Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
Commission File number 1-8086
GENERAL DATACOMM INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-0853856
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6 Rubber Avenue, Naugatuck, Connecticut 06770
-----------------------------------------------------------
(Address of principal executive offices, including zip code)
(203) 729-0271
--------------
(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 [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
Applicable only to Registrants involved in bankruptcy proceeding during the
preceding five years:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by the Court. Yes [X] No [ ]
Number of shares of Common Stock and Class B Stock
outstanding as of January 30, 2004:
3,303,872 Shares of Common Stock
664,978 Shares of Class B Stock
GENERAL DATACOMM INDUSTRIES, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
PART I FINANCIAL INFORMATION Page
- ------ ----
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of
December 31, 2003 and September 30, 2003.........................................3
Condensed Consolidated Statements of Operations for
the Three Months Ended December 31, 2003 and 2002 ...............................4
Condensed Consolidated Statements of Cash Flows for
the Three Months Ended December 31, 2003 and 2002................................5
Notes to the Condensed Consolidated Financial Statements..............................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................11
Item 3. Quantitative and Qualitative Disclosures about
Market Risk..........................................................................30
Item 4. Controls and Procedures...................................................................30
PART II OTHER INFORMATION
- -------
Item 5. Exhibits and Reports on Form 8-K..........................................................31
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
General DataComm Industries, Inc.
Condensed Consolidated Balance Sheets
(in thousands except shares)
CAPTION> December 31, September 30,
2003 2003*
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Assets:
Current assets:
Cash and cash equivalents $ 1,334 $ 2,113
Restricted cash 54 325
Accounts receivable, less allowance for doubtful
accounts of $491 in December and $514 in September 4,025 3,431
Notes receivable, net 25 136
Inventories 4,666 4,744
Other current assets 502 877
- ------------------------------------------------------------------------------------------------------------------------------------
Total current assets 10,606 11,626
====================================================================================================================================
Property, plant and equipment, net 4,279 4,309
Other assets -- 4
- ------------------------------------------------------------------------------------------------------------------------------------
Total Assets $ 14,885 $ 15,939
====================================================================================================================================
Liabilities and Stockholders' Deficit:
Current liabilities:
Current portion of long-term debt $ 3,000 $ 3,000
Accounts payable 1,529 1,579
Accrued payroll and payroll-related costs 929 1,104
Other current liabilities 7,489 7,544
- ------------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 12,947 13,227
====================================================================================================================================
Long-term debt, less current portion 36,363 36,817
Other liabilities 2,901 2,654
- ------------------------------------------------------------------------------------------------------------------------------------
52,211 52,698
====================================================================================================================================
Commitments and contingencies -- --
Redeemable 5% preferred stock, par value $1.00 per share; issued and
outstanding: no shares at December 31 and 73,000 shares at September 30 -- 1,825
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' deficit:
9% Preferred stock, par value $1.00 per share, 3,000,000 shares authorized;
787,900 shares issued and outstanding; $25.9 million liquidation preference
at December 31, 2003 788 788
Class B common stock, par value $.01 per share, 10,000,000 shares
authorized; 664,978 shares issued and outstanding 7 7
Common stock, par value $.01 per share, 50,000,000 shares authorized; 33 33
3,305,833 shares issued
Capital in excess of par value 198,312 196,487
Accumulated deficit (236,321) (235,754)
Common stock held in treasury, at cost; 1,961 shares (145) (145)
====================================================================================================================================
Total Stockholders' Deficit (37,326) (38,584)
====================================================================================================================================
Total Liabilities and Stockholders' Deficit $ 14,885 $ 15,939
====================================================================================================================================
* Derived from the Company's audited consolidated balance sheet at
September 30, 2003.
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
General DataComm Industries, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands except share data)
Three Months Ended
December 31,
2003 2002
- ------------------------------------------------------------------------------------------------------------------
Net sales $ 5,101 $ 4,856
Cost of sales 2,179 2,269
- ------------------------------------------------------------------------------------------------------------------
Gross profit 2,922 2,587
Operating expenses:
Selling, general and administrative 1,909 1,777
Research and product development 767 789
- ------------------------------------------------------------------------------------------------------------------
2,676 2,566
Operating income 246 21
Other income (expense):
Interest expense (904) (1,156)
Gain on legal settlement -- 2,450
Other, net 96 53
- ------------------------------------------------------------------------------------------------------------------
(808) 1,347
Income (loss) before reorganization item and income taxes (562) 1,368
- ------------------------------------------------------------------------------------------------------------------
Reorganization item:
Professional fees -- 451
- ------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (562) 917
Income tax provision 5 37
- ------------------------------------------------------------------------------------------------------------------
Net income (loss) (567) 880
Less: dividends applicable to preferred stock (451) (478)
- ------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common and Class B stock $ (1,018) $ 402
==================================================================================================================
Earnings (loss) per share (basic and diluted) $ (0.26) $ 0.12
==================================================================================================================
Weighted average number of common and Class B shares outstanding
(basic and diluted) 3,958,541 3,400,138
==================================================================================================================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
General DataComm Industries, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
Three Months Ended
December 31,
2003 2002
- ---------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ (567) $ 880
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization 45 45
Changes in:
Accounts receivable (594) 306
Inventories 78 (110)
Accounts payable (50) 389
Accrued payroll and payroll-related costs (175) (102)
Other net current assets 532 637
Other net long-term assets 39 5
- ---------------------------------------------------------------------------------------------------------------
Net cash (used) provided by operating activities (692) 2,050
===============================================================================================================
Cash flows from investing activities:
Acquisition of property, plant and equipment, net (15) (4)
Notes receivable collections 111 368
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 96 364
===============================================================================================================
Cash flows from financing activities:
Proceeds from notes payable to related parties 600 -
Principal payments on term loan obligation (1,054) (3,061)
- ---------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (454) (3,061)
===============================================================================================================
Net decrease in cash and cash equivalents (1,050) (647)
Cash and cash equivalents, beginning of period 2,438 3,235
- ---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 1,388 2,588
===============================================================================================================
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 257 $ 485
Income taxes $ 16 $ --
Reorganization item $ 253 $ 795
===============================================================================================================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
GENERAL DATACOMM INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 - Basis of Presentation, Liquidity and Recent Developments
The accompanying unaudited interim condensed consolidated financial
statements of General DataComm Industries, Inc. (the "Company") have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, these statements include all
adjustments, consisting of normal and recurring adjustments, considered
necessary for a fair presentation of the results for the periods presented. The
results of operations for the periods presented are not necessarily indicative
of results which may be achieved for the entire fiscal year ending September 30,
2004. The unaudited interim condensed consolidated financial statements should
be read in conjunction with the financial statements and notes thereto contained
in the Company's annual report on Form 10-K for the fiscal year ended September
30, 2003 as filed with the Securities and Exchange Commission.
The accompanying condensed consolidated financial statements were
prepared on the basis that the Company will continue as a going concern. The
Company has virtually no current ability to borrow additional funds. It must,
therefore, fund operations from cash balances and cash generated from operating
activities. The Company has significant short-term obligations including payment
of professional fees and monthly payments of principal and interest (currently
such principal and interest totals approximately $335,000 each month) under its
new loan agreement. Furthermore, at December 31, 2003 the Company has
significant outstanding long-term debt obligations ($39.4 million) and priority
tax claims ($2.9 million), along with interest thereon. In addition, the Company
is required to meet an "EBITDA" (earnings before interest, taxes, depreciation
and amortization) financial covenant to avoid an event of default. The Company
believes that there is significant risk that it may default on the financial
covenant requirement for the quarter ending March 31, 2004. If there is such a
default, the senior secured lenders may accelerate payment of the outstanding
debt ($16.2 million at December 31, 2003) and have the right to foreclose on
their security interests.
In fiscal 2003 and 2002, operations were funded primarily through cash generated
from operations. Proceeds realized from sales and liquidations of non-core
assets were required to pay down the secured debt. In prior years the Company
had obtained cash from a combination of loans, convertible debt, and sales of
common and preferred stock.
As a result of the Company's potential liquidity and cash flow risks, the
Company's independent auditors for fiscal 2003 expressed uncertainty about the
Company's ability to continue as a going concern in their opinion on the
Company's financial statements.
Management has responded to such risks as part of an ongoing strategy by
restructuring its sales force, increasing factory and office shutdown time,
containing expenses and reducing the size of the employee workforce. In
addition, on December 30, 2003 the Company obtained $600,000 from loans from
related parties to be used for working capital and general purposes (see
6
Note 4). The Company also is actively marketing for sale its land and building
and pursuing other asset recoveries, the proceeds of which would be used to
reduce secured debt and related interest.
While the Company is aggressively pursuing opportunities and corrective actions,
there can be no assurance that the Company will be successful in its efforts to
generate sufficient cash from operations or obtain additional funding sources.
The Company's condensed consolidated financial statements do not include any
adjustments that may result from the outcome of these uncertainties.
Recent Developments
- -------------------
The Company experienced an unanticipated slow-down in orders in the quarter
ended December 31, 2003 and through the filing date of this report, primarily
from its customer base of large telecommunication carriers. This has resulted in
lower-than anticipated revenues in such periods and will also negatively impact
revenue in future months.
In response to the lower revenues, on February 11, 2004 the Company announced to
employees cost reduction actions, including for all employees a reduction in the
work-week to approximately four days or approximately 20% wage or salary
reductions for all employees. Such actions were taken to conserve cash and jobs
during this slow period.
Note 2 - Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net income
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share gives effect to all
dilutive potential common shares outstanding during the period. In computing
diluted earnings per share, the average price of the Company's common stock for
the period is used in determining the number of shares assumed to be purchased
from exercise of stock options. Dividends applicable to preferred stock
represent accumulating dividends that are not declared or accrued. The following
table sets forth the computation of basic and diluted earnings (loss) applicable
to common stock for the three months ended December 31, 2003 and 2002 (in
thousands, except share data):
Three Months Ended
December 31,
-------------------------
2003 2002
- -------------------------------------------------------------------------------------------------------------------
Numerator:
Net income (loss) $ (567) $ 880
Less: dividends applicable to preferred stock (451) (478)
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common and Class B stock $ (1,018) $ 402
===================================================================================================================
Denominator:
Weighted average common and Class B shares outstanding 3,958,541 3,400,138
- -------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings (loss) per share $ (0.26) $ 0.12
===================================================================================================================
7
Options to purchase 283,210 and 55,279 shares of common stock were
outstanding at December 31, 2003 and 2002, respectively, but were not included
in the computation of diluted earnings per share because inclusion of such
options would have been antidilutive or would have diluted the loss in the three
months ended December 31, 2003. Other outstanding securities, not included in
the computation of earnings (loss) per share because of their antidilutive
impact on reported earnings (loss) per share, but which could potentially dilute
basic earnings per share in the future, include contingent shares underlying
warrants granted to secured lenders, convertible preferred stock, convertible
notes payable to related parties and other warrants.
3. Inventories
Inventories consist of (in thousands):
December 31, September 30,
2003 2003
- ------------------------------------------------------------------------------
Raw materials $1,401 $1,674
Work-in-process 1,706 1,501
Finished goods 1,559 1,569
- ------------------------------------------------------------------------------
$4,666 $4,744
==============================================================================
Inventories are stated at the lower of cost or market using the first-in, first
out method. Reserves in the amount of $4,023,000 and $4,177,000 were recorded at
December 31, 2003 and September 30, 2003, respectively, for excess and obsolete
inventories.
4. Long-Term Debt
Long-term debt consists of (in thousands): December 31, September 30,
2003 2003
- ------------------------------------------------------------------------------
Term Obligation $ 13,721 $14,775
PIK Obligation 2,500 2,500
Convertible Notes Payable to Related Parties 600 --
Debentures 22,542 22,542
- ------------------------------------------------------------------------------
39,363 39,817
Less current portion 3,000 3,000
- ------------------------------------------------------------------------------
$ 36,363 $36,817
==============================================================================
Long-term debt matures in amounts totaling $3,000,000 in each of fiscal 2003 and
2004, $3,600,000 in fiscal 2005, $3,000,000 in each of fiscal 2006 and 2007, and
$23,763,000 in fiscal 2008.
Term Obligation, PIK Obligation and Debentures
Under the terms of the New Loan Agreement which became effective September 15,
2003, minimum payments under the Term Obligation are $250,000 per month, or
$3,000,000 per year, and interest is payable monthly at the annual rate of 7.25%
through December 31, 2003, and thereafter at the greater of (i) 7.25% and (ii)
the prime rate plus 2.5%. In addition, proceeds from the potential sales of
non-core assets and certain other proceeds must be used to reduce the term
obligations.
The Company also entered into a loan in the original principal amount of $5
million, subject to adjustment, due December 31, 2007 (the "PIK Obligation").
8
Interest accrues at the same rates as the Term Obligation. The outstanding
principal and accrued interest thereon shall be forgiven in increments of $1.25
million if the Term Obligation was reduced by $5 million by June 30, 2003, by
$10 million by December 31, 2003, by $15 million by June 30, 2004 and by $25
million (in full) by December 31, 2004. Since by September 30, 2003 the Term
Obligation has been reduced by more than $10 million, the current balance owing
on the PIK Obligation was reduced to $2.5 million, plus accrued interest, in the
accompanying condensed consolidated balance sheets at September 30, 2003 and
December 31, 2003.
Debentures with principal and interest due in fiscal 2008 were issued to
unsecured creditors as part of the Company's Plan of Reorganization.
For further details of the New Loan Agreement and a description of the Term
Obligation, PIK Obligation and Debentures, see Note 6, "Reorganization Plan and
Emergence from Chapter 11" included in Item 8 of Form 10-K for the year ended
September 30, 2003 as filed with the Securities and Exchange Commission.
Convertible Notes Payable to Related Parties
On December 30, 2003, pursuant to authorization by the Board of Directors and
amendment of the New Loan Agreement, the Corporation borrowed $300,000 from each
of Howard S. Modlin, Chairman of the Board, and John L. Segall, a Director, for
working capital purposes. The loans are for two years payable on December 29,
2005 and bear interest at the rate of 10% per annum payable monthly commencing
May 1, 2004. The notes are convertible at the option of the holder into common
stock at a conversion price of $2.12 per share and are secured by all the assets
of the Corporation subordinate to the first lien of the Corporation's senior
lenders who hold the Term and PIK Obligations. Any shares issued on conversion
will not be registered and must be held for investment without a view to
distribution.
Note 5. Accounting for Stock-Based Compensation
As permitted under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", the Company has elected to continue
to measure costs for its employee stock compensation plans by using the
accounting methods prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", which allows that no compensation
cost be recognized provided the exercise price of options granted is equal to or
greater than fair market value of the Company's stock at date of grant.
9
Proforma results, representative of financial results which would have been
reported by the Company if it had adopted the fair value based method of
accounting for stock-based compensation under SFAS No. 123, are summarized
below:
Three Months Ended December 31,
(Amounts in thousands, except per share data)
2003 2002
---- ----
Net income (loss), as reported $ (567) $ 880
Less: total stock-based employee compensation
expense determined under fair value based method
for all awards (18) (22)
- ----------------------------------------------------------------------------------------------------------
Proforma net income (loss) (585) 858
Less: dividends applicable to preferred stock (451) (478)
- ----------------------------------------------------------------------------------------------------------
Proforma net income (loss) applicable to common and Class B stock $(1,036) $ 380
==========================================================================================================
Proforma basic and diluted earnings (loss) per share $ (0.26) $ 0.11
==========================================================================================================
The Black-Scholes method was used to compute the proforma amounts presented
above. No material stock options or other stock-based employee compensation
awards were granted to employees in the quarters ended December 31, 2003 and
2002.
Note 6. Comprehensive Income
The Company has adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (SFAS 130) which establishes standards for
reporting comprehensive income and its components in a company's financial
statements. The company had no items of comprehensive income as defined in SFAS
130 in the quarters ended December 31, 2003 and 2002.
Note 7. Conversion of 5% Preferred Stock
On November 5, 2003, the holder of the remaining 73,000 shares of 5% Preferred
Stock surrendered such shares for conversion into 27,097 shares of the
Corporation's Common Stock, which surrender and conversion had the effect of
reducing the stockholders' deficit by $1,825,000.
10
Note 8. Related Party Transactions
Mr. Howard Modlin, Secretary and a Director of the Company since 1969 and
Chairman of the Board of Directors of the Company since November 2001 and
currently Chairman, President and Chief Executive Officer, is also President of
the law firm of Weisman Celler Spett & Modlin, P.C. ("WCSM") to whom the
Company was indebted for legal services in excess of $2,179,000 for work
performed prior to November 2001 and in settlement for which the Company issued
subordinated debentures. WCSM has filed a claim for $294,000 for work performed
between November 2001 and September 15, 2003 which was approved and authorized
by the bankruptcy court subsequent to September 30, 2003. The Company has
accrued additional estimated WCSM legal fees in the amount of $75,000 for the
three months ended December 31, 2003. Furthermore, the Company was indebted to
Mr. Modlin for fees for Company director meetings he attended prior to November
2001 for which he received subordinated debentures in the total amount of
$16,400. WCSM was paid $690,000 by the Company in fiscal 2001 (none in fiscal
2002, 2003 and 2004) for services rendered.
On September 30, 2003 the Stock Option Committee of the Board of Directors
awarded Mr. Modlin 459,268 shares of the Corporation's Class B stock and Lee M.
Paschall and John L. Segall, Directors, 25,000 shares each of the Corporation's
Common Stock, all subject to registration restrictions. Messrs. Segall and
Paschall respectively received subordinated debentures in the total amount of
$19,900 and $17,900 in payment for directors fees for Company director meetings
they attended prior to November 2001. In addition, Messrs. William G. Henry,
Vice President, Finance and Administration, and George M. Gray, Vice President,
Manufacturing and Engineering have filed claims in Chapter 11 bankruptcy
proceedings for past services and bonuses in the amounts of $561,385 and
$50,000, respectively. These claims are still pending in the bankruptcy
proceedings and the amount of these claims is included in debentures in
long-term debt, along with claims of other unsecured creditors at the time of
the bankruptcy filing, in the accompanying balance sheet. If these claims are
not allowed in the bankruptcy proceeding, at such time adjustments will be made
in the amount of debentures in long-term debt.
See Note 4 regarding loans made to the Company by Messrs. Howard Modlin and John
L. Segall.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Notice Concerning Forward-Looking Statements
The following Management's Discussion and Analysis contains "forward-looking
statements" within the meaning of the federal securities laws, including
forward-looking statements regarding future sales of our products to our
customers, inventory levels, expectations regarding our operating expenses,
gross margins, working capital and expenditure requirements and operating
requirements. In some cases, forward-looking statements can be identified by the
use of terminology such as "may," will, "expects," "intends," "plans,"
"anticipates," "estimates," "potential," or "continue," or the negative thereof
or other comparable terminology. These statements are based on current
expectations and projections about our industry and assumptions made by
management and are not guarantees of future performance. Although we believe
that the expectations reflected in the forward-looking statements contained
herein are reasonable, these expectations or any of the forward-looking
statements could prove to be incorrect and actual results could differ
materially from those projected or assumed in the forward-looking statements.
The Company's future financial condition, as well as any forward-looking
statements, are subject to risks and uncertainties, including but not limited to
11
the factors set forth in the "Risk Factors" section elsewhere in this report, as
well as in the Company's annual report on Form 10-K for the year ended September
30, 2003 as filed with the Securities and Exchange Commission. Unless required
by law, we undertake no obligation to update any forward-looking statements or
reasons why actual results may differ.
Overview
The Company is a provider of networking and telecommunications products and
services to domestic and international customers. The Company designs,
assembles, markets, installs and maintains products and services that enable
telecommunications common carriers, corporations and governments to build,
upgrade and better manage their global telecommunications networks.
Specifically, GDC's switching, routing and LAN extension solutions, networking
products including integrated access systems for digital and analog transport
and multiplexers for network consolidation, constitute the Company's major
product elements.
From 1994 through 2002, the Company incurred significant net losses and as of
December 31, 2003 had an accumulated deficit of $236.3 million. The majority of
the Company's operating losses have resulted from costs incurred developing and
marketing Asynchronous Transfer Mode ("ATM") technology in the former Broadband
Systems Division ("BSD").
After implementing a number of restructuring and cost reduction programs in an
attempt to better align the Company's operating cost structure with revenues, in
2001 three of the Company's business units were actively marketed for sale with
the objective of reducing outstanding debt and providing additional liquidity.
Between June and August 2001, three of the Company's four operating divisions
representing a significant portion of the assets of the Company, including BSD,
were sold. However, due to the impact of a general economic downturn and a
decline in the telecommunications industry in particular, the Company did not
realize sufficient proceeds from the sales to satisfy its secured debtors.
Revenues of divisions sold constituted 61% of consolidated revenues in fiscal
2001. By the end of fiscal 2001 the number of employees declined to 210
employees from 1,019 at the beginning of the year. Further cost-saving
reductions were implemented in fiscal 2002 and 2003 which reduced headcount to
111 employees at September 30, 2003.
On November 2, 2001 General DataComm Industries Inc. and its domestic
subsidiaries ("the Debtors") filed a voluntary petition for relief under Chapter
11 of Title 11 of the United States Code, 11 U.S.C. ss. 101 et seq. (the
"Bankruptcy Code") of the Bankruptcy Code in the United States Bankruptcy Court
for the District of Delaware. The Company continued in possession of its
properties and the management of its business as debtors in possession pursuant
to sections 1107 and 1108 of the Bankruptcy Code.
12
During the year ended September 30, 2002, and in the aftermath of the sales of
its business units, the Company consolidated its remaining operations into its
owned facility in Naugatuck, Connecticut, and downsized its staff and operating
assets to more properly reflect current operating requirements for its one
remaining business unit.
On April 29, 2003, the Debtors and its secured lenders (the "Lenders") filed
their Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy
Code (as amended, the "Plan") and accompanying disclosure statement (the
"Disclosure Statement"), both of which set forth the consensual Chapter 11 plan
that was agreed upon by and between the Lenders, the Creditors Committee and the
Debtors. On June 24, 2003, the Court authorized the Debtors to commence the
solicitation process for the approval of the Plan including mailing of the
Disclosure Statement. On August 5, 2003, the Court entered an order confirming
the Plan. The Plan became effective on September 15, 2003 (the "Effective
Date").
RESULTS OF OPERATIONS
Net Sales
Three Months Ended December 31,
------------------------------
(in thousands) 2003 2002
---- ----
Net Sales $ 5,101 $ 4,856
Net sales for the three months ended December 31, 2003 increased 5% to
$5,101,000 from revenues of $4,856,000 for the three months ended December 31,
2002. This increase was predominately the result of slightly higher unit sales
to large telecommunication infrastructure customers in the United States.
However, net sales declined 16% sequentially from the quarter ended September
30, 2003 and reflects continued weakness in the Company's markets. This decline
began in fiscal 2001 due to economic and industry-wide factors affecting the
telecommunications industry, including financial constraints affecting customers
and over-capacity in our customers' markets. The Company anticipates that the
current reduced capital spending levels by its customers will continue to affect
sales until there is an overall recovery in the telecommunications market, which
market is not expected to significantly change in 2004. Accordingly, the ability
to forecast future revenue trends in the current environment is difficult.
Gross Profit
Three Months Ended December 31,
------------------------------
(in thousands) 2003 2002
---- ----
Gross profit $ 2,922 $ 2,587
Percentage of revenues 57.3% 53.3%
13
Gross profit, as a percentage of sales, in the three months ended December 31,
2003 was 57.3% as compared to 53.3% in the three months ended December 31, 2002.
The 4.0% increase in gross profit margin in the three months ended December 31,
2003 was attributable to the sale of obsolete inventory that had previously been
written off (1.5%) and the balance (2.5%) to lower negotiated material component
costs, lower subcontractor assembly costs and the benefit from cost reduction
measures enacted during fiscal 2003 and 2002.
In future periods, the Company's gross profit will vary depending upon a number
of factors, including the mix of products sold, the cost of products
manufactured at subcontract facilities, the channels of distribution, the price
of products sold, discounting practices, price competition, increases in
material costs and changes in other components of cost of sales. As and to the
extent the Company introduces new products, it is possible that such products
may have lower gross profit margins than other established products in higher
volume production. Accordingly, gross profit as a percentage of sales may vary.
Selling, General and Administrative
Three Months Ended December 31,
------------------------------
(in thousands) 2003 2002
---- ----
Selling, general and administrative $1,909 $1,777
Percentage of sales 37.4% 36.6%
The Company's selling, general and administrative ("SG&A") expenses increased to
$1,909,000, or 37.4% of sales in the three months ended December 31, 2003 from
$1,777,000, or 36.6% of sales in the three months ended December 31, 2002. The
increase in the three months ended December 31, 2003 was due primarily to labor
and expense costs associated with sales people hired to penetrate the enterprise
sales market as part of the Company's strategy to reduce its dependence on
telecommunication carriers and pursue other market opportunities.
Research and Product Development
Three Months Ended December 31,
------------------------------
(in thousands) 2003 2002
---- ----
Research and product development $ 767 $ 789
Percentage of sales 15.0% 16.2%
Research and development ("R&D") expenses decreased to $767,000 or 15.0% of
sales in the three months ended December 31, 2003 as compared to $789,000 or
16.2% of sales in the three months ended December 31, 2002. This small decrease
was due primarily to reductions in outside development costs and internal staff
in an effort to reduce expenses in line with lower revenue levels.
14
Interest Expense
Interest expense decreased to $904,000 in the three months ended December 31,
2003 from $1,156,000 in the three months ended December 31, due to higher
adequate protection payments while the Company operated in Chapter 11 in 2002.
Interest is currently required to be paid only on the Term Obligation, which
interest payments amounted to $257,000 in the three months ended December 31,
2003, whereas interest is not currently paid on the PIK Obligation, Debentures,
Convertible Notes and Priority Tax Claims.
Other Income (Expense)
Other income for the three months ended December 31, 2003 is comprised of
$72,000 proceeds from the sale of excess furniture and equipment, and other
individually smaller items. Other income for the three months ended December 31,
2002 is comprised primarily of $2,450,000 from the settlement of legal claims in
favor of the Company.
Reorganization Items
Reorganization items include professional fees of $451,000 in the three months
ended December 31, 2002 (none in 2003) associated with the Company's bankruptcy
proceedings, primarily related to the Company's unaffiliated legal advisors and
the Creditors' Committee's legal and financial advisors.
Provision for Income Taxes
No federal income tax provisions or tax benefits were provided in the three
months ended December 31, 2003 and 2002 due to the valuation allowance provided
against the net change in deferred tax assets. The Company established a full
valuation allowance against its net deferred tax assets due to the uncertainty
of realization of benefits of the net operating loss carry forwards from prior
years. The Company has federal tax credit and net operating loss carry forwards
of approximately $12.2 million and $210.5 million, respectively, as of September
30, 2003. Income tax provisions for the three months ended December 31, 2003 and
2002 reflect minimum state taxes.
15
Liquidity and Capital Resources
December 31, September 30,
(in thousands) 2003 2003
---- ----
Cash and cash equivalents $ 1,334 $ 2,113
Working capital (deficit) (2,341) (1,601)
Total assets 14,885 15,939
Long-term debt, including current portion 39,363 39,817
Total liabilities (excluding redeemable preferred stock) 52,211 52,698
stock)
Three Months Ended December 31,
------------------------------
2003 2002
---- ----
Net cash provided (used) by:
Operating activities $ (692) $ 2,050
Investing activities 96 364
Financing activities (454) (3,061)
Note: Significant risk factors exist due to the Company's limited financial
resources and dependence on achieving future positive cash flows in order to
satisfy its obligations and avoid a default under its loan and debenture
obligations. See "Risk Factors" below for further discussion.
Cash Flows
Net cash used by operating activities totaled $692,000 for the three months
ended December 31, 2003 compared to net cash provided by operating activities of
$2,050,000 for the three months ended December 31, 2002. The decrease in cash
provided by operating activities was primarily due to the settlement of a
lawsuit in 2002, which generated $2,450,000 in cash, and, an increase in
accounts receivable in 2003 which the Company attributes to delays in payments
from customers due to holidays.
Cash provided by investing activities for the three months ended December 31,
2003 was $96,000 compared to $364,000 for the three months ended December 31,
2002. In both periods the cash provided was due to collections of notes
receivable offset in part by modest spending on capital equipment.
Net cash used by financing activities was $454,000 for the three months ended
December 31, 2003 compared to $3,061,000 for the three months ended December 31,
2002. In 2003 the Company received $600,000 in loans from related parties and
paid $1,054,000 in principal payments on secured debt. In 2002, $3,061,000 was
required to be paid as adequate protection payments to secured lenders while the
Company was in bankruptcy.
16
Liquidity
The Company has virtually no current ability to borrow additional funds. It
must, therefore, fund operations from cash balances and cash generated from
operating activities. The Company has significant short-term obligations
including payment of professional fees and monthly payments of principal and
interest (currently such principal and interest totals approximately $335,000
each month) under its new agreement. Furthermore, at December 31, 2003 the
Company has significant outstanding long-term debt obligations ($39.4 million)
and priority tax claims ($2.9 million), along with interest thereon.
The Company's failure to make required payments under its new loan agreement
would constitute an event of default. In addition, the Company is required to
meet an "EBITDA" (earnings before interest, taxes, depreciation and
amortization) financial covenant to avoid an event of default.
The ability of the Company to meet cash flow and loan covenant requirements is
directly affected by the factors described below in the section titled "Risk
Factors". There can be no assurance that the Company will be able to avoid a
default on its new loan agreement. Furthermore, the Company believes that there
is significant risk that it may default on the financial covenant requirement
for the quarter ending March 31, 2004. If there is such a default, the senior
secured lenders may accelerate payment of the outstanding debt ($16.2 million at
December 31, 2003) and have the right to foreclose on their security interests
which likely would require the Company to again file for bankruptcy protection.
The Company emerged from Chapter 11 bankruptcy on September 15, 2003. Under the
plan of emergence, the Company plans to pay all creditors 100% of their allowed
claims based upon a five year business plan. The ability to meet the objectives
of this business plan is directly affected by the factors described in the "Risk
Factors Section". The Company cannot assure investors that it will be able to
obtain new customers or to generate the increased revenues required to meet its
business plan objectives. In addition, in order to execute the business plan,
the Company may need to seek additional funding through public or private equity
offerings, debt financings or commercial partners. The Company cannot assure
investors that it will obtain funding on acceptable terms, if at all. If the
Company is unable to generate sufficient revenues or access capital on
acceptable terms, it may be required to (a) obtain funds on unfavorable terms
that may require the Company to relinquish rights to certain of its technologies
or that would significantly dilute its stockholders and/or (b) significantly
scale back current operations. Either of these two possibilities would have a
material adverse effect on the Company's business, financial condition and
results of operations.
17
In fiscal 2003 and 2002, operations were funded primarily through cash generated
from operations. Proceeds realized from sales and liquidations of non-core
assets were required to pay down the secured debt. In prior years the Company
had obtained cash from a combination of loans, convertible debt, and sales of
common and preferred stock.
At December 31, 2003 the Company's principal source of liquidity included cash
and cash equivalents of approximately $1.3 million compared to $2.1 million at
September 30, 2003. At December 31, 2003, the Company's working capital was a
deficit of approximately $2.3 million.
The Company has significant unpaid professional fees (approximately $1.1
million) at December 31, 2003 that are expected to be paid in fiscal 2004. These
include independent auditors' fees, and remaining bankruptcy professional fees.
In order to meet these and other future payments, the Company's financial
projections anticipate that revenue growth combined with minimal inventory and
capital asset investment will be required to sustain operations.
Because our operating results fluctuate significantly due to decreases in
customer demand or decreases in the acceptances of our future products, the
Company may be unable to generate positive cash flow from operations. Should the
need arise, it may become necessary to borrow additional funds or otherwise
raise additional capital. However, since the Company does not have any source of
additional funds or capital in place, any such requirement could have a material
adverse effect on the Company. See the section titled "Risk Factors".
As a result of the potential liquidity and cash flow risks described above, the
Company's independent auditors for fiscal 2003 expressed uncertainty about the
Company's ability to continue as a going concern in their opinion on the
Company's financial statements. Management has responded to such risks as part
of an ongoing strategy by restructuring its sales force, increasing factory and
office shutdown time, containing expenses and reducing the size of the employee
workforce (see the "Recent Developments" section of Note 1 of the Notes to
Condensed Consolidated Financial Statements in Item 1 of this Form 10-Q). In
addition, on December 30, 2003 the Company obtained $600,000 in loans from
related parties to be used for working capital and general purposes (see Note 4
of the Notes to Consolidated Financial Statements included in Item 1 in this
Form 10-Q). The Company also is actively marketing for sale its land and
building and pursuing other asset recoveries, the proceeds of which would be
used to reduce secured debt and related interest.
18
Critical Accounting Policies
The Company's financial statements and accompanying notes are prepared in
accordance with generally accepted accounting principles in the United States of
America. Preparing financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities, revenue
and expenses. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be reasonable under
the circumstances. Due to the inherent uncertainty involved in making estimates,
actual results reported in future periods might be based upon amounts that
differ from those estimates. The following represent what the Company believes
are among the critical accounting policies most affected by significant
management estimates and judgments. See Note 2 to Consolidated Financial
Statements in Item 8 of the Company's Annual Report on Form 10-K for the year
ended September 30, 2003 as filed with the Securities and Exchange Commission
for a summary of the Company's financial accounting policies.
Revenue Recognition. The Company recognizes a sale when the product is shipped
and the following four criteria are met upon shipment: (1) persuasive evidence
of an arrangement exists; (2) title and risk of loss transfers to the customer;
(3) the selling price is fixed or determinable; and (4) collectibility is
reasonably assured. A reserve for future product returns is established at the
time of the sale based on historical return rates and return policies including
stock rotation for sales to distributors that stock the Company's products.
Warranty Reserves - The Company offers warranties of various lengths to our
customers depending on the specific product and the terms of our customer
purchase agreements. Standard warranties require the Company to repair or
replace defective product returned during the warranty period at no cost to the
customer. An estimate for warranty related costs is recorded based on actual
historical return rates and repair costs at the time of sale. On an on-going
basis, management reviews these estimates against actual expenses and makes
adjustments when necessary. While warranty costs have historically been within
expectations of the provision established, there is no guarantee that the
Company will continue to experience the same warranty return rates or repair
costs as in the past. A significant increase in product return rates or the
costs to repair our products would have a material adverse impact on the
Company's operating results.
Impairment of Long-Lived Assets and Goodwill. The Company assesses the
impairment of long-lived assets and goodwill whenever events or changes in
circumstances indicate that the carrying value may not be recoverable under the
guidance prescribed by SFAS No.'s 144 and 142, respectively. The Company's
long-lived assets include, but are not limited to, real estate, property and
equipment and software licenses.
At December 31, 2003 and September 30, 2003, real estate represents the only
significant remaining long-lived asset that has not been fully impaired.
Inventories. The Company values inventory at the lower of cost or market. Cost
is computed using standard cost, which approximates actual cost on a first-in,
first-out basis. Agreements with certain customers provide for return rights.
19
The Company is able to reasonably estimate these returns and they are accrued
for at the time of shipment. Inventory quantities on hand are reviewed on a
quarterly basis and a provision for excess and obsolete inventory is recorded
based primarily on product demand for the preceding twelve months. Historical
product demand may prove to be an inaccurate indicator of future demand in which
case the Company may increase or decrease the provision required for excess and
obsolete inventory in future periods. The Company has possession of inventory
from its former Broadband Systems Division that was sold in 2001 which has been
written off for financial reporting purposes. If the Company is able to sell
inventory in the future that has been previously written off such sales will
result in higher than normal gross margin.
Allowance for Doubtful Accounts. The Company estimates losses resulting from the
inability of our customers to make payments for amounts billed. The
collectability of outstanding invoices is continually assessed. Assumptions are
made regarding the customer's ability and intent to pay, and are based on
historical trends, general economic conditions and current customer data. Should
our actual experience with respect to collections differ from these assessments,
there could be adjustments to our allowance for doubtful accounts.
Deferred Tax Assets. The Company has provided a full valuation allowance related
to its deferred tax assets. In the future, if sufficient evidence of the
Company's ability to generate sufficient future taxable income in certain tax
jurisdictions becomes apparent, the Company will be required to reduce its
valuation allowances, resulting in income tax benefits in the Company's
consolidated statement of operations. Management evaluates the realizability of
the deferred tax assets and assesses the need for the valuation allowance each
year.
Off Balance Sheet Arrangements. The Company has no off balance sheet
arrangements.
RISK FACTORS
THE FOLLOWING IS A DISCUSSION OF CERTAIN FACTORS THAT CURRENTLY IMPACT THE
COMPANY'S BUSINESS, OPERATING RESULTS AND/OR FINANCIAL CONDITION AND, AS A
RESULT, PAST PERFORMANCE SHOULD NOT BE CONSIDERED TO BE A RELIABLE INDICATION OF
FUTURE PERFORMANCE.
GDC Limited Operating History Since Emerging from Bankruptcy. The Company
recently emerged from Bankruptcy on September 15, 2003. The Company voluntarily
filed for protection under Chapter 11 of the US Bankruptcy Code on November 2,
2001, after incurring seven consecutive years of losses and selling three of its
four operating divisions in 2001. Accordingly, an investor in our common stock
must evaluate the risks, uncertainties, and difficulties frequently encountered
by a company emerging from Chapter 11 and that operates in rapidly evolving
markets such as the telecommunications equipment industry.
20
Due to the Company's limited operating history since emergence, the Company may
not successfully implement any of its strategies or successfully address these
risks and uncertainties. As described by the following factors, past financial
performance should not be considered to be a reliable indicator of future
performance, and investors should not use historical trends to anticipate
results or trends in future periods.
Limited Financial Resources and Risk of Default. The Company has virtually no
current ability to borrow additional funds. It must, therefore, substantially
fund operations from cash balances and cash generated from operating activities.
The Company has significant short term obligations including payment of
professional fees and monthly payments of principal and interest (currently such
principal and interest totals approximately $335,000 per month) under its new
loan agreement. Furthermore, the Company has significant long-term debt
obligations outstanding (approximately $36.4 million).
The Company's failure to make required payments under the new loan agreement
would constitute an event of default. In addition, the Company is required to
meet a minimum quarterly EBITDA (earnings before interest, taxes, depreciation
and amortization) financial covenant of $1,100,000 starting with the quarter
ending March 31, 2004 in order to avoid an event of default.
The ability of the Company to meet cash flow and loan covenant requirements is
directly affected by the factors described elsewhere in this section on "Risk
Factors".
There can be no assurance that the Company will be able to avoid a default on
the new loan agreement. If there is such a default, the senior secured lenders
may accelerate payment of the outstanding debt ($16.2 million at December 31,
2003) and foreclose on their security interests which likely would require the
Company to again file for bankruptcy protection. In addition, the Company's new
loan agreement provides the lenders with warrants to (i) purchase up to 51% of
the Company's common stock at $.01 per share in the event of default and (ii)
purchase 10% of the Company's common stock if the debt owing to them is not
fully paid by December 31, 2007. Both such warrants and any common stock issued
thereunder will be cancelled if the lender's outstanding debt is fully paid by
December, 2007.
Dependence on Legacy and Recently Introduced Products and New Product
Development. The Company's future results of operations are dependent on market
acceptance of existing and future applications for the Company's current
products and new products in development. The majority of sales continue to be
provided by the Company's legacy products which represented approximately 85% of
net sales in fiscal 2003. The Company anticipates that net sales from legacy
products will decline over the next several years and net sales of new products
will increase at the same time, with significant quarterly fluctuations
possible, and without assurance that sales of new products will increase at the
same time.
21
Market acceptance of both the Company's recently introduced InnovX product line
and future product lines is dependent on a number of factors, not all of which
are in the Company's control, including the continued growth in the use of
bandwidth intensive applications, continued deployment of new telecommunication
services, market acceptance of multiservice access devices, the availability and
price of competing products and technologies, and the success of the Company's
sales and marketing efforts. Failure of the Company's products to achieve market
acceptance would have a material adverse effect on the Company's business,
financial condition and results of operations. Failure to introduce new products
in a timely manner in order to replace sales of legacy products could cause
customers to purchase products from competitors and have a material adverse
effect on the Company's business, financial condition and results of operations.
New products under development may require additional development work,
enhancement and testing or further refinement before the Company can make them
commercially available. The Company has in the past experienced delays in the
introduction of new products, product applications and enhancements due to a
variety of internal factors, such as reallocation of priorities, financial
constraints, difficulty in hiring sufficient qualified personnel, and unforeseen
technical obstacles, as well as changes in customer requirements. Such delays
have deferred the receipt of revenue from the products involved. If the
Company's products have performance, reliability or quality shortcomings, then
the Company may experience reduced orders, higher manufacturing costs, delays in
collecting accounts receivable, and additional warranty and service expenses.
Customer Concentration. The Company's historical customers have consisted
primarily of RBOCs, long distance service providers, wireless service providers,
and Resellers who sell to these customers. The market for the services provided
by the majority of these service providers has been influenced largely by the
passage and interpretation of the Telecommunications Act of 1996. Service
providers require substantial capital for the development, construction, and
expansion of their networks and the introduction of their services. The ability
of service providers to fund such expenditures often depends on their ability to
budget or obtain sufficient capital resources. Over the past several years,
resources made available by these customers for capital acquisitions have
declined, particularly due to recent negative market conditions in the United
States. If the Company's current or potential service provider customers cannot
successfully raise the necessary funds, or if they experience any other adverse
effects with respect to their operating results or profitability, their capital
spending programs may be adversely impacted which could materially adversely
affect the Company's business, financial condition and results of operations.
A small number of customers have historically accounted for a majority of the
Company's sales. Sales to the Company's top five customers accounted for 61% of
sales in fiscal 2003. There can be no assurance that the Company's current
customers will continue to place orders with the Company, that orders by
22
existing customers will continue at the levels of previous periods, or that the
Company will be able to obtain orders from new customers. GDC expects the
economic climate and conditions in the telecommunication equipment industry to
remain unpredictable in fiscal 2004, and possibly beyond. The loss of one or
more of our service provider customers, such as occurred during the past three
years through industry consolidation or otherwise, could have a material adverse
effect on our sales and operating results. A bankruptcy filing by one or more of
the Company's major customers could materially adversely affect the Company's
business, financial condition and results of operations.
Dependence on Key Personnel. The Company's future success will depend to a large
extent on the continued contributions of its executive officers and key
management, sales, and technical personnel. Each of the Company's executive
officers, and key management, sales and technical personnel would be difficult
to replace. The Company does not have employment contracts with its key
employees. The Company implemented significant cost and staff reductions in
recent years which may make it more difficult to attract and retain key
personnel. The loss of the services of one or more of the Company's executive
officers or key personnel, or the inability to attract qualified personnel,
could delay product development cycles or otherwise could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Key Suppliers and Component Availability. The Company generally
relies upon several contract manufacturers to assemble finished and
semi-finished goods. The Company's products use certain components, such as
microprocessors, memory chips and pre-formed enclosures that are acquired or
available from one or a limited number of sources. Component parts that are
incorporated into board assemblies are sourced directly by the company from
suppliers. The Company has generally been able to procure adequate supplies of
these components in a timely manner from existing sources.
While most components are standard items, certain application-specific
integrated circuit chips used in many of the Company's products are customized
to the Company's specifications. None of the suppliers of components operate
under contract. Additionally, availability of some standard components may be
affected by market shortages and allocations. The Company's inability to obtain
a sufficient quantity of components when required, or to develop alternative
sources due to lack of availability or degradation of quality, at acceptable
prices and within a reasonable time, could result in delays or reductions in
product shipments which could materially affect the Company's operating results
in any given period. In addition, as referenced above the Company relies heavily
on outsourcing subcontractors for production. The inability of such
subcontractors to deliver products in a timely fashion or in accordance with the
Company's quality standards could materially affect the Company's operating
results and business.
The Company uses internal forecasts to manage its general finished goods and
components requirements. Lead times for materials and components may vary
significantly, and depend on factors such as specific supplier performance,
contract terms, and general market demand for components. If orders vary from
23
forecasts, the Company may experience excess or inadequate inventory of certain
materials and components, and suppliers may demand longer lead times and higher
prices. From time to time, the Company has experienced shortages and allocations
of certain components, resulting in delays in fulfillment of customer orders.
Such shortages and allocations may occur in the future, and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Fluctuations in Quarterly Operating Results. The Company's sales are subject to
quarterly and annual fluctuations due to a number of factors resulting in more
variability and less predictability in the Company's quarter-to-quarter sales
and operating results. As a small number of customers have historically
accounted for a majority of the Company's sales, order volatility by any of
these major customers has had and may have an impact on the Company in the
prior, current and future fiscal quarters and years.
Most of the Company's sales require short delivery times. The Company's ability
to affect and judge the timing of individual customer orders is limited. Large
fluctuations in sales from quarter-to-quarter could be due to a wide variety of
factors, such as delay, cancellation or acceleration of customer projects, and
other factors discussed below. The Company's sales for a given quarter may
depend to a significant degree upon planned product shipments to a single
customer, often related to specific equipment or service deployment projects.
The Company has experienced both acceleration and slowdown in orders related to
such projects, causing changes in the sales level of a given quarter relative to
both the preceding and subsequent quarters.
Delays or lost sales can be caused by other factors beyond the Company's
control, including late deliveries by the third party subcontractors the Company
is using to outsource its manufacturing operations and by vendors of components
used in a customer's products, slower than anticipated growth in demand for the
Company's products for specific projects or delays in implementation of projects
by customers and delays in obtaining regulatory approvals for new services and
products. Delays and lost sales have occurred in the past and may occur in the
future. The Company believes that sales in the past have been adversely impacted
by merger and restructuring activities by some of its top customers. These and
similar delays or lost sales could materially adversely affect the Company's
business, financial condition and results of operations. See "Customer
Concentration" and "Dependence on Key Suppliers and Component Availability".
The Company's backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for that quarter. To achieve its sales
objectives, the Company is dependent upon obtaining orders in a quarter for
shipment in that quarter. Furthermore, the Company's agreements with certain of
its customers typically provide that they may change delivery schedules and
cancel orders within specified timeframes, typically up to 30 days prior to the
scheduled shipment date, without significant penalty. Some of the Company's
customers have in the past built, and may in the future build, significant
inventory in order to facilitate more rapid deployment of anticipated major
projects or for other reasons. Decisions by such customers to reduce their
24
inventory levels could lead to reductions in purchases from the Company in
certain periods. These reductions, in turn, could cause fluctuations in the
Company's operating results and could have an adverse effect on the Company's
business, financial condition and results of operations in the periods in which
the inventory is reduced.
Operating results may also fluctuate due to a variety of factors, including
market acceptance of the Company's new InnovX line of products, delays in new
product introductions by the Company, market acceptance of new products and
feature enhancements introduced by the Company, changes in the mix of products
and or customers, the gain or loss of a significant customer, competitive price
pressures, changes in expenses related to operations, research and development
and marketing associated with existing and new products, and the general
condition of the economy.
All of the above factors are difficult for the Company to forecast, and these or
other factors can materially and adversely affect the Company's business,
financial condition and results of operations for one quarter or a series of
quarters. The Company's expense levels are based in part on its expectations
regarding future sales and are fixed in the short term to a certain extent.
Therefore, the Company may be unable to adjust spending in a timely manner to
compensate for any unexpected shortfall in sales. Any significant decline in
demand relative to the Company's expectations or any material delay of customer
orders could have a material adverse effect on the Company's business, financial
condition, and results of operations. There can be no assurance that the Company
will be able to be profitable on a quarterly or annual basis. In addition, the
Company has had, and in some future quarter may have operating results below the
expectations of public market analysts and investors. In such event, the price
of the Company's Common Stock would likely be materially and adversely affected.
See "Potential Volatility of Stock Price".
Competition. The market for telecommunications network access equipment
addressed by the Company's SpectraComm, InnovX and TMS/OCM product families can
be characterized as highly competitive, with intensive equipment price pressure.
This market is subject to rapid technological change, wide-ranging regulatory
requirements, the entrance of low cost manufacturers and the presence of
formidable competitors that have greater name recognition and financial
resources. Certain technology such as the V.34 and DSU/CSU portion of the
SpectraComm and InnovX lines are not considered new and the market has
experienced decline in recent years.
Industry consolidation could lead to competition with fewer, but stronger
competitors. In addition, advanced termination products are emerging, which
represent both new market opportunities, as well as a threat to the Company's
current products. Furthermore, basic line termination functions are increasingly
being integrated by competitors, such as Cisco, Lucent Technologies, Inc. and
Nortel Networks, into other equipment such as routers and switches. To the
extent that current or potential competitors can expand their current offerings
to include products that have functionality similar to the Company's products
and planned products, the Company's business, financial condition and results of
operations could be materially adversely affected. Many of the Company's current
25
and potential competitors have substantially greater technical, financial,
manufacturing and marketing resources than the Company. In addition, many of the
Company's competitors have long-established relationships with network service
providers. There can be no assurance that the Company will have the financial
resources, technical expertise, manufacturing, marketing, distribution and
support capabilities to compete successfully in the future.
Rapid Technological Change. The network access and telecommunications equipment
markets are characterized by rapidly changing technologies and frequent new
product introductions. The rapid development of new technologies increases the
risk that current or new competitors could develop products that would reduce
the competitiveness of the Company's products. The Company's success will depend
to a substantial degree upon its ability to respond to changes in technology and
customer requirements. This will require the timely selection, development and
marketing of new products and enhancements on a cost-effective basis. The
development of new, technologically advanced products is a complex and uncertain
process, requiring high levels of innovation. The Company may need to supplement
its internal expertise and resources with specialized expertise or intellectual
property from third parties to develop new products.
Furthermore, the communications industry is characterized by the need to design
products that meet industry standards for safety, emissions and network
interconnection. With new and emerging technologies and service offerings from
network service providers, such standards are often changing or unavailable. As
a result, there is a potential for product development delays due to the need
for compliance with new or modified standards. The introduction of new and
enhanced products also requires that the Company manage transitions from older
products in order to minimize disruptions in customer orders, avoid excess
inventory of old products and ensure that adequate supplies of new products can
be delivered to meet customer orders. There can be no assurance that the Company
will be successful in developing, introducing or managing the transition to new
or enhanced products, or that any such products will be responsive to
technological changes or will gain market acceptance. The Company's business,
financial condition and results of operations would be materially adversely
affected if the Company were to be unsuccessful, or to incur significant delays
in developing and introducing such new products or enhancements. See "Dependence
on Legacy and Recently Introduced Products and New Product Development".
Compliance with Regulations and Evolving Industry Standards. The market for the
Company's products is characterized by the need to meet a significant number of
communications regulations and standards, some of which are evolving as new
technologies are deployed. In the United States, the Company's products must
comply with various regulations defined by the Federal Communications Commission
and standards established by Underwriters Laboratories and Bell Communications
Research and new products introduced in the SpectraComm line will need to be
NEBS Certified. As standards continue to evolve, the Company will be required to
modify its products or develop and support new versions of its products. The
failure of the Company's products to comply, or delays in compliance, with the
26
various existing and evolving industry standards, could delay introduction of
the Company's products, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
GDC May Require Additional Funding to Sustain Operations. The Company emerged
from Chapter 11 bankruptcy on September 15, 2003. Under the plan of emergence,
the Company plans to pay all creditors 100% of their allowed claims based upon a
five year business plan. The ability to meet the objectives of this business
plan is directly affected by the factors described in this section "Risk
Factors". The Company cannot assure investors that it will be able to obtain new
customers or to generate the increased revenues required to meet our business
plan objectives. In addition, in order to execute the business plan, the Company
may need to seek additional funding through public or private equity offerings,
debt financings or commercial partners. The Company cannot assure investors that
it will obtain funding on acceptable terms, if at all. If the Company is unable
to generate sufficient revenues or access capital on acceptable terms, it may be
required to (a) obtain funds on unfavorable terms that may require the Company
to relinquish rights to certain of our technologies or that would significantly
dilute our stockholders and/or (b) significantly scale back current operations.
Either of these two possibilities would have a material adverse effect on the
Company's business, financial condition and results of operations.
Risks Associated With Entry into International Markets. The Company to date has
had minimal direct sales to customers outside of North America since 2001. The
Company has little recent experience in international markets with the exception
of a few direct customers and resellers/integrators. The Company intends to
expand sales of its products outside of North America and to enter certain
international markets, which will require significant management attention and
financial resources. Conducting business outside of North America is subject to
certain risks, including longer payment cycles, unexpected changes in regulatory
requirements and tariffs, difficulties in supporting foreign customers, greater
difficulty in accounts receivable collection and potentially adverse tax
consequences. To the extent any Company sales are denominated in foreign
currency, the Company's sales and results of operations may also be directly
affected by fluctuations in foreign currency exchange rates. In order to sell
its products internationally, the Company must meet standards established by
telecommunications authorities in various countries, as well as recommendations
of the Consultative Committee on International Telegraph and Telephony. A delay
in obtaining, or the failure to obtain, certification of its products in
countries outside the United States could delay or preclude the Company's
marketing and sales efforts in such countries, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Risk of Third Party Claims of Infringement. The network access and
telecommunications equipment industries are characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
27
copyright, trademark and other intellectual property rights to technologies that
are important to the Company. The Company has not conducted a formal patent
search relating to the technology used in its products, due in part to the high
cost and limited benefits of a formal search. In addition, since patent
applications in the United States are not publicly disclosed until the related
patent is issued and foreign patent applications generally are not publicly
disclosed for at least a portion of the time that they are pending, applications
may have been filed which, if issued as patents, could relate to the Company's
products. Software comprises a substantial portion of the technology in the
Company's products. The scope of protection accorded to patents covering
software-related inventions is evolving and is subject to a degree of
uncertainty which may increase the risk and cost to the Company if the Company
discovers third party patents related to its software products or if such
patents are asserted against the Company in the future.
The Company may receive communications from third parties asserting that the
Company's products infringe or may infringe the proprietary rights of third
parties. In its distribution agreements, the Company typically agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In the
event of litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from productive tasks. In the event of an
adverse ruling in such litigation, the Company might be required to discontinue
the use and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses from third parties. There can be no
assurance that licenses from third parties would be available on acceptable
terms, if at all. In the event of a successful claim against the Company and the
failure of the Company to develop or license a substitute technology, the
Company's business, financial condition, and results of operations could be
materially adversely affected.
Limited Protection of Intellectual Property. The Company relies upon a
combination of patent, trade secret, copyright, and trademark laws and
contractual restrictions to establish and protect proprietary rights in its
products and technologies. The Company has been issued certain U.S. and Canadian
patents with respect to certain products. There can be no assurance that third
parties have not or will not develop equivalent technologies or products without
infringing the Company's patents or that a court having jurisdiction over a
dispute involving such patents would hold the Company's patents valid,
enforceable and infringed. The Company also typically enters into
confidentiality and invention assignment agreements with its employees and
independent contractors, and non-disclosure agreements with its suppliers,
distributors and appropriate customers so as to limit access to and disclosure
of its proprietary information. There can be no assurance that these statutory
and contractual arrangements will deter misappropriation of the Company's
technologies or discourage independent third-party development of similar
technologies. In the event such arrangements are insufficient, the Company's
business, financial condition and results of operations could be materially
adversely affected. The laws of certain foreign countries in which the Company's
products are or may be developed, manufactured or sold may not protect the
28
Company's products or intellectual property rights to the same extent as do the
laws of the United States and thus, make the possibility of misappropriation of
the Company's technology and products more likely.
Potential Volatility of Stock Price. The trading price of the Company's common
stock may be subject to wide fluctuations in response to quarter-to-quarter
variations in operating results, announcements of technological innovations or
new products by the Company or its competitors, developments with respect to
patents or proprietary rights, general conditions in the telecommunication
network access and equipment industries, changes in earnings estimates by
analysts, or other events or factors. In addition, the stock market has
experienced extreme price and volume fluctuations, which have particularly
affected the market prices of many technology companies and which have often
been unrelated to the operating performance of such companies. Company-specific
factors or broad market fluctuations may materially adversely affect the market
price of the Company's common stock. The Company has experienced significant
fluctuations in its stock price and share trading volume in the past and may
continue to do so.
The Company is Controlled by a Small Number of Stockholders and Certain
Creditors. In particular, Mr. Modlin, Chairman of the Board and Chief Executive
Officer, and President of Weisman Celler Spett & Modlin, P.C., legal counsel for
the Company, owns approximately 70% of the Company's outstanding shares of Class
B stock. Furthermore, Mr. Modlin is also executor of the estate of Mr. Charles
P. Johnson, the former Chairman of the Board and Chief Executive Officer, and
such estate owns approximately 27% of the outstanding shares of Class B stock.
Class B stock under certain circumstances has 10 votes per share in the election
of Directors. The Board of Directors is to consist of no less than three and no
more than thirteen directors, one of which may be (and has been) designated by
the Creditors Committee (and thereafter the Trustee). The holders of the 9%
Preferred Stock are presently entitled to designate two directors until all
arrears on the dividends on such 9% Preferred Stock are paid in full. In
addition, until the Company's primary secured loan obligations are paid in full,
the primary secured lender, Ableco Finance LLC ("Ableco") is entitled to
designate three directors and, upon default in its loan, its affiliate shall
have the right under the two warrants it holds, to (i) acquire from 5% to 51% of
the outstanding Common Stock depending on the amount of the outstanding secured
debt at such time and (ii) acquire 10% of the outstanding common stock on a
diluted basis. If Ableco's loan is not repaid in full by September 15, 2006, the
Trustee may designate two more directors, and in the event of a payment default
under the Debentures which is not cured within 60 days after written notice, the
Trustee shall be entitled to select a majority of the Board of Directors.
Accordingly, in the absence of a default under Ableco's loan, or a payment
default under the Debentures, Mr. Modlin may be able to elect all members of the
Board of Directors not designated by the holders of the 9% Preferred Stock,
Ableco and the Trustee and determine the outcome of certain corporate actions
requiring stockholder approval, such as mergers and acquisitions of the Company.
This level of ownership by such persons and entities could have the effect of
29
making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, control of the Company. Such provisions
could limit the price that certain investors might be willing to pay in the
future for shares of the Company's common stock, thereby making it less likely
that a stockholder will receive a premium in any sale of shares. To date, the
holders of the 9% Preferred Stock and Ableco have not designated any directors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that impacts our financial position,
results of operations or cash flows due to adverse changes in financial and
commodity market prices and rates. Historically the Company has had little or no
exposure to market risk for changes in foreign currency exchange rates as
measured against the United States dollar, except to the extent the Company
invoices customers in foreign currencies and is, therefore, subject to foreign
currency exchange rate risk on any individual invoice while it remains unpaid, a
period that normally is less than 90 days. At December 31, 2003 the Company had
net accounts receivable denominated in Canadian dollars of approximately
$1,855,000 (equivalent to approximately 1,432,000 U.S. dollars).
The Company is subject to interest rate risks on its long-term debt. If market
interest rates were to increase immediately and uniformly by 10% from levels as
of December 31, 2003, the additional interest expense would be approximately
$1.5 million annually. However, the Company believes that the effect, if any, of
reasonably possible near-term changes in interest rates on the Company's
financial position, results of operations and cash flows would not be material.
ITEM 4. CONTROLS AND PROCEDURES
For the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Company's management,
including the Company's President and Chief Executive Officer, and Vice
President and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15. Based upon that evaluation, the Company's President
and Chief Executive Officer, and Vice President and Chief Financial Officer,
have concluded that the Company's disclosure controls and procedures are
effective to ensure the information required to be disclosed in reports filed or
submitted under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms. There have been no significant changes in
the Company's internal controls over financial reporting that occurred during
the period covered by this Quarterly Report on From 10-Q that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
30
ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Index:
Exhibit Number Description of Exhibit
- ------------- ----------------------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act
of 1934.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act
of 1934
32.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on From 8-K
During the quarter ended December 31, 2003, reports on Form 8-K were filed as
follows:
(i) A report on Form 8-K dated October 8, 2003 advising that the
Company's independent accountants, PricewaterhouseCoopers LLP
("PwC"), had declined to stand for re-election as the Company's
independent accountants for the year ended September 30, 2003.
(ii) A report on Form 8-K dated October 16, 2003 advising that PwC had
declined to stand for re-election as the independent accountants
for the Company's 401(k) plan.
(iii) A report on Form 8-K dated November 4, 2003 containing
information on awards, grants and options authorized by the
Company's Stock Option Committee pursuant to the Company's 2003
Stock and Bonus Plan.
(v) A report on Form 8-K dated November 10, 2003 advising of the
retention of Eisner LLP as the Company's independent accountants
for the year ended September 30, 2003.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GENERAL DATACOMM INDUSTRIES< INC.
/s/ William G. Henry
February 13, 2004 ---------------------------------
- ----------------- William G. Henry
Vice President, Finance and Administration
Chief Financial Officer
32