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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the transition period from __________________________________ to ________________________________

COMMISSION FILE NUMBER:    0-17893

TELTRONICS, INC.

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(Exact name of registrant as specified in its charter)

2150 Whitfield Industrial Way, Sarasota, Florida          34243

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(Address of principal executive offices including zip code)

Issuer's telephone number, including area code:          (941) 753-5000

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Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [   ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12-b-2 of the Exchange Act.) Yes [   ] No [ X ]

As of November 11, 2004, there were 7,861,539 shares of the Registrant's Common Stock, par value $.001, outstanding.

Exhibit index appears on page 35.

TABLE OF CONTENTS

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PART I – FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TELTRONICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS - Continued

LIABILITIES AND SHAREHOLDERS' DEFICIENCY

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 OPERATIONS

(Unaudited)

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)

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 - Continued

(Unaudited)

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 electronic manufacturing services primarily in the telecommunication industry.

The accompanying condensed consolidated financial statements include the accounts of the Company and are comprised of its wholly-owned subsidiaries TTG Acquisition Corp., Teltronics, S.A. de C.V., 36371 Yukon Inc. and Teltronics Limited. All significant intercompany transactions and balances have been eliminated in consolidation.

Effective May 30, 2003, the Company closed on its acquisition of the Vortex technology and related assets from Tri-Link Technologies Inc. ("Tri-Link"). Tri-Link designed a pure soft switch that utilizes Ethernet LAN to provide voice over internet protocol ("VoIP"). Our new product offering derived from this technology, Cypreon™, is the first IP-PCX solution to deliver advanced telephone, videoconferencing, and LAN capabilities in an easily-installed system. The Vortex technology and assets are being held in 36371 Yukon Inc.

Effective February 1, 2004, the Company through its UK subsidiary, Teltronics Limited, entered into a Business Sale and Purchase Agreement ("Business Agreement") with SMARTCALL Limited ("SMARTCALL").

The Company and its UK subsidiary also entered into a Restrictive Covenant and Consultancy Agreement ("Consultancy Agreement") with Beck & Cook Management Services with an effective date of February 1, 2004.

The Company through the execution of the Business Agreement and Consultancy Agreement, collectively referred to as the "Acquisition", acquired the 20-20® maintenance business and the related service inventories of SMARTCALL located in the UK.

This acquisition will enable the Company to change its operating model in the UK and Europe from a pure distributor sales model to a supported sales model selling through distribution and direct. The acquisition will also help the Company fund expansion of its operations in the UK and Europe through the existing maintenance revenues of the business acquired.

The final allocation of the $572,000 USD purchase price to the fair values of assets acquired and liabilities assumed is summarized below. The preliminary purchase price allocation has changed since March 31, 2004 based on completion of the Company's analysis. At March 31, 2004, $432,000 was preliminarily allocated to goodwill.

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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 months and nine months ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

The balance sheet at December 31, 2003 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, 2003.

NOTE 2 - OPERATIONAL MATTERS

The condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company had incurred net losses of approximately $3.3 million, $4.6 million and $6.7 million for the years ended December 31, 2003, 2002, and 2001, respectively, and as discussed below, was in arrears on three significant debt obligations. As a result of the items noted above, which conditions existed as of December 31, 2003, the Report of Independent Certified Public Accountants for the year ended December 31, 2003 indicated that there was substantial doubt regarding the Company's ability to continue as a going concern.

Operations

Sales have decreased over 15% and 14% from 2001 to 2002 and 2002 to 2003, respectively. This has primarily been the result of a weak telecommunications market during the period. Due to the fixed nature of a majority of the Company's expenses, the Company implemented cost cutting measures which resulted in a reduction of operating expenses of $3.2 million from 2001 to 2002 and $2.7 million from 2002 to 2003. The cost cutting measures also contributed to increased gross profit margin percentages in 2002 and 2003. As a majority of the expense reductions in 2003 were made in June 2003, we have been realizing the benefits from these reductions during 2004.

We released two new product offerings late in the fourth quarter of 2003. Although not yet fully realized, we believe that these products should contribute additional sales to the Company and not result in significant additional costs. If sales don't meet the forecasted amounts, the Company will continue to evaluate various operational and financing alternatives.

Secured Promissory Note

On August 16, 2004, the Company entered into a Patent Transfer Agreement with Harris Corporation ("Harris") under which the Company conveyed and transferred all of its rights, title and interest in certain patents initially acquired from Harris in exchange for consideration consisting of the following items: (i) a credit in the amount of $578,022 of accrued and unpaid interest as of June 1, 2004 owed to Harris under the terms of the Secured Promissory Note ("Secured Note") as a result of the Company's acquisition of the Harris 20-20® Product Line in June 2000, (ii) a credit in the amount of $406,792 of unpaid and past due scheduled principal payments as of June 1, 2004 owed to Harris under the terms of the Secured Note, and (iii) a credit of $290,414 representing interest and regularly scheduled principal payments that were due under the terms of the Secured Note for the period from July 1, 2004 through September 1, 2004. The interest rate reverted from the default rate of 12.5% to the original rate of 8.0%, effective June 1, 2004. Consequently, the Company has re-classified $7.5 million of the Secured Note in long-term debt as of September 30, 2004.

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In connection with the Patent Transfer Agreement, the Company recognized a gain of approximately $1.2 million during the three months ended September 30, 2004. The Company has a net operating loss carryforward of approximately $21 million that will be used to offset the $1.2 million gain.

The Secured Note with Harris requires a monthly payment that is due on the first of each month, but no later than the fourth of each month. Certain machinery, equipment and inventory represent the security on the Secured Note. As of December 31, 2003, the Company had been unable to make all payments on the Secured Note since September 2003. Harris had all the rights of a secured party including:

• declaring the entire unpaid balance of the secured note, together with interest accrued thereon, if any and all other sums due from us to be immediately due and payable;

• immediately taking possession or control of the collateral;
• notifying any and all creditors of such event of default and of Harris' enforcement of any rights under the security agreement; or
• selling, assigning or otherwise liquidating, or directing Teltronics to sell, assign or otherwise liquidate any or all of the collateral and to take possession of the proceeds of any such sale or liquidation;

For the six months ended June 30, 2004, the Company paid Harris $84,000 that was applied to past due interest payments. In April 2004, the Company and Harris agreed to offset $234,000 of a February 2004 product sale by Teltronics to Harris against past due interest payments.

As of December 31, 2003, the entire outstanding balance on the Secured Note had been classified in the current portion of long-term debt.

The Company is also in arrears on six quarterly dividend payments due to Harris on the Preferred Series C Convertible stock at September 30, 2004 that totaled $600,000, excluding interest. The Company was in arrears on three quarterly dividend payments at December 31, 2003 that totaled $300,000, excluding interest. The per share amount of dividends in arrears at September 30, 2004 and December 31, 2003 was $15.00 and $7.50, respectively.

Senior Secured Promissory Note

For the period October 2003 through March 2004, the Company had been unable to make any payments on the Senior Secured Promissory Note ("Senior Note") with Finova. On April 30, 2004, the Company and Finova entered into a Forbearance Agreement ("Agreement") through June 30, 2004. In connection with the Agreement, the Company paid $50,000 to Finova on April 30, 2004. The payment represented $8,582 of accrued interest through April 27, 2004, a fee of $7,000, and principal of $34,418.

In September 2004, the Company paid the Senior Note with a payment of $221,000 to Finova of which $220,000 represented principal and $1,000 represented interest.

As of December 31, 2003, the entire outstanding balance on the Senior Note had been classified in the current portion of long-term debt.

The Company is also in arrears on three quarterly dividend payments due on the Preferred Series B Convertible stock at September 30, 2004 that totaled $164,126, excluding interest. The Company was in arrears on two quarterly dividend payments at December 31, 2003 that totaled $101,000, excluding interest. The per share amount of dividends in arrears at September 30, 2004 and December 31, 2003 was $13.00 and $8.00, respectively.

Note payable to Tri-Link

The Company was unable to make its scheduled quarterly installments in November 2003, February 2004, May 2004, August 2004, and November 2004 on the Note Payable ("Note") to Tri-Link. The Note does not provide for an acceleration of all outstanding amounts if a payment is claimed to be past due and therefore, $540,000 of this Note is classified as long-term debt as of September 30, 2004. At

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December 31, 2003, $1,080,000 of this Note was classified as long-term debt. The Company is currently in arbitration with Tri-Link regarding various claims against each other, including the non-payment of the November 2003, February 2004, May 2004, August 2004, and November 2004 scheduled quarterly installments on the Note (see Note 10).

NOTE 3 - ACCOUNTING FOR STOCK-BASED COMPENSATION

Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans based on the fair value of options granted. The Company has chosen to account for stock based compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, because the grant price equals the market price on the date of grant for options issued by the Company, no compensation expense is recognized for stock options issued to employees.

In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, Accounting for Stock Based Compensation - Transition and Disclosure, which amends SFAS No. 123. SFAS No. 148 requires more prominent and frequent disclosures about the effects of stock-based compensation.

Had compensation cost for the Company's stock options been recognized based upon the estimated fair value on the grant date under the fair value methodology prescribed by SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been as follows:

The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and the Company's experience.

NOTE 4 - COMPREHENSIVE INCOME (LOSS)

Total comprehensive income (loss) is as follows:

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NOTE 5 - 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.

The following table sets forth the computation of basic and diluted net income (loss) per share:

For the three months and nine months ended September 30, 2004, and the three months ended September 30, 2003, options to purchase 1,078,000 and 1,048,000 shares of common stock, respectively, were not included in the computation of diluted net income per share because those options' exercise prices were greater than the average market price of the common shares, and therefore the effect would be anti-dilutive.

For the nine months ended September 30, 2003, options to purchase 1,626,000 shares of common stock were not included in the computation of diluted net loss per share because the effect would be anti-dilutive.

For the three months and nine months ended September 30, 2004 and 2003, warrants to purchase 1,190,000 shares of common stock were not included in the computation of diluted net income (loss) per share because the effect would be anti-dilutive.

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NOTE 6 - COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

Costs and estimated earnings on uncompleted contracts includes unbilled revenue of approximately $192,000 and $254,000 as of September 30, 2004 and December 31, 2003, respectively.

NOTE 7 - INVENTORIES

The major classes of inventories are as follows:

The valuation allowance for slow moving inventories was $527,000 and $1,222,000 as of September 30, 2004 and December 31, 2003, respectively.

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NOTE 8 - OTHER INTANGIBLE ASSETS

The Company's other intangible assets are as follows:

September 30, 2004 (Unaudited)

December 31, 2003

As a result of the SMARTCALL acquisition, $432,000 of the purchase price was allocated to Customer contracts and relationships as of September 30, 2004.

As further described in Note 2, the Company sold certain patents with a net book value of approximately $42,000 in August 2004.

Amortization is provided over the estimated useful lives of the respective assets using the straight-line method. Amortization expense related to intangible assets was $25,510 and $15,185 for the three months ended September 30, 2004 and 2003, respectively. Amortization expense related to intangible assets was $74,235 and $45,555 for the nine months ended September 30, 2004 and 2003, respectively. Estimated amortization expense related to other intangible assets for each of the five years in the period ending December 31, 2009 and thereafter is: 2004 - $24,904; 2005 - $82,927; 2006 - $71,358; 2007 - $71,358; 2008 - $71,358; 2009 - $71,358; thereafter - $115,037.

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NOTE 9 - DEBT

Debt consists of the following:

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The Company maintains a Secured 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. 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 and all accrued and unpaid interest will be due. The interest rate was 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. The Secured Note is secured by a first lien on certain of the acquired assets and a lien on the Company's other assets.

As a result of the event of default described in Note 2 with respect to the Secured Note prior to the Patent Transfer Agreement, the interest rate was increased from 8.0% to 12.5%. As of December 31, 2003, the entire outstanding balance on the Secured Note had been classified in the current portion of long-term debt.

On February 25, 1998, the Company entered into Senior Secured Loans for $1,000,000 and $280,000 with Finova. 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 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. On September 30, 2002, Finova and the Company entered into a Fourth Amended and Restated Senior Secured Promissory Note. Under the terms of this note, monthly principal and interest payments of $55,000 were required commencing October 1, 2002 until August 13, 2003 at which time a balloon payment of the remaining unpaid balance of $303,000 would be due. The interest rate was increased from 12% to 14%. On September 9, 2003, the Company and Finova entered into a Fifth Amended and Restated Senior Secured Promissory Note ("Senior Note"). Under the terms of the Senior Note, monthly principal and interest payments of $55,000 were required commencing September 1, 2003 until February 1, 2004 (maturity date). The interest rate remained at 14%.

On April 30, 2004, the Company and Finova entered into a Forbearance Agreement ("Agreement") through June 30, 2004. In connection with the Agreement, the Company paid $50,000 to Finova on April 30, 2004. The payment represented $8,582 of accrued interest through April 27, 2004, a fee of $7,000, and a reduction in the outstanding principal balance of $34,418.

In September 2004, the Company paid the Senior Note with a payment of $221,000 to Finova of which $220,000 represented principal and $1,000 represented interest.

The entire outstanding balance on the Senior Note had been classified in the current portion of long-term debt as December 31, 2003.

Finova 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 Third Amended and Restated Senior Secured Promissory Note, Finova and the Company entered into an Amended and Restated Stock Purchase 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. 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 $160,200 in 2002. This fee was expensed as a financing cost in our condensed consolidated statement of operations in 2002.

As described above, the Company and Finova entered into an Agreement on April 30, 2004. In accordance with the Agreement, the exercise period of the 890,000 warrants was extended from February 26, 2004 to February 21, 2005. As a result of extending the exercise period, the Company recorded a financing fee of approximately $53,000 in April 2004. This fee was expensed as a financing

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cost in our condensed consolidated statement of operations during the nine months ended September 30, 2004.

The covenants in the Secured Note 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.

As described in Note 1 to the condensed consolidated financial statements, the Company closed on its acquisition of the Vortex technology from Tri-Link with an effective date of May 30, 2003. The consideration for the assets purchased from Tri-Link was $2,500,000, of which $250,000 was paid at closing with the remaining balance of $2,250,000 scheduled to be paid in quarterly principal installments of $187,500 plus interest at 6.5%. The Note Payable ("Note") is collateralized primarily by the Vortex technology and technology assets. Tri-Link was granted the right, at its sole option, to convert at any time and from time to time, up to $750,000 of the balance of the purchase price then remaining unpaid into shares of the Company's voting common stock at prices ranging from $0.22 per share to $1.00 per share (maximum of 1,125,000 shares of common stock).

On October 24, 2003, the Company issued 375,000 shares of Common stock to Tri-Link as consideration for the conversion of $82,500 of the Company's obligation to Tri-Link. As a result of the conversion, the Company's quarterly principal installment was reduced to $180,000.

The Company was unable to make its scheduled quarterly installments in November 2003, February 2004, May 2004, August 2004 and November 2004 on the Note to Tri-Link (see Note 10). The Note does not provide for an acceleration of all outstanding amounts if a payment is claimed to be past due and therefore, $540,000 of this Note is classified as long-term debt as of September 30, 2004. At December 31, 2003, $1,080,000 of this Note was classified as long-term debt.

During the three months ended September 30, 2004, an entity controlled by a Director of the Company provided a short-term loan of $350,000 and was subsequently repaid $350,000, plus a financing fee of $50,000.

NOTE 10 - CONTINGENCIES

Legal Proceedings

The Company from time to time is involved in legal actions arising in the ordinary course of business. With respect to these matters, management believes that it has adequate legal defenses or has provided adequate accruals for related costs such that the ultimate outcome will not have a material adverse effect on the Company's future financial position or results of operations.

The Company was formally notified by Tri-Link on March 9, 2004 that Teltronics, Inc. was in default of its obligations under the Tri-Link Agreement of Purchase and Sale ("Agreement"). In the default notice, Tri-Link demands immediate payment of the past due principal and interest payments totaling $426,098 (November 2003 and February 2004 quarterly installments). The notice also stated that Tri-Link would immediately compel final and binding arbitration as allowed in the Agreement and would enforce all such other remedies, provisional and otherwise, as it may have with respect to such claims under the Agreement.

On March 10, 2004, the Company received a Demand for Arbitration notice from the American Arbitration Association notifying Teltronics of Tri-Link's demand for arbitration. Teltronics was further notified on March 12, 2004 by the International Centre for Dispute Resolution of their receipt of Tri-Link's demand for arbitration. Limited discovery will occur over the next few months and an arbitration hearing is scheduled to commence on February 28, 2005 in Toronto.

In its Demand for Arbitration, Tri-Link seeks payment by Teltronics of the total sum of $426,098 and the immediate issuance to Tri-Link of 900,000 shares of Teltronics' common voting stock.

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In its Answering Statement and Counterclaims, Teltronics seeks a declaration that issuance of 900,000 shares of its common voting stock satisfies the requirements of the contract for payment where the appropriate cash payments have not been made. In addition, as and for its counterclaims, Teltronics seeks findings that Tri-Link is in breach of the purchase agreement and its obligation of good faith and fair dealing inherent in that contract; that Tri-Link breached its express and implied warranties and fitness for a particular purpose; that Tri-Link engaged in fraudulent concealment and inducement; and that Tri-Link is guilty of negligent misrepresentation. Teltronics seeks an amount, as stated in its Answering Statement, in excess of $1 million.

The Company has been notified by Tri-Link that it intends to seek possession of the Vortex technology which Tri-Link claims secures its right to payment.

The Company was named as a party to a lawsuit filed in the State of New York. The lawsuit alleges that various parties who entered into contracts with the New York Department of Education, did not insure that a subcontractor paid its employees in accordance with the prevailing wage rate required by the State of New York. The Company intends to vigorously defend itself and believes it has meritorious defenses.

NOTE 11 - EXIT ACTIVITY

In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146 Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146). SFAS No. 146 required recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing or other exit or disposal activity.

The Company reduced its work force by approximately 15% at June 30, 2003. The reduction in force was part of an overall effort by the Company to reduce its expenses to better align them with the current sales levels. The reduction in force was across the Company and affected the majority of employee groups and locations. As a result of the reduction in force, the Company recognized a one time termination benefit charge of approximately $250,000 in June 2003. This charge was allocated to cost of goods sold and the operating expense categories.

The Company leases office space for a research and development facility in Dallas, Texas. The lease expires in December 2006. In December 2002, the Company closed its facility in Dallas, Texas. Teltronics will continue to incur rental costs under the Dallas lease agreement without receiving any future economic benefit.

Teltronics early adopted the provisions of SFAS No. 146 in 2002, and as a result, the Company recorded an expense of approximately $437,000 in December 2002 that represented the present value of our liability (lease obligation) as of December 31, 2002. This expense was reported as a general and administrative expense in our consolidated statement of operations for 2002. Prior to the closing of our Dallas facility, our Dallas rental expenses were reported as a research and development expense. Commencing January 1, 2003, our Dallas rental expenses are reported as a general and administrative expense.

Effective June 1, 2004, the Company and Eagle-Midway Place, L.P. ("Lessor") entered into an Amendment to Industrial Real Estate Lease ("Amendment") for the Dallas facility. The Amendment was caused by a 35% reduction in office space leased by the Company and the corresponding lease payments. As a result of the Amendment, the Company recorded a reduction in the present value of the lease obligation of approximately $103,000. In addition, the Company incurred a charge of $49,000 for tenant improvements caused by the reduction in office space, however; the Company will receive a credit from the Lessor of $24,500 that will be applied to past due rent payments as of May 31, 2004. The Company is in default under the lease for non-payment of rent.

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In connection with the Amendment, the Company recorded a benefit of approximately $79,000 during the nine months ended September 30, 2004. This benefit was reported as a reduction in general and administrative expense in our condensed consolidated statements of operations.

The changes in the Company's unaudited lease obligation for the nine months ended September 30, 2004 and 2003 are as follows:

NOTE 12 - WARRANTY

The Company provides currently for the estimated cost that may be incurred under product warranties. Factors that affect the Company's product liability include the number of installed units, historical and anticipated rates of warranty claims, and cost per claim. The Company provides a limited warranty on its products, for a period from 3 to 18 months (depending on the product), under which the Company agrees to repair or replace, in the Company's sole discretion, units defective in material or workmanship, provided the equipment has not been subjected to alteration or abuse.

Changes in the Company's unaudited product liability during the nine months ended September 30, 2004 and 2003 are as follows:

NOTE 13 - SHAREHOLDERS' DEFICIENCY

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, whereby the annual dividend rate increased from $12 per share to $16 per share, payable quarterly, effective February 26, 2002. The annual dividend rate increased to $18 per share on February 27, 2004 and will increase 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 Third Amended and

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Restated Senior Secured Promissory Note. Commencing in 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 covenants. If we are in arrears on four quarterly dividend payments on our Preferred Series B Convertible stock (whether or not consecutive) or any part thereof, including interest, then the number of directors comprising our Board of Directors shall be increased to a number that allows the holders of our Preferred Series B Convertible stock to elect a majority of our Board of Directors.

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)           Common stock - In March 2003, the Company recorded the issuance of 1.0 million shares of Common stock with a fair value of $200,000 as additional compensation for 2003 services by its Board of Directors. The compensation was expensed as a general and administrative expense in our condensed consolidated statements of operations commencing January 1, 2003 through December 31, 2003.

In April 2003, the Company issued 362,184 shares with a fair value of $42,958 in connection with the Employee Stock Purchase Plan.

In June 2003, the Company issued 62,311 shares with a fair value of $33,648 to the Savings Plan ("401(k) plan").

In April 2004, the Company issued 11,803 shares with a fair value of $3,520 in connection with the Employee Stock Purchase Plan.

(C)           Warrants - In connection with the Third Amended and Restated Senior Secured Promissory Note, Finova and the Company entered into an Amended and Restated Stock Purchase 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.

On April 30, 2004, the Company and Finova entered into a Forbearance Agreement ("Agreement") through June 30, 2004. In accordance with the Agreement, the exercise period was extended from February 26, 2004 to February 21, 2005. As a result of extending the exercise period, the Company recorded a financing expense of approximately $53,000 during the nine months ended September 30, 2004.

In connection with our financial advisory and investment banking agreement entered into in September 2002 with Atlantic American Capital Advisors, LLC, the Company issued warrants to purchase 300,000 shares of its Common stock at an exercise price of $1.00 per share. The exercise period of the warrants is five years.

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NOTE 14 - SEGMENT INFORMATION

The Company's operations are classified into three reportable segments, Teltronics, Mexico and Teltronics Limited. As described in Note 1, the Company acquired the assets of the 20-20® maintenance business of SMARTCALL Limited located in the UK. As a result, the Company has classified the operations of our subsidiary, Teltronics Limited, referred to as the UK segment, as a reportable segment commencing February 1, 2004.

The accounting policies of the segments are the same. Company management evaluates performance based on segment profit (loss), which is net income (loss) before taxes, excluding nonrecurring gains or losses.

The following table presents unaudited information about reportable segment operations and assets.

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NOTE 15 - SUBSEQUENT EVENT

On October 19, 2004, the Company entered into an Investment Agreement ("Investment Agreement") under which the Company would issue to International Media Network AG ("IMN") 24,000,000 unregistered, restricted shares of its voting Common Stock ("Shares") which, if consummated, would result in IMN owning more than 51% of the outstanding Common Stock of the Company after issuance. The proposed purchase price of the Shares is $45,000,000 U.S. which would be payable by IMN's delivery at the Closing of $15,000,000 U.S. cash and two (2) Promissory Notes, each in the amount of $15,000,000 U.S. (respectively referred to as the "First Promissory Note" and the "Second Promissory Note").

The First Promissory Note would be payable one (1) year after the Closing Date. The Second Promissory Note would be payable two (2) years after the Closing Date, provided the Company maintains a budget for the 2005 calendar year as contemplated by the Investment Agreement. The obligations of IMN under the First Promissory Note, Second Promissory Note and the Investment Agreement would be secured by a pledge of the Shares not fully paid for by IMN.

The Investment Agreement contains covenants requiring IMN to execute documents at Closing that among other things will maintain a board of the Company consisting of seven (7) members, two (2) of which would be designated by IMN.

The Closing under the Investment Agreement is conditioned upon the Company's Senior Vice President of Business Development, Norman R. Dobiesz, exchanging his 100,000 shares of the Company's Series A Preferred Stock for 33.4 percent of IMN's Common Stock pursuant to a Share Exchange Agreement with IMN. Among other things, the Share Exchange Agreement is conditioned on the Company amending its Certificate of Designation, Preferences and Rights relating to the Series A Preferred Stock so that the Series A Preferred Stock will have additional rights and preferences including conversion rights on a one-to-one basis into shares of Common Stock at a price of $2.00 U.S. per share and payments of $150 U.S. per share in the event of liquidation, dissolution of winding up of the Company.

The Share Exchange Agreement contemplates that at the Closing, IMN will enter into a voting agreement with Mr. Dobiesz granting Mr. Dobiesz the right to vote the Series A Preferred Stock for a minimum of five (5) years and terminating after complete and final performance by IMN of all of its obligations under the Investment Agreement.

The Closing of the proposed transactions provided in the Investment Agreement and the Share Exchange Agreement are scheduled to occur on or before February 28, 2005, and are subject to several conditions that may not occur. The Company, therefore, cannot assure that the Closing will ever occur, or that if it occurs, the Closing will be on the terms and conditions contained in the Investment Agreement and the Share Exchange Agreement.

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ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

References in this report to the "Company," "Teltronics," "we," or "us" mean Teltronics, Inc. together with its subsidiaries, except where the context otherwise requires. 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 can generally be identified as such because the context of the statement will include words such as we "believe," "anticipate," "expect," or words of similar import. Similarly, statements that describe our future plans, objectives, strategies or goals are also forward-looking statements. These forward-looking statements involve a number of risks and uncertainties that may materially adversely affect the anticipated results. Such risks and uncertainties include, but are not limited to, 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, and other factors described in the Company's filings with the Securities and Exchange Commission. Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements made herein and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Form 10-Q and we disclaim any obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

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. We have identified the following critical accounting policies that affect the more significant judgments and estimates used in preparing our condensed consolidated financial statements. The condensed consolidated financial statements and the related notes thereto should be read in conjunction with the following discussion of our critical accounting policies.

Our critical accounting policies and estimates are as follows:

Revenue recognition. Teltronics generates revenues through different sources.

• Manufacturing. Revenues from sales of product, including our electronic manufacturing services business are recognized when title and risk of loss passes, which is generally when the product is shipped. Based on the Company's history of providing 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). SOP 81-1 provides two generally accepted methods of accounting for construction or production type contracts: (1) the percentage of completion method and (2) the completed contract method. The determination of which of the two methods is preferable is based on a careful evaluation of circumstances because the two methods should not be acceptable alternatives for the same circumstances. The circumstance that the Company considers the most significant when determining the appropriate method of accounting is the right to require the customer to make progress payments to support their ownership investment and to approve the services performed to date if they meet the contract requirements.

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The percentage of completion method recognizes revenue and related costs as work on a contract progresses. The progress of a contract in terms of recognizing revenue and related costs is based on satisfying the milestones for the specified contract.

The completed contract method recognizes revenue and related costs when the contract is completed and has been accepted by the customer. All costs and related billings are reported as costs and estimated earnings on uncompleted contracts in the balance sheet until that time.

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.

• 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. Costs from support and maintenance activities are recognized when the related revenue is recognized or when those costs are incurred, whichever occurs first.

• Revenue Arrangements with Multiple Deliverables. Certain of the Company's arrangements include multiple deliverables, which consist of product, installation, and training. In the absence of higher-level specific authoritative guidance, the Company determines the units of accounting for multiple element arrangements in accordance with Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Specifically, the Company will consider a delivered item as a separate unit of accounting if it has value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and, if the arrangement includes a general right of return relative to the delivered element, delivery or performance of the undelivered element is considered probable and is substantially within the Company's control.

Accounts receivable. A considerable amount of judgment is required when we assess the ultimate realization of receivables, including assessing the following factors: probability of collection, the current credit-worthiness of each customer and the economy. We recognize an allowance for doubtful accounts based on these factors, including the length of time the receivables are past due and an analysis of the specific facts relative to the customer. We may record an additional provision for doubtful accounts to our allowance for doubtful accounts if factors relative to the customer change. We charge off outstanding balances after all collection efforts have been exhausted.

Slow moving inventories. We write down our slow moving inventories equal to the difference between the carrying value of the inventories 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, an additional inventory write-down may be required.

Impairment of Intangible and Long-Lived Assets. Long-lived assets consist of fixed assets and intangible assets. We periodically evaluate the recovery of long-lived assets when impairment indicators are present. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions, estimated future cash flows, expected useful life of long-lived assets and the operational performance of our business. Future events could cause us to conclude that impairment indicators exist and that long-lived assets associated with our business are impaired.

The Company periodically performs reviews of the recoverability of capitalized software costs. At the time a determination is made that capitalized amounts are not recoverable based on the estimated cash flows to be generated from the applicable software, any remaining capitalized amounts are written off.

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Warranty and Service. The Company provides currently for the estimated cost that may be incurred under product warranties. Factors that affect the Company's product liability include the number of installed units, historical and anticipated rates of warranty claims, and cost per claim. The Company provides a limited warranty on its products, for a period from 3 to 18 months (depending on the product), under which the Company agrees to repair or replace, in the Company's sole discretion, units defective in material or workmanship, provided the equipment has not been subjected to alteration or abuse. The product liability may change in the future based on changes in the factors noted above.

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.

Seasonality

The Company has experienced seasonality due in part to purchasing tendencies of our customers during the fourth and first quarters of each calendar year. Consequently, net sales for the fourth and first quarters of each calendar year are typically not as strong as results during the other quarters. The net sales of the Company continued to be impacted by the general slowdown of telecommunications expenditures.

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 months and nine months ended September 30, 2004 and 2003.

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Net Sales and Gross Profit Margin

Net sales decreased $1.6 million or 12.2% for the three months ended September 30, 2004 as compared to the same period in 2003. Net sales decreased $2.7 million or 7.2% for the nine months ended September 30, 2004 as compared to the same period in 2003. The decreases in net sales were primarily attributable to a slow down in net sales to our larger customers.

Gross profit margin for the three months ended September 30, 2004 and 2003 was 41.0% and 40.8%, respectively. Gross profit margin for the nine months ended September 30, 2004 and 2003 was 40.9% and 39.8%, respectively.

Excluding affects of the provision for slow moving inventories, the gross profit margin for the three months and nine months ended September 30, 2004 would have been 41.8% and 41.5%, respectively. Gross profit margin, excluding affects of the provision for slow moving inventories for the year ended December 31, 2003 would have been 41.3%. The gross profit margin is impacted by changes in product mix, manufacturing variances and project management.

Operating Expenses

Operating expenses were $4.2 million and $4.3 million for the three months ended September 30, 2004 and 2003, respectively.

General and administrative expenses decreased $25,000 for the three months ended September 30, 2004 as compared to the same period in 2003. The net decrease for the three months ended September 30, 2004 was primarily a result of the following items: (a) a $78,000 decrease in wages and benefits related to the departure of personnel in 2004, (b) a $51,000 decrease in public entity expense, and (c) a $20,000 decrease in 401(k) expense. These decreases were partially offset by a $34,000 increase in professional fees and a $91,000 increase in the provision for doubtful accounts.

Sales and marketing expenses decreased $81,000 for the three months ended September 30, 2004 as compared to the same period in 2003. The net decrease for the three months ended September 30, 2004 was primarily a result of the following items: (a) a $39,000 decrease in wages and benefits related to the departure of personnel in 2004, (b) a $126,000 decrease in commissions, (c) a $39,000 decrease in rent, (d) a $9,000 decrease in travel, meals, and entertainment, (e) a $19,000 decrease in telephone and cell phone charges, and (f) a $21,000 decrease in professional fees. These decreases were partially offset by an increase in UK expenses of $171,000, as a result of the SMARTCALL acquisition effective February 1, 2004.

Research and development expenses increased $65,000 for the three months ended September 30, 2004 as compared to the same period in 2003. The net increase for the three months ended September 30, 2004 was primarily a result of a $221,000 increase in operating supplies at our research facilities, which was partially offset by a $156,000 decrease in wages and benefits related to the departure of personnel in 2004.

Operating expenses were $13.2 million and $15.3 million for the nine months ended September 30, 2004 and 2003, respectively.

General and administrative expenses decreased $375,000 for the nine months ended September 30, 2004 as compared to the same period in 2003. The net decrease for the nine months ended September 30, 2004 was primarily a result of the following items: (a) a $169,000 decrease in public entity expense, (b) an $80,000 decrease in rental expense related to the net reduction in the Dallas lease obligation due to the lease amendment in 2004, (c) a $293,000 decrease in wages, benefits and severance related to the June 2003 reduction in force and departure of personnel in 2004, and (d) a $53,000 decrease in 401(k) expense. These decreases were partially offset by a $150,000 increase in professional fees and a $98,000 increase in the provision for doubtful accounts.

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Sales and marketing expenses decreased $642,000 for the nine months ended September 30, 2004 as compared to the same period in 2003. The net decrease for the nine months ended September 30, 2004 was primarily a result of the following items: (a) a $416,000 decrease in wages, benefits and severance related to the June 2003 reduction in force and departure of personnel in 2004, (b) a $265,000 decrease in commissions, (c) a $146,000 decrease in travel, meals, and entertainment, (d) a $47,000 decrease in advertising and trade shows, (e) a $46,000 decrease in telephone and cell phone charges, and (f) a $77,000 decrease in professional fees. These decreases were partially offset by an increase in UK expenses of $410,000, as a result of the SMARTCALL acquisition effective February 1, 2004.

Research and development expenses decreased $1.0 million for the nine months ended September 30, 2004 as compared to the same period in 2003. The net decrease for the nine months ended September 30, 2004 was primarily a result of the following items: (a) a $775,000 decrease in wages, benefits and severance related to the June 2003 reduction in force and departure of personnel in 2004, (b) a $121,000 decrease in operating supplies, and (c) a $40,000 decrease in professional fees.

Other Income (Expense)

For the three months ended September 30, 2004, interest expense decreased $61,000, financing costs increased $1,000, and other expenses decreased $12,000 as compared to the same period in 2003. The decrease in interest expense was primarily a result of the decrease in our outstanding debt. The gain on sale of patents of $1.2 million was a result of the Patent Transfer Agreement the Company entered into with Harris Corporation in August 2004. This transaction is further described in Note 2 of the September 30, 2004 Notes to Condensed Consolidated Financial Statements.

For the nine months ended September 30, 2004, interest expense increased $174,000, financing costs decreased $45,000, and other expenses decreased $6,000 as compared to the same period in 2003. The increase in interest expense was primarily a result of the increase in interest rate on the Harris debt for the period January 1, 2004 to June 1, 2004. The decrease in financing costs was primarily related to the services of Atlantic American in 2003 that were terminated by December 31, 2003, offset by the extension of the exercise period of the Finova warrants and the financing fees from an investment services firm and related party. The gain on sale of patents of $1.2 million was a result of the Patent Transfer Agreement the Company entered into with Harris Corporation in August 2004. This transaction is further described in Note 2 of the September 30, 2004 Notes to Condensed Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

Net cash flows provided by Operating Activities

Net cash flows provided by operating activities were $152,000 for the nine months ended September 30, 2004. The $152,000 was comprised of the following items: (1) net income of $1,105,000, (2) non-cash expenses(gain) of $897,000, (3) a net increase in operating assets, net of acquisition, of $3,629,000, and (4) a net increase in operating liabilities, net of acquisition, of $1,779,000. The net increase in operating assets was primarily a result of an increase in accounts receivable of $4,721,000. The net increase in operating liabilities was a result of an increase in accounts payable of $1,727,000, an increase in deferred revenue of $167,000, and an increase in billings in excess of costs and estimated earnings on uncompleted contracts of $30,000, which were partially offset by a decrease in accrued expenses of $145,000.

Net cash flows used in Investing Activities

Net cash flows used in investing activities were $452,000 for the nine months ended September 30, 2004 as the Company acquired $134,000 of property and equipment to support its operations and made payments of $318,000 for inventories and customer contracts and relationships in connection with its acquisition of SMARTCALL Limited.

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Net cash flows provided by Financing Activities

Net cash flows provided by financing activities were $1,051,000 for the nine months ended September 30, 2004. The Company had net borrowings on its line of credit of $1,532,000 and net principal repayments of $385,000 related to its debt to Finova and finance companies. Additionally, the Company paid dividends on the Preferred Series B Convertible stock of $101,000. These uses of cash were partially offset by proceeds from the issuance of Common stock under the Company's Employee Stock Purchase Plan of $5,000. During the nine months ended September 30, 2004, an entity controlled by a Director of the Company provided a short-term loan of $350,000 and was subsequently repaid $350,000, plus a financing fee of $50,000, from cash flows generated from operating activities.

Liquidity

Our liquidity needs arise from our debt service obligations, working capital needs and capital expenditures. We have historically funded our liquidity needs with proceeds from our line of credit with CIT and cash flows from operations. We have incurred a net loss of $3.3 million, $4.6 million and $6.7 million in 2003, 2002 and 2001, respectively. These losses have significantly weakened our financial position and ability to make the required debt service and dividend payments. Future liquidity and cash requirements will depend on a wide range of factors including the level of business in existing operations and credit lines extended by trade suppliers. Our ability to maintain sufficient liquidity in the future is impacted by several factors including continued management of our costs and balance sheet, successfully achieving our product release schedules and the attainment of our forecasted sales objectives.

The Company has engaged an investment services firm as financial advisor to assist the Company in developing and exploring strategic opportunities, which may include raising capital, mergers, acquisitions, strategic partnerships or joint ventures, and various other services, all ultimately designed to maximize shareholder value.

On October 19, 2004, the Company entered into an Investment Agreement ("Investment Agreement") under which the Company would issue to International Media Network AG ("IMN") 24,000,000 unregistered, restricted shares of its voting Common Stock ("Shares") which, if consummated, would result in IMN owning more than 51% of the outstanding Common Stock of the Company after issuance. The proposed purchase price of the Shares is $45,000,000 U.S. which would be payable by IMN's delivery at the Closing of $15,000,000 U.S. cash and two (2) Promissory Notes, each in the amount of $15,000,000 U.S. (respectively referred to as the "First Promissory Note" and the "Second Promissory Note").

The First Promissory Note would be payable one (1) year after the Closing Date. The Second Promissory Note would be payable two (2) years after the Closing Date, provided the Company maintains a budget for the 2005 calendar year as contemplated by the Investment Agreement. The obligations of IMN under the First Promissory Note, Second Promissory Note and the Investment Agreement would be secured by a pledge of the Shares not fully paid for by IMN.

The Investment Agreement contains covenants requiring IMN to execute documents at Closing that among other things will maintain a board of the Company consisting of seven (7) members, two (2) of which would be designated by IMN.

The Closing under the Investment Agreement is conditioned upon the Company's Senior Vice President of Business Development, Norman R. Dobiesz, exchanging his 100,000 shares of the Company's Series A Preferred Stock for 33.4 percent of IMN's Common Stock pursuant to a Share Exchange Agreement with IMN. Among other things, the Share Exchange Agreement is conditioned on the Company amending its Certificate of Designation, Preferences and Rights relating to the Series A Preferred Stock so that the Series A Preferred Stock will have additional rights and preferences including conversion rights on a one-to-one basis into shares of Common Stock at a price of $2.00 U.S. per share and payments of $150 U.S. per share in the event of liquidation, dissolution of winding up of the Company.

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The Share Exchange Agreement contemplates that at the Closing, IMN will enter into a voting agreement with Mr. Dobiesz granting Mr. Dobiesz the right to vote the Series A Preferred Stock for a minimum of five (5) years and terminating after complete and final performance by IMN of all of its obligations under the Investment Agreement.

The Closing of the proposed transactions provided in the Investment Agreement and the Share Exchange Agreement are scheduled to occur on or before February 28, 2005, and are subject to several conditions that may not occur. The proceeds from the closing of the proposed transactions are expected to be used to retire a portion of the Company's debt and for working capital. The Company, therefore, cannot assure that the Closing will ever occur, or that if it occurs, the Closing will be on the terms and conditions contained in the Investment Agreement and the Share Exchange Agreement.

As described above, the Company is working to raise additional capital; however, there is no assurance that these efforts will be successful and that we will achieve profitability or, if we achieve profitability, that it will be sustainable, or that we will continue as a going concern. As a result, our predecessor independent certified public accountants included an explanatory paragraph for a going concern matter in their report for the year ended December 31, 2003. The year ended December 31, 2003 and nine months ended September 30, 2004 financial statements do not include any adjustments relating to the recoverability of recorded asset amounts that might be necessary as a result of the above uncertainty.

As of September 30, 2004, the Company had cash and cash equivalents of $909,345 as compared to $146,277 as of December 31, 2003. Working capital deficiency as of September 30, 2004 and December 31, 2003 was $2,235,900 and $10,888,995, respectively. The working capital deficiency at December 31, 2003 was primarily a result of the long-term portion of the secured promissory note payable to Harris of approximately $7.7 million being classified as current portion of long- term debt due to our inability to make principal and interest payments.

Our principal obligations as of September 30, 2004, consisted primarily of the following items: (1) a Secured Note payable to Harris of $8.0 million, (2) dividends on our Series B and Series C Preferred Stock, of which $1,450,000 will be due and payable within the next twelve months, (4) a bank line of credit payable to CIT of $2,928,000, and (5) a Note for $1,980,000 aggregate principal amount payable to Tri-Link.

On August 16, 2004, the Company entered into a Patent Transfer Agreement with Harris Corporation ("Harris") under which the Company conveyed and transferred all of its rights, title and interest in certain patents initially acquired from Harris in exchange for consideration consisting of the following items: (i) a credit in the amount of $578,022 of accrued and unpaid interest as of June 1, 2004 owed to Harris under the terms of the Secured Promissory Note ("Secured Note"), (ii) a credit in the amount of $406,792 of unpaid and past due scheduled principal payments as of June 1, 2004 owed to Harris under the terms of the Secured Note, and (iii) a credit of $290,414 representing interest and regularly scheduled principal payments that were due under the terms of the Secured Note for the period from July 1, 2004 through September 1, 2004. The interest rate reverted from the default rate of 12.5% to the original rate of 8.0%, effective June 1, 2004. Consequently, the Company has re-classified $7.5 million of the Secured Note in long-term debt as of September 30, 2004. In connection with the Patent Transfer Agreement, the Company recognized a gain of approximately $1.2 million during the three months ended September 30, 2004.

On September 9, 2003, the Company and Finova entered into a Fifth Amended and Restated Senior Secured Promissory Note ("Senior Note"). Under the terms of the Senior Note, monthly principal and interest payments of $55,000 were required commencing September 1, 2003 until February 1, 2004 (maturity date). The interest rate remained at 14%. On April 30, 2004, the Company and Finova entered into a Forbearance Agreement ("Agreement") through June 30, 004. In connection with the Agreement, the Company paid $50,000 to Finova on April 30, 2004. The payment represented $8,582 of accrued interest through April 27, 2004, a fee of $7,000, and principal of $34,418.

In September 2004, the Company paid the Senior Note with a payment of $221,000 to Finova of which $220,000 represented principal and $1,000 represented interest.

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We have 12,625 shares of Series B and 40,000 shares of Series C Preferred Stock outstanding as of December 31, 2003. Holders of shares of our Series B Preferred Stock were entitled to receive annual dividends of $16 per share, payable quarterly. The annual dividends increased to $18 per share on February 27, 2004 and will increase to $20 per share on February 27, 2005. Holders of shares of our Series C Preferred Stock are entitled to receive annual dividends of $10 per share, payable quarterly and increasing to $20 per share beginning April 1, 2007. If we are in arrears on four quarterly dividend payments on our Series B Preferred Stock (whether or not consecutive) or any part thereof, including interest, then the number of directors comprising our Board of Directors shall be increased to a number that allows the holders of our Series B Preferred Stock to elect a majority of our Board of Directors. As of September 30, 2004, we were in arrears six dividend payments on our Series C Preferred Stock and three payments on our Series B Preferred Stock.

We have a credit facility with CIT, as described in the notes to our consolidated financial statements. The credit facility has a maximum credit limit of $5.5 million with an interest rate of 2.5% above prime. The applicable margin (2.5%) may vary from 2.0% to 3.0% depending on the Company's financial results for the year ended December 31, 2002 and the year ended December 31, 2003. At September 30, 2004 and December 31, 2003, the Company's interest rate was 7.75% and 7.00%, respectively. The amount available under this credit facility is subject to restriction based on availability formulas. The availability formulas relate primarily to the eligibility of accounts receivable as part of the Company's borrowing base. As a result of the foregoing availability restrictions, the amount available under this credit facility as of September 30, 2004 was $232,000. The CIT credit facility is secured by a lien on substantially all our assets and a pledge of substantially all the capital stock of our subsidiaries. Effective October 28, 2004, the Company and CIT entered into a Termination Extension through November 30, 2004. The Company is continuing negotiations with CIT regarding a possible further extension of our credit facility. There is no assurance that the Company will be able to renegotiate the CIT credit facility. We are also evaluating comparable line of credit arrangements with other lenders; however, we do not have any commitments for such funding at this time. If the Company does not have sufficient liquidity to satisfy the CIT credit facility, the Company could seek protection under the United States Bankruptcy laws.

On June 4, 2003, we completed the acquisition of Vortex technology and related assets from Tri-Link of Burnaby, British Columbia, pursuant to an Agreement of Purchase and Sale (the "Agreement") of Vortex Technology dated October 31, 2002, as amended on May 30, 2003, for $2.5 million. We also agreed to pay to Tri-Link, royalties on the net sales derived by us from certain components of the Vortex technology. We paid $250,000 of the purchase price, in cash, at the closing. We paid the remainder of the purchase price, excluding royalties, by delivering our Note for $2,250,000 aggregate principal amount. Our Note in favor of Tri-Link is payable in twelve equal quarterly principal payments of $187,500 plus interest at 6.5%, beginning on August 1, 2003. Our Note to Tri-Link is secured by a lien on the Vortex technology and related technology assets. The Company was unable to make the November 2003 and the February 2004 quarterly installments. According to the terms of the Agreement, if we fail to make any quarterly payment on the Note by the end of the tenth day after such payment is due, then on the fortieth day after such payment was due, we must issue to Tri-Link that number of shares of our common stock equal to 22,500 times the number of days by which the applicable payment default exceeds ten days. In addition, failure to make payments on the Note when due may result in Tri-Link seeking to obtain a judgment and attempting to seize our Vortex technology securing the Note in satisfying such past-due payments. Tri-Link may have the right at its sole option to convert at any time and from time to time, up to $750,000 of the balance of the purchase price then remaining into shares of the Company's voting common stock at prices ranging from $0.22 per share to $1.00 per share (maximum of 1,125,000 shares of common stock).

On October 24, 2003, the Company issued 375,000 shares of Common stock to Tri-Link as consideration for the conversion of $82,500 of the Company's obligation to Tri-Link. As a result of the conversion, the Company's quarterly principal installment was reduced to $180,000.

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ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have no material changes to the disclosure under the caption "Quantitative and Qualitative Disclosures About Market Risks" in our Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference.

ITEM 4.   CONTROLS AND PROCEDURES

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely making known to them material information relating to the Company and the Company's consolidated subsidiaries required to be disclosed in the Company's reports filed or submitted under the Exchange Act. There has been no change in the Company's internal control over financial reporting during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS

The Company from time to time is involved in legal actions arising in the ordinary course of business. With respect to these matters, management believes that it has adequate legal defenses or has provided adequate accruals for related costs such that the ultimate outcome will not have a material adverse effect on the Company's future financial position or results of operations.

The Company was formally notified by Tri-Link on March 9, 2004 that Teltronics, Inc. was in default of its obligations under the Tri-Link Agreement of Purchase and Sale ("Agreement"). In the default notice, Tri-Link demands immediate payment of the past due principal and interest payments totaling $426,098 (November 2003 and February 2004 quarterly installments). The notice also stated that Tri-Link would immediately compel final and binding arbitration as allowed in the Agreement and would enforce all such other remedies, provisional and otherwise, as it may have with respect to such claims under the Agreement.

On March 10, 2004, the Company received a Demand for Arbitration notice from the American Arbitration Association notifying Teltronics of Tri-Link's demand for arbitration. Teltronics was further notified on March 12, 2004 by the International Centre for Dispute Resolution of their receipt of Tri-Link's demand for arbitration. Limited discovery will occur over the next few months. The arbitration hearing is scheduled to commence on February 28, 2005 in Toronto.

In its Demand for Arbitration, Tri-Link seeks payment by Teltronics of the total sum of $426,098 and the immediate issuance to Tri-Link of 900,000 shares of Teltronics' common voting stock.

In its Answering Statement and Counterclaims, Teltronics seeks a declaration that issuance of 900,000 shares of its common voting stock satisfies the requirements of the contract for payment where the appropriate cash payments have not been made. In addition, as and for its counterclaims, Teltronics seeks findings that Tri-Link is in breach of the purchase agreement and its obligation of good faith and fair dealing inherent in that contract; that Tri-Link breached its express and implied warranties and fitness for a particular purpose; that Tri-Link engaged in fraudulent concealment and inducement; and that Tri-Link is guilty of negligent misrepresentation. Teltronics seeks an amount, as stated in its Answering Statement, in excess of $1 million.

The Company has been notified by Tri-Link that it intends to seek possession of the collateral which Tri-Link claims secures its right to payment.

The Company was named as a party to a lawsuit filed in the State of New York. The lawsuit alleges that various parties who entered into contracts with the New York Department of Education, did not insure that a subcontractor paid its employees in accordance with the prevailing wage rate required by the State of New York. The Company intends to vigorously defend itself and believes it has meritorious defenses.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS - None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

As of September 30, 2004, we were in arrears on dividend payments on our Series B and Series C Preferred Stock in the amounts of $164,810 and $645,000, respectively, which amounts include interest thereon. We were also in arrears on debt payments on our Note Payable to Tri-Link in the amount of $720,000.

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ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At our Annual Meeting of Stockholders, held on August 27, 2004, the following proposals were voted upon by the stockholders as indicated below:

           1.     To elect the full Board of Directors.

           2.     To ratify the selection of Kirkland, Russ, Murphy & Tapp, P.A. as independent auditors for the Company.

           3.     To ratify the 2005 Incentive Stock Option Plan.

ITEM 5.  OTHER INFORMATION- None 

ITEM 6(a).   EXHIBITS

ITEM 6(b).   REPORTS ON FORM 8-K

The Company filed two reports on Form 8-K during the quarter ended September 30, 2004. Information regarding the item reported on is as follows:

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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.

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EXHIBIT INDEX

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