching Product Line in 2001.
Sales and marketing expenses decreased $676,000 and $584,000 for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001. The decreases resulted primarily from reductions in work force implemented during 2001 that were partially offset by personnel hired in December 2001 and January 2002, for our direct sales efforts in our new marketplaces located in Salt Lake City, Utah and Petaluma, California.
Research and development expenses decreased $682,000 and $1.1 million for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001. The decreases resulted primarily from reductions in work force implemented during 2001.
Other Expenses
Other expenses decreased $42,000 and $116,000 for the three month period and six month period ended June 30, 2002, respectively, as compared to the same periods in 2001. The decreases resulted primarily from reductions in interest expense.
LIQUIDITY AND CAPITAL RESOURCES
Net cash flows provided by operating activities
Net cash flows provided by operating activities were $803,000 for the six month period ended June 30, 2002. The $803,000 was comprised of the following items: (1) net loss of $930,000, (2) non-cash expenses of $2,522,000, (3) net increase in operating assets of $190,000, and (3) net decrease in operating liabilities of $599,000. The net decrease in operating liabilities was primarily a result of a decrease in accounts payable of $868,000 caused by projects commencing in 2001 and completed in 2002 for IBM.
Net cash flows provided by operating activities were $4, 479,000 for the six month period ended June 30, 2001. The $4,479,000 was comprised of the following items: (1) net loss of $276,000, (2) non-cash expenses of $1,545,000, (3) net increase in operating assets of $3,778,000, and (4) net increase in operating liabilities of $6,988,000. The net increase in operating assets was primarily a result of an increase in accounts receivable of $4,489,000. The net increase in operating liabilities was primarily a result of an increase in accounts payable and accrued expenses of $5,969,000. The increases in accounts receivable, accounts payable and accrued expenses were caused by the substantial completion of a $20 million project with the City of New York Board of Education as of June 30, 2001.
Net cash flows used in investing activities
Net cash flows used in investing activities were $264,000 for the six month period ended June 30, 2002. The Company acquired property and equipment of $289,000, which was offset by $25,000 of proceeds from the sale of property and equipment.
Net cash flows used in investing activities were $965,000 for the six month period ended June 30, 2002. The Company acquired property and equipment of $966,000, which was offset by $1,000 of proceeds from the sale of property and equipment.
Net cash flows used in financing activities
Net cash flows used in financing activities were $261,000 for the six month period ended June 30, 2002. The $261,000 was comprised of the following items: (1) net borrowings of $14,000 on the line of credit, (2) net repayments of $207,000 on loans, notes and capital leases, (3) proceeds of $74,000 related to the Employee Stock Purchase Plan, and (4) dividends paid of $142,000 on Preferred Series B and C Convertible stock.
Net cash flows used in financing activities were $3,475,000 for the six month period ended June 30, 2001. The $3,475,000 was comprised of the following items: (1) net repayments of $2,602,000 on the line of credit, (2) net
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repayments of $930,000 on loans, notes and capital leases, (3) proceeds of $133,000 related to the Employee Stock Purchase Plan, and (4) dividends paid of $76,000 on Preferred Series B Convertible stock.
Liquidity
As of June 30, 2002, the Company had cash and cash equivalents of $324,000 as compared to $63,000 as of December 31, 2002. Working capital as of June 30, 2002 and December 31, 2001 was $4,860,000 and $4,737,000, respectively. Principal obligations as of June 30, 2002 were comprised primarily of the following: (1) Promissory note payable to Harris Corporation of $9,100,000 in which $412,000 is expected to be paid within the next twelve months, (2) Bank line of credit payable to The CIT Group/Credit Finance, Inc. ("CIT") of $3,172,000, and (3) Secured loan payable to Finova Mezzanine Capital Corp. of $909,000 that matures on August 13, 2002. The Company is in discussions with Finova regarding extending the maturity date.
The credit facility with CIT is further described in Note 5 to the condensed consolidated financial statements. The credit facility has a maximum available limit of $5,500,000 with interest at prime plus 2%.
We believe that our cash balances and the cash flows generated by operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. However, because our operating results may fluctuate significantly as a result of a decrease in customer demand or the acceptance of our products, our ability to generate positive cash flows from operations may be jeopardized. As a result, we may require additional funds to support our working capital requirements, or for other purposes, and may seek to raise such additional funds through public or private equity financings or from other sources. We may not be able to obtain adequate or favorable financing at that time. Any financing we obtain may dilute your ownership interests. In addition, if our cash flows were to substantially decrease, our long-lived assets or goodwill may become impaired and we would have to record a charge for impairment, which may be material to our financial position and results of operations.
A portion of our cash may be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, we may evaluate potential acquisitions of such businesses, products or technologies. We anticipate that our cash requirements for investing activities for 2002 will not be significant.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS From time to time, the Company is a party to litigation, which arises, in the normal course of business.
There have been no changes to the legal proceedings as previously reported on Form 10-K. Management is not aware of the commencement of any new legal proceedings.
ITEM 2. CHANGES IN SECURITIES - None ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None ITEM 5. OTHER INFORMATION - None ITEM 6A. EXHIBITS 3 Amended Designations Establishing Series of Shares and Articles of Amendment of Teltronics, Inc. filed with the Delaware Secretary of State on April 29, 2002.
10.1 Third Amended and Restated Senior Secured Promissory Note in the amount of $1,000,000 dated and delivered May 2, 2002 by Teltronics, Inc. to Finova Mezzanine Capital, Inc. f/k/a Sirrom Capital Corporation.
10.2 Amended and Restated Stock Purchase Warrant covering 525,000 shares Common Stock of Teltronics, Inc. issued May 2, 2002 to Finova Mezzanine Capital, Inc. f/k/a/Sirrom Capital Corporation.
10.3 Amended and Restated Stock Purchase Warrant covering 365,000 shares Common Stock of Teltronics, Inc. issued May 2, 2002 to Finova Mezzanine Capital, Inc. f/k/a/Sirrom Capital Corporation.
99.1 Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.
99.2 Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.
ITEM 6B. REPORTS ON FORM 8-K - None
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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.
TELTRONICS, INC. August 14, 2002 /s/ Patrick G. Min
Patrick G. Min
Vice President Finance & Chief Financial Officer
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