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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
000-31770
(Commission File Number)
Digital Lightwave, Inc.
(Exact name of Registrant as specified in its charter)
Delaware | 95-4313013 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
5775 Rio Vista Drive | ||
Clearwater, Florida | 33760 | |
(Address of principal executive offices) | (Zip Code) |
(727) 442-6677
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
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 report(s)), and (2) has been subject to such filing requirements for the past 90 days.
YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer | ¨ | Accelerated Filer | ¨ | |||
Non-accelerated Filer | ¨ (Do not check if a smaller reporting company) | Smaller Reporting Company | x |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES ¨ NO x
The number of shares outstanding of the Registrants Common Stock as of November 1, 2009 was 255,489,847.
Table of Contents
QUARTERLY REPORT ON FORM 10-Q
For the Period Ended September 30, 2009
INDEX
Page | ||||
PART I. FINANCIAL INFORMATION | ||||
Item 1. |
Financial Statements: |
|||
Consolidated Balance Sheets September 30, 2009 (Unaudited) and December 31, 2008 |
1 | |||
2 | ||||
3 | ||||
4 | ||||
5 | ||||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
12 | ||
Item 3. |
19 | |||
Item 4(T). |
19 | |||
PART II. OTHER INFORMATION | ||||
Item 1. |
20 | |||
Item 1A. |
20 | |||
Item 2. |
20 | |||
Item 3. |
20 | |||
Item 4. |
20 | |||
Item 5. |
20 | |||
Item 6. |
20 | |||
21 | ||||
22 |
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PART I
FINANCIAL INFORMATION
Item 1. | Financial Statements |
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
September 30, 2009 |
December 31, 2008 |
|||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets: |
||||||||
Cash |
$ | 366 | $ | 15 | ||||
Accounts receivable, less allowance of $61 in 2009 and $76 in 2008 |
2,169 | 1,730 | ||||||
Inventories, net |
2,602 | 3,576 | ||||||
Prepaid expenses and other current assets |
128 | 196 | ||||||
Total current assets |
5,265 | 5,517 | ||||||
Property, plant and equipment |
981 | 950 | ||||||
Other assets, net |
213 | 214 | ||||||
Total assets |
$ | 6,459 | $ | 6,681 | ||||
LIABILITIES AND STOCKHOLDERS DEFICIT | ||||||||
Current liabilities: |
||||||||
Accounts payable and accrued liabilities |
$ | 2,015 | $ | 2,896 | ||||
Current portion of notes payable to related party |
39,206 | | ||||||
Total current liabilities |
41,221 | 2,896 | ||||||
Other long-term liabilities |
338 | 319 | ||||||
Notes payable to related party |
| 37,204 | ||||||
Total liabilities |
41,559 | 40,419 | ||||||
Stockholders equity (deficit): |
||||||||
Preferred stock, $.0001 par value; authorized 20,000,000 shares; no shares issued or outstanding |
| | ||||||
Common stock, $.0001 par value; authorized 300,000,000 shares; issued and outstanding 255,489,847 shares in 2009 and 2008 |
26 | 26 | ||||||
Additional paid-in capital |
123,263 | 123,167 | ||||||
Accumulated deficit |
(158,389 | ) | (156,931 | ) | ||||
Total stockholders deficit |
(35,100 | ) | (33,738 | ) | ||||
Total liabilities and stockholders deficit |
$ | 6,459 | $ | 6,681 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per-share data)
Three Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
Net sales |
$ | 3,168 | $ | 4,115 | ||||
Cost of goods sold |
1,411 | 1,909 | ||||||
Gross profit |
1,757 | 2,206 | ||||||
Operating expenses: |
||||||||
Engineering and development |
448 | 565 | ||||||
Sales and marketing |
660 | 627 | ||||||
General and administrative |
258 | 284 | ||||||
Total operating expenses |
1,366 | 1,476 | ||||||
Operating profit |
391 | 730 | ||||||
Other expense, net |
(187 | ) | (360 | ) | ||||
Net profit |
$ | 204 | $ | 370 | ||||
Per share of common stock: |
||||||||
Basic net income per share |
$ | 0.00 | $ | 0.00 | ||||
Diluted net income per share |
$ | 0.00 | $ | 0.00 | ||||
Weighted average common shares outstanding |
255,489,847 | 255,489,847 | ||||||
Weighted average common shares outstanding - diluted |
255,489,847 | 255,489,847 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per-share data)
Nine Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
Net sales |
$ | 6,837 | $ | 8,915 | ||||
Cost of goods sold |
3,532 | 4,701 | ||||||
Gross profit |
3,305 | 4,214 | ||||||
Operating expenses: |
||||||||
Engineering and development |
1,444 | 1,618 | ||||||
Sales and marketing |
1,929 | 1,868 | ||||||
General and administrative |
748 | 848 | ||||||
Gain on sale of property and equipment |
(12 | ) | | |||||
Total operating expenses |
4,109 | 4,334 | ||||||
Operating loss |
(804 | ) | (120 | ) | ||||
Other expense, net |
(654 | ) | (1,566 | ) | ||||
Net loss |
$ | (1,458 | ) | $ | (1,686 | ) | ||
Per share of common stock: |
||||||||
Basic net loss per share |
$ | (0.01 | ) | $ | (0.01 | ) | ||
Diluted net loss per share |
$ | (0.01 | ) | $ | (0.01 | ) | ||
Weighted average common shares outstanding |
255,489,847 | 255,487,679 | ||||||
Weighted average common shares outstanding - diluted |
255,489,847 | 255,487,679 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (1,458 | ) | $ | (1,686 | ) | ||
Adjustments to reconcile net loss to cash used in operating activities: |
||||||||
Compensation expense for stock option grants |
| 2 | ||||||
Contributed services from related party |
96 | 64 | ||||||
Depreciation and amortization |
292 | | ||||||
Gain on sale of property and equipment |
(12 | ) | | |||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(439 | ) | 734 | |||||
Inventories |
651 | (1,040 | ) | |||||
Prepaid expenses and other assets |
69 | (108 | ) | |||||
Accounts payable, accrued expenses and other liabilities |
(862 | ) | 1,542 | |||||
Net cash used in operating activities |
(1,663 | ) | (492 | ) | ||||
Cash flows from investing activities: |
||||||||
Proceeds from sale of property and equipment |
12 | | ||||||
Net cash provided by investing activities |
12 | | ||||||
Cash flows from financing activities: |
||||||||
Proceeds from notes payable - related party |
2,013 | 1,100 | ||||||
Principal payments on notes payable - related party |
(11 | ) | (530 | ) | ||||
Proceeds from sale of common stock |
| 1 | ||||||
Net cash provided by financing activities |
2,002 | 571 | ||||||
Net increase in cash and cash equivalents |
351 | 79 | ||||||
Cash and cash equivalents at beginning of period |
15 | 12 | ||||||
Cash and cash equivalents at end of period |
$ | 366 | $ | 91 | ||||
Supplemental disclosures of non cash activities - related party: |
||||||||
Inventory used as demonstration and rental units transferred to property and equipment |
$ | 323 | $ | | ||||
Accrued interest converted to related party note payable |
$ | | $ | 857 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Cash paid for interest |
$ | 1,065 | $ | 321 |
The accompanying notes are an integral part of these consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business and Basis of Presentation
Digital Lightwave, Inc. provides the global fiber-optic communications industry with products and technology used to develop, install, maintain, monitor and manage fiber-optic communication networks. Telecommunications service providers, owners of private networks (utilities, government and large enterprises) and equipment manufacturers deploy the Companys products to provide quality assurance and ensure optimum performance of advanced optical communications networks and network equipment. The Companys products are sold worldwide to telecommunications service providers, owners of private networks (utilities, government and large enterprises), telecommunications equipment manufacturers, equipment leasing companies and international distributors. The Companys wholly owned subsidiaries are Digital Lightwave (UK) Limited (DLL), Digital Lightwave Asia Pacific Pty, Ltd. (DLAP), and Digital Lightwave Latino Americana Ltda. (DLLA). DLL, DLAP, and DLLA provided international sales support, but are currently inactive. All significant intercompany transactions and balances are eliminated in consolidation.
The accompanying unaudited consolidated financial statements of Digital Lightwave, Inc. and its subsidiaries (the Company, Digital Lightwave, us, we, our, etc.) 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 results for such periods. The results of operations for the three- and nine -months ended September 30, 2009, are not necessarily indicative of results that may be achieved for the full fiscal year or for any future period. The unaudited interim financial statements should be read in conjunction with the financial statements and notes thereto contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2008. Subsequent events have been evaluated through November 12, 2009, the date the final statements were issued.
Operational Matters
On April 4, 2008, the Company and Optel Capital, LLC (Optel) entered into a Credit and Restructuring Agreement (the Credit Agreement) pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of approximately $28.0 million of principal, which bore interest at 10% per annum, and accrued interest thereon of approximately $7.7 million, all of which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to make a $2.5 million revolving credit facility available to the Company. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.
Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and, together with the Restated Note, the Notes). As of September 30, 2009, the principal balances of the Restated Note and New Commitment Note were $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus 1.0% per annum and are secured by substantially all the Companys assets pursuant to an amended and restated security agreement (the Security Agreement). Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010.
All the indebtedness evidenced by the Notes is convertible into common stock of the Company at the option of Optel at any time following approval of the conversion feature by the disinterested stockholders at a conversion price based on the average trading price of the stock during the five-day period preceding the date of any conversion. The Company and Optel have made it a condition to the indebtedness evidenced by the Notes becoming convertible, that the conversion feature be approved by the holders of a majority of the outstanding shares of common stock of the Company who are not affiliated with Optel or any of its affiliates at the Companys 2009 annual meeting of stockholders. If such holders do not approve the conversion feature, the outstanding debt and accrued interest would immediately become due and payable in full upon demand by Optel at any time after the stockholders meeting. As of September 30, 2009, the disinterested stockholders have not yet approved the conversion feature and the Convertible Note is not convertible.
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On March 26, 2009, March 30, 2009, June 25, 2009, June 29, 2009 and July 22, 2009 the Company borrowed $200,000, $225,000, $75,000, $213,000 and $350,000, respectively from Optel to fund its working capital requirements. The loans were made outside the Credit Agreement and are evidenced by secured promissory notes that bear interest at 10.0% per annum and are secured by a security interest in substantially all of the Companys assets. Principal and any accrued but unpaid interest under the secured promissory notes are currently due and payable upon demand by Optel.
The financial statements have been prepared assuming the Company will continue as a going concern. While the Company has been exploring alternative financing to raise additional funding, it has not identified a funding source other than Optel that would be willing to provide current or future financing. In the future, if the Company issues additional equity securities to raise funds, the ownership percentage of the existing stockholders would be diluted, and the new investors may demand rights, preferences or privileges senior to those of existing holders of common stock. Additional debt incurred by the Company would be senior to equity with respect to the ability of the debt holders to make claims on the assets. In addition, the terms of any debt issued could impose restrictions on the Companys operations. If adequate funds are not available to satisfy either short- or long-term capital requirements, the Company may be required to curtail operations significantly or to seek funds through arrangements with strategic partners or other parties that may require the Company to relinquish material rights to certain of its products, technologies or potential markets, or may be forced to seek protection under bankruptcy laws. The Company cannot assure that it will be able to obtain adequate financing which raises substantial doubt about the Companys ability to continue as a going concern. The accompanying financial statements do not reflect any adjustments that might result from the outcome of this uncertainty.
On October 14, 2009, a group of stockholders controlled by Dr. Bryan J. Zwan, the Companys chairman of the board of directors who controls 91.1% of the outstanding shares of the Company, filed a Schedule 13E-3 with the Securities and Exchange Commission disclosing that such stockholders will cause the Company to merge with a newly formed corporation, Optel Acquisition Corp. (OAC), in a going private transaction whereby the Company will emerge as a privately held corporation. Under Delaware law, the transaction does not require the approval of the Companys board of directors or stockholders, other than OAC. The merger will not be consummated any sooner than November 13, 2009. Pursuant to the terms of a merger and contribution agreement the Companys stockholders (other than OAC) will be entitled to receive $0.055 in cash per share of outstanding common stock.
Accrued Warranty
The Company provides the customer a warranty with each product sold. The Companys policy for product warranties is to review the warranty reserve on a quarterly basis for specifically identified or new matters and review the reserve for estimated future costs associated with any open warranty years. The reserve is an estimate based on historical trends, the number of products under warranty, the costs of replacement parts and the expected reliability of the Companys products. A change in these factors could result in a change in the reserve balance. Warranty costs are charged against the accrual when incurred. The reconciliation of the warranty reserve is as follows:
Three Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
(In thousands) | ||||||||
Beginning balance |
$ | 333 | $ | 415 | ||||
Warranty provision |
35 | 34 | ||||||
Warranty costs |
(32 | ) | (73 | ) | ||||
Ending balance |
$ | 336 | $ | 376 | ||||
Nine Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
(In thousands) | ||||||||
Beginning balance |
$ | 338 | $ | 471 | ||||
Warranty provision |
190 | 117 | ||||||
Warranty costs |
(192 | ) | (212 | ) | ||||
Ending balance |
$ | 336 | $ | 376 | ||||
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Revenue Recognition
The Company derives its revenue principally from product sales. The Company recognizes revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured.
For all sales, the Company uses a binding purchase order as evidence that a sales arrangement exists. Sales through international distributors are evidenced by a master agreement governing the relationship with the distributor. The Company either obtains an end-user purchase order documenting the order placed with the distributor or proof of delivery to the end user as evidence that a sales arrangement exists. For demonstration units sold to distributors, the distributors binding purchase order is evidence of a sales arrangement.
For domestic sales, delivery generally occurs when product is delivered to a common carrier. Demonstration units sold to international distributors are considered delivered when the units are delivered to a common carrier. An allowance is provided for sales returns based on historical experience.
For sales made under an OEM arrangement, delivery generally occurs when the product is delivered to a common carrier. OEM sales are defined as sales of the Companys products to a third party that will market the products under their brand.
The Company sells extended warranty contracts. Revenue is recognized over the period of the extended warranty after the expiration of the initial warranty. In 2007 the Company began selling software maintenance agreements for its NIC product line. These agreements extend the software maintenance period two or three years from the expiration of the initial software maintenance period provided with each unit sold. Revenue from these contracts is recognized on a monthly basis beginning after the initial period has expired. The Company provides one year of free software maintenance for each NIC product sale. Maintenance revenue is amortized quarterly during the free software maintenance period.
For trade-in sales, including both Company and competitor products, that have a cash component of greater than 25% of the fair value of the sale, the Company recognizes revenue based upon the fair value of what is sold or received, whichever is more readily determinable, if the Company has demonstrated the ability to sell its trade-in inventory for that particular product class. Otherwise, the Company accounts for the trade-in sale as a non-monetary transaction and follows the guidance of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) topic 845-10, Non-monetary transactions (ASC 845-10). Revenue and cost of sales are recorded based upon the cash portion of the transaction. The remaining costs associated with the new units are assigned to the units received on trade. When the trade-in units are resold, revenue is recorded based upon the sales price and cost of goods sold is charged with the value assigned to trade-in units from the original transaction. The adoption of ASC 845-10 did not have a significant impact on the financial statements for the nine months ended September 30, 2009.
At the time of the transaction, the Company assesses whether the price associated with its revenue transactions is fixed and determinable and whether or not collection is reasonably assured. The Company assesses whether the price is fixed and determinable based on the payment terms associated with the transaction. Standard payment terms for domestic customers are 30 days from the invoice date. Distributor contracts provide standard payment terms of 60 days from the invoice date. Generally, the Company does not offer extended payment terms.
The Company assesses collectability based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. Collateral is not requested from customers. If it is determined collectability is not reasonably assured at the time of the sale, revenue is recognized at the time collection becomes reasonably assured.
Most sales arrangements do not include acceptance clauses. However, if a sales arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.
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Computation of Net Loss Per Share
Basic net loss per share is based on the weighted average number of common shares outstanding during the periods presented. For the three- and nine-month periods ended September 30, 2009 and 2008, diluted loss per share does not include the effect of incremental shares from common stock equivalents using the treasury stock method, as the inclusion of such equivalents would be anti-dilutive. There were no incremental shares from common stock equivalents for the three- and nine-month periods ended September 30, 2009 and 2008. Total outstanding stock options of 1,950,000 shares for the three- and nine-month periods ended September 30, 2009 were excluded from the computation, as the inclusion of such would be anti-dilutive. Total outstanding stock options of 2,150,000 shares for the three-and nine-month periods ended September 30, 2008 were excluded from the computation, as the inclusion of such would be anti-dilutive. The table below presents the basic weighted average common shares outstanding and the incremental number of shares arising from common stock equivalents under the treasury stock method:
Three Months Ended September 30, | ||||||
2009 | 2008 | |||||
Basic: |
||||||
Weighted average common shares outstanding | 255,489,847 | 255,489,847 | ||||
Diluted: |
||||||
Incremental shares for common stock equivalents | | | ||||
Total dilutive | 255,489,847 | 255,489,847 | ||||
Nine Months Ended September 30, | ||||||
2009 | 2008 | |||||
Basic: |
||||||
Weighted average common shares outstanding | 255,489,847 | 255,487,679 | ||||
Diluted: |
||||||
Incremental shares for common stock equivalents | | | ||||
Total dilutive | 255,489,847 | 255,487,679 | ||||
Stock Based Compensation
The Companys compensation cost for stock-based employee compensation was $0 for the three- and nine-month periods ended September 30, 2009. The Companys cost for stock based employee compensation was $0 and $1,600 for the three- and nine-month periods ended September 30, 2008. No tax benefits were recognized for these costs due to recurring losses.
The expected term of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Volatility is based on historical volatility of the Companys stock. The Company has not historically paid any dividends on its common stock and does not expect to in the future.
Stock Option Plans
The Company has one stock option plan with 10,037,214 shares available for grant as of September 30, 2009 as follows:
Plan 2001 |
|||
Minimum exercise price as a percentage of fair market value at date of grant |
100 | % | |
Plan termination date |
December 31, 2011 |
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Options granted under the plan have a term of six years. Option grants generally vest in one-third annual increments or quarterly over a three-year period, with the exception of certain option agreements that provide for various vesting schedules throughout the same three-year vesting period or options allowing vesting acceleration based on certain performance milestones on each anniversary of the grant date, commencing with the first anniversary. The Company generally recognizes compensation costs for awards on a straight-line basis over the service period.
The following is a summary of the changes in outstanding options during the nine months ended September 30, 2009:
Shares (In thousands) |
Weighted Average Exercise Price |
Aggregate Intrinsic Value (In thousands) | |||||||
Outstanding at December 31, 2008 |
2,100 | $ | 1.56 | $ | 0 | ||||
Granted |
| | | ||||||
Exercised |
| | | ||||||
Forfeited and expired |
(150 | ) | $ | 1.28 | $ | 0 | |||
Outstanding at September 30, 2009 |
1,950 | $ | 1.59 | $ | 0 | ||||
Exercisable at end of period |
1,950 | $ | 1.59 | $ | 0 | ||||
There were no stock options exercised during the nine-month period ended September 30, 2009. The surviving corporation will not assume any unexercised options issued under the 2001 Stock Option Plan after the Merger.
The following table summarizes information about stock options outstanding at September 30, 2009:
Range of Exercise Price |
Number Outstanding At September 30, 2009 |
Outstanding Weighted Average Remaining Life |
Outstanding Weighted Average Exercise Price |
Number Exercisable At September 30, 2009 |
Exercisable Weighted Average Exercise Price | |||||||
$ 0.22 - $ 1.40 |
995,000 | 1.20 | $ | 0.97 | 995,000 | $ | 0.97 | |||||
$ 1.60 - $ 2.26 |
955,000 | 0.45 | $ | 2.23 | 955,000 | $ | 2.23 | |||||
1,950,000 | 1,950,000 | $ | 1.59 | |||||||||
There was no intrinsic value of options exercised for the years ended September 30, 2009. As of September 30, 2009, there was no unrecognized compensation cost related to non-vested options that are expected to be recognized in 2009. There was no intrinsic value of options fully vested or expected to vest at September 30, 2009.
Income Taxes
The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses for all periods presented. No interest or penalties have been recognized during the nine months ended September 30, 2009 or 2008.
The Company follows the provisions of the Financial Accounting Standards Board (FASB) ASC Topic 740, Income Taxes (ASC 740). ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. The Company must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements.
Based on the analysis performed, the Company did not record any unrecognized tax positions as of September 30, 2009 and December 31, 2008. There is a possibility that a limitation on the Companys net operating loss carry-forwards may have come into effect under Section 382 of the Internal Revenue Code as a result of cumulative stock ownership changes. As of September 30, 2009 and December 31, 2008, the impact of such a limitation has no impact on the accompanying financial
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statements since all net operating losses have a full valuation allowance; however, such a limitation could impact substantially the reported gross asset related to the net operating loss carry-forwards.
New Accounting Pronouncements
In May 2009, the FASB issued SFAS No. 165 Subsequent Events (SFAS 165) as codified in FASB ASC Topic 855-10 (ASC 855-10). ASC 855-10 established general standards of accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued. ASC 855-10 is effective for interim or annual periods ending after June 15, 2009, and accordingly, the Company adopted this standard during the third quarter ended September 30, 2009.
Effective July 1, 2009, the Company adopted the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 105, Generally Accepted Accounting Principles - FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (ASC 105). ASC 105 establishes the FASB Accounting Standards Codification (the Codification) as the source of authoritative United States generally accepted accounting principles (GAAP) recognized by the FASB to be applied to nongovernmental entities. The Codification did not create any new GAAP standards but incorporated existing accounting and reporting standards into a new topical structure with a new referencing system to identify authoritative accounting standards. The Codification supersedes all previously existing non-SEC accounting and reporting standards and the FASB will not issue new standards in the form of Statement of Financial Accounting Standards (SFAS), Emerging Issues Task Force (EITF), and FASB Staff Positions (RSP). Instead, the FASB will issue Accounting Standards Updates (ASUs), with a year and assigned sequence number. The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions with respect to the change or changes to the Codification. The adoption of the Codification did not have a material impact on the Companys consolidated financial statements.
In October 2009, the FASB concurrently issued the following Accounting Standards Updates:
ASU No. 2009-14 - Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (formerly EITF Issue No. 09-3). This standard removes tangible products from the scope of software revenue recognition guidance and also provides guidance on determining whether software deliverables in an arrangement that includes a tangible product, such as embedded software, are within the scope of the software revenue guidance.
ASU No. 2009-13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (formerly EITF Issue No. 08-1). This standard modifies the revenue recognition guidance for arrangements that involve the delivery of multiple elements, such as product, software, services or support, to a customer at different times as part of a single revenue generating transaction. This standard provides principles and application guidance to determine whether multiple deliverables exist, how the individual deliverables should be separated and how to allocate the revenue in the arrangement among those separate deliverables. The standard also expands the disclosure requirements for multiple deliverable revenue arrangements.
These Accounting Standards Updates should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. Alternatively, an entity can elect to adopt these standards on a retrospective basis, but both these standards must be adopted in the same period using the same transition method. We expect to apply this standard on a prospective basis for revenue arrangements entered into or materially modified beginning January 1, 2010. We are currently evaluating the potential impact these standards may have on our financial position and results of operations.
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2. INVENTORIES
Inventories are summarized as follows:
September 30, 2009 (In thousands) |
December 31, 2008 (In thousands) | |||||
Raw materials, net |
$ | 2,483 | $ | 3,425 | ||
Finished goods, net |
119 | 151 | ||||
$ | 2,602 | $ | 3,576 | |||
The Company has established reserves for excess and obsolete inventory based upon current and expected sales trends, the amount of parts on-hand, the market value of parts on-hand and the viability and technical obsolescence of products and components. As of September 30, 2009, inventory reserves were approximately $13.8 million.
3. LEGAL PROCEEDINGS
The Company from time to time may be involved in lawsuits and actions by third parties arising in the ordinary course of business. The Company is not aware of any pending litigation, claims or assessments that could have a material adverse effect on the Companys business, financial condition and results of operations.
4. COMMITMENTS
At September 30, 2009, the Company had outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $1.0 million.
5. RELATED PARTY TRANSACTIONS
Services Rendered
During the three- and nine-month periods ended September 30, 2009, Optel provided the Company with approximately $38,000 and $96,000 respectively, in services associated with information technology and accounting. During the three- and nine-month periods ended September 30, 2008, Optel provided the Company with approximately $23,000 and $64,000 respectively, in services associated with information technology and accounting. These services are shown as a contribution of capital and are expensed within general and administration expenses.
6. SUBSEQUENT EVENTS
On October 14, 2009, a group of stockholders controlled by Dr. Bryan J. Zwan, the Companys chairman of the board of directors who controls 91.1% of the outstanding shares of the Company, filed a Schedule 13E-3 with the Securities and Exchange Commission disclosing that such stockholders will cause the Company to merge with a newly formed corporation, Optel Acquisition Corp. (OAC), in a going private transaction whereby the Company will emerge as a privately held corporation. Under Delaware law, the transaction does not require the approval of the Companys board of directors or stockholders, other than OAC. The merger will not be consummated any sooner than November 13, 2009. Pursuant to the terms of a merger and contribution agreement the Companys stockholders (other than OAC) will be entitled to receive $0.055 in cash per share of outstanding common stock.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
FORWARD LOOKING STATEMENTS
The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict, potential or continue, the negative of terms like these or other comparable terminology. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements, except as required by law. These statements are only predictions. These statements involve known and unknown risks and uncertainties and other factors that may cause actual events or results to differ materially from the results and outcomes discussed in the forward-looking statements. All forward-looking statements included in this report are based on information available to us on the date of filing, and we assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors, including the risks outlined under the caption Risk Factors set forth in Item 1A of Part I of our Annual Report on Form 10-K and those contained from time to time in our other filings with the U.S. Securities and Exchange Commission. We caution you that our business and financial performance are subject to substantial risks and uncertainties.
This information should be read in conjunction with (i) the consolidated condensed financial statements and notes thereto included in Item 1 of Part I of this quarterly report on Form 10-Q, and (ii) the consolidated financial statements and notes thereto, as well as the accompanying Managements Discussion and Analysis of Results of Operations, for the years ended December 31, 2008 and 2007 included in our Annual Reports on Form 10-K.
OVERVIEW
Executive Summary
On April 4, 2008, the Company and Optel Capital, LLC (Optel) entered into a Credit and Restructuring Agreement (the Credit Agreement) pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of approximately $28.0 million of principal, which bore interest at 10% per annum, and accrued interest thereon of approximately $7.7 million, all of which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to make a $2.5 million revolving credit facility available to the Company. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.
Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and, together with the Restated Note, the Notes). As of September 30, 2009, the balance of the Restated Note and New Commitment Note was $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus 1.0% per annum and are secured by substantially all the Companys assets pursuant to an amended and restated security agreement (the Security Agreement). Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010.
On March 26, 2009, March 30, 2009, June 25, 2009, June 29, 2009 and July 22, 2009 the Company borrowed $200,000, $225,000, $75,000, $213,000 and $350,000, respectively from Optel to fund its working capital requirements. The loans were made outside the Credit Agreement and are evidenced by secured promissory notes that bear interest at 10.0% per annum and are secured by a security interest in substantially all of the Companys assets. Principal and any accrued but unpaid interest under the secured promissory notes are currently due and payable upon demand by Optel.
On October 14, 2009, a group of stockholders controlled by Dr. Bryan J. Zwan, the Companys chairman of the board of directors who controls 91.1% of the outstanding shares of the Company, filed a Schedule 13E-3 with the Securities and Exchange Commission disclosing that such stockholders will cause the Company to merge with a newly formed corporation, Optel Acquisition Corp. (OAC), in a going private transaction whereby the Company will emerge as a privately held corporation. Under Delaware law, the transaction does not require the approval of the Companys board of directors or stockholders, other than OAC. The merger will not be consummated any sooner than November 13, 2009. Pursuant to the terms of a merger and contribution agreement the Companys stockholders (other than OAC) will be entitled to receive $0.055 in cash per share of outstanding common stock.
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The Company designs and manufactures its products in portable and rack mountable form factors to serve varied customer types. Portable products are lightweight, self-contained test instruments that are used for field applications such as network diagnostics, maintenance and troubleshooting. The Company provides the same technologies in a rack-mountable product offering, designed for deployment at key points throughout the network, namely at central offices, data centers, and co-location facilities. The rack-mounted equipment provides for remote monitoring from a centralized network management console residing at the service providers network operations center. Having remotely deployed equipment allows service providers to monitor and manage their network on a full-time basis, thereby optimizing labor resources and minimizing the time and expense of diagnosis and resolution of network emergencies and repairs.
The Companys products are also applicable to laboratory and manufacturing applications. Network equipment manufacturers use our products during the research and development phase to ensure new equipment performs to designed specifications and conforms to international standards. Service providers and private network operators use our products in the laboratory environment to confirm network equipment functionality, compatibility and conformance to international standards. The Companys products are also used to confirm functionality as part of the manufacturing process for network equipment providers throughout the world.
Average Selling Price and Significant Customers
The Companys net sales are generated from sales of its products less an estimate for customer returns. We expect that the average selling price (ASP) of our products will fluctuate based on a variety of factors, including market demand, product configuration, potential volume discounts to customers, the timing of new product introductions and enhancements and the introduction of competitive products. Because the cost of goods sold tends to remain relatively stable for any given product, fluctuations in the ASP may have a material adverse effect on our business, financial condition and results of operations.
For the nine months ended September 30, 2009, two customers accounted for, in the aggregate, approximately 21% of total net sales. For the nine months ended September 30, 2008, one customer accounted for, in the aggregate, approximately 16% of total net sales. No other customers accounted for more than 10% of net sales.
Backlog
As of September 30, 2009, our backlog was approximately $1.1 million, which consists of approximately $635,000 of maintenance contracts that are accrued over the length of the contracts, which vary from 3-5 years, and $502,000 for unfulfilled purchase orders for current products and services. The maintenance contract backlog consists of (i) approximately $513,000 of revenue which the Company has received and which will be recognized over the length of the contracts, and (ii) $122,000 of accounts receivable which will be recognized over the length of the contracts. We believe that our level of backlog as of September 30, 2009 is above average, but not inordinately so, and as of the date of this filing we have no reason to expect in the foreseeable future the level of orders we receive for our current products and services to increase significantly from the normal operating trends of our business.
Recognition of Revenue and Warranty Reserve
The Company recognizes revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured. When selling through a distributor to an end-user customer, we either obtain an end-user purchase order documenting the order placed with the distributor or proof of delivery to the end-user as evidence that a sales arrangement exists. No revenue is recognized on products shipped on a trial basis. We believe that our accrued warranty reserve is sufficient to meet our responsibilities for potential future warranty work on products sold.
Long Term Agreements
The Company has not entered into long-term agreements or blanket purchase orders for the sale of its products and, accordingly, does not carry substantial backlog from quarter to quarter. Our sales during a particular quarter are highly dependent upon orders placed by customers during that period. Most of our operating expenses are fixed and cannot be easily reduced in response to decreased revenues. Variations in the timing of revenues could cause significant variations in results of operations from quarter to quarter and result in continuing quarterly losses. The deferral of any large order from one quarter to another would negatively affect the results of operations for the earlier quarter. The Company must obtain orders during each quarter for shipment in that quarter to achieve revenue and profit objectives.
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Maintaining Technology Leadership and Channel Partners
In order to maintain our market share, we are focused on maintaining technological leadership with our product lines. We have evaluated our sales efforts to identify opportunities where our account presence can be improved and are working to exploit those opportunities. Subject to resolution of our working capital constraints, we are seeking new applications for our installed product base to be realized with use of new modular add-ons and enhancements. We also established channel partners such as independent sales representatives and distributors to complement our sales force.
Critical Accounting Estimates
We believe that estimating asset valuation allowances and accrued liabilities are critical in the portrayal of our financial condition and results of operations and they require difficult, subjective and complex judgments that are often the result of estimates that are inherently uncertain. Specifically, we believe the following estimates to be critical:
| sales returns and other allowances; |
| reserve for uncollectible accounts; |
| reserve for excess and obsolete inventory; |
| assessments of uncertain tax positions; |
| impairment of long-lived assets; |
| deferred tax valuation allowance; and |
| warranty reserve. |
We make significant judgments and estimates and assumptions in connection with establishing the above-mentioned asset valuation allowances and accrued liabilities. If we made different judgments or used different estimates or assumptions for establishing such amounts, it is likely that the amount and timing of our revenue or operating expenses for any period would be materially different.
We derive our revenues principally from product sales. We recognize revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured. We estimate the amount of potential future product returns related to current period product revenue. We consider many factors when making our estimates, including analyzing historical returns, current economic trends, changes in customer demand and acceptance of our products to evaluate the adequacy of the sales returns and other allowances. As of September 30, 2009, a review of the amount of potential future product returns indicated no allowance was required.
We also estimate the collectability of our accounts receivable. We consider many factors when making our estimates, including analyzing accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the reserve for uncollectible accounts. As of September 30, 2009, our accounts receivable balance was $2.2 million, net of our estimated reserve for uncollectible accounts of approximately $61,000.
We estimate the amount of excess and obsolete inventory and lower of cost or market adjustments. We consider many factors when making our estimates, including analyzing current and expected sales trends, the amount of current parts on hand, the current market value of parts on hand and the viability and technical obsolescence of our products. The assumptions made relative to expected sales trends are subjective in nature and have a material impact on the estimate of the reserve requirement. Should future sales trends, in total or by product line, fluctuate from that used in our estimates, this reserve could be overstated or understated. Our inventory balance was $2.6 million as of September 30, 2009, net of our estimated reserve for excess and obsolete inventory and lower of cost or market adjustments of approximately $13.8 million.
We estimate the impairment of long-lived assets. We monitor events and changes in circumstances that indicate whether carrying amounts of long-lived assets may not be recoverable. These events and circumstances include decrease in market price of a long-lived asset, change in the manner in which a long-lived asset is used, changes in legal factors and a current-period operating loss or cash flow loss combined with a history of operating losses or cash flow losses or a forecast that demonstrates continuing losses associated with the use of long-lived assets. When such an event or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. We recognize impairment when there is an excess of the assets carrying value over the fair value as estimated using a discounted expected future cash flows model. In estimating undiscounted expected future cash flows, we must make judgments and estimates related to future sales and profitability.
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Should future sales trends or profitability be significantly less than that forecasted, our impairment could be understated. We could be required to take an additional impairment charge in the future should our actual cash flows be less than forecasted.
We recognize deferred tax liabilities and assets for expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the consolidated financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We provide for a valuation allowance for the deferred tax assets when we conclude that it is more likely than not that the deferred tax assets will not be realized.
We estimate the amount of our warranty reserve. We consider many factors when making our estimate, including historical trends, the number of products under warranty, the costs of replacement parts and the expected reliability of our products. We believe that our accrued warranty reserve is sufficient to meet our responsibilities for potential future warranty work on products sold. Our accrued warranty reserve as of September 30, 2009 was approximately $336,000.
Recently Issued Accounting Standards
Effective July 1, 2009, the Company adopted the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 105, Generally Accepted Accounting Principles - FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (ASC 105). ASC 105 establishes the FASB Accounting Standards Codification (the Codification) as the source of authoritative United States generally accepted accounting principles (GAAP) recognized by the FASB to be applied to nongovernmental entities. The Codification did not create any new GAAP standards but incorporated existing accounting and reporting standards into a new topical structure with a new referencing system to identify authoritative accounting standards. The Codification supersedes all previously existing non-SEC accounting and reporting standards and the FASB will not issue new standards in the form of Statement of Financial Accounting Standards (SFAS), Emerging Issues Task Force (EITF), and FASB Staff Positions, (RSP). Instead, the FASB will issue Accounting Standards Updates (ASUs), with a year and assigned sequence number. The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions with respect to the change or changes to the Codification. The adoption of the Codification did not have a material impact on the Companys consolidated financial statements.
In October 2009, the FASB concurrently issued the following Accounting Standards Updates:
ASU No. 2009-14 - Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (formerly EITF Issue No. 09-3). This standard removes tangible products from the scope of software revenue recognition guidance and also provides guidance on determining whether software deliverables in an arrangement that includes a tangible product, such as embedded software, are within the scope of the software revenue guidance.
ASU No. 2009-13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (formerly EITF Issue No. 08-1). This standard modifies the revenue recognition guidance for arrangements that involve the delivery of multiple elements, such as product, software, services or support, to a customer at different times as part of a single revenue generating transaction. This standard provides principles and application guidance to determine whether multiple deliverables exist, how the individual deliverables should be separated and how to allocate the revenue in the arrangement among those separate deliverables. The standard also expands the disclosure requirements for multiple deliverable revenue arrangements.
These Accounting Standards Updates should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. Alternatively, an entity can elect to adopt these standards on a retrospective basis, but both these standards must be adopted in the same period using the same transition method. We expect to apply this standard on a prospective basis for revenue arrangements entered into or materially modified beginning January 1, 2010. We are currently evaluating the potential impact these standards may have on our financial position and results of operations.
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RESULTS OF OPERATIONS
The following is a discussion of significant changes in the results of operations of the Company, which occurred in the three- and nine-months ended September 30, 2009, compared to the three- and nine-months ended September 30, 2008. The following sets forth certain financial data as a percentage of net sales:
Percent of Net Sales for the Three Months Ended September 30, |
Percent
of Net Sales for the Nine Months Ended September 30, |
|||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Net sales |
100 | % | 100 | % | 100 | % | 100 | % | ||||
Cost of goods sold |
45 | 46 | 52 | 53 | ||||||||
Gross profit |
55 | 54 | 48 | 47 | ||||||||
Operating expenses: |
||||||||||||
Engineering and development |
14 | 14 | 21 | 18 | ||||||||
Sales and marketing |
21 | 15 | 28 | 21 | ||||||||
General and administrative |
8 | 7 | 11 | 10 | ||||||||
Gain on sale of property and equipment |
| | | | ||||||||
Total operating expenses |
43 | 36 | 60 | 49 | ||||||||
Operating profit (loss) |
12 | 18 | (12 | ) | (2 | ) | ||||||
Other loss, net |
(6 | ) | (9 | ) | (9 | ) | (17 | ) | ||||
Profit (loss) before income taxes |
6 | 9 | (21 | ) | (19 | ) | ||||||
Provision for income taxes |
| | | | ||||||||
Net profit (loss) |
6 | % | 9 | % | (21 | )% | (19 | )% | ||||
Net Sales
Net sales for the quarter ended September 30, 2009 decreased $947,000, or 23%, to $3.2 million from $4.1 million for the quarter ended September 30, 2008. The decrease in net sales was primarily due to adverse business conditions affecting the telecommunications industry. International net sales for the quarter ended September 30, 2009 were approximately $960,000, or 30% of net sales, as compared to approximately $1.5 million, or 36% of net sales, for the quarter ended September 30, 2008.
Net sales for the nine months ended September 30, 2009 decreased $2.1 million, or 23%, to $6.8 million from $8.9 million for the nine months ended September 30, 2008. The decrease in net sales was primarily due to adverse business conditions affecting the telecommunications industry. International net sales for the nine months ended September 30, 2009 were approximately $2.4 million, or 35% of net sales, as compared to approximately $3.1 million, or 35% of net sales, for the nine months ended September 30, 2008.
Cost of Goods Sold
Cost of goods sold for the quarter ended September 30, 2009 totaled approximately $1.4 million, or 45% of net sales, as compared to $1.9 million, or 46% of net sales, for the quarter ended September 30, 2008. For the quarter ended September 30, 2009, cost of goods sold percentage was lower due to increased margins for new feature enhancement and decreased allocated expenses.
Cost of goods sold for the nine months ended September 30, 2009 totaled approximately $3.5 million, or 52% of net sales, as compared to $4.7 million, or 53% of net sales, for the nine months ended September 30, 2008. For the nine months ended September 30, 2009, cost of goods sold as a percentage of net sales was relatively unchanged.
Gross Profit
Gross profit for the quarter ended September 30, 2009 decreased by approximately $449,000 to approximately $1.8 million, or 55% of net sales, from $2.2 million, or 54% of net sales, for the quarter ended September 30, 2008. Gross profit decreased as a result of the lower sales volume.
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Gross profit for the nine months ended September 30, 2009 decreased by approximately $909,000 to approximately $3.3 million, or 48% of net sales, from $4.2 million, or 47% of net sales, for the nine months ended September 30, 2008. The decrease in gross profit was commensurate with the decrease in net sales.
Engineering and Development
Engineering and development expenses principally include salaries for engineering and development personnel, outside consulting fees and other development expenses. Engineering and development expenses for the quarter ended September 30, 2009 decreased by approximately $117,000 to $448,000, or 14% of net sales, from approximately $565,000, or 14% of net sales, for the quarter ended September 30, 2008. The decrease was primarily due to a shift to software development resulting in less hardware prototyping expense being incurred.
Engineering and development expenses for the nine months ended September 30, 2009, decreased by approximately $174,000 to $1.4 million, or 21% of net sales, from approximately $1.6 million, or 18% of net sales, for the nine months ended September 30, 2008. The decrease was primarily due to a shift to software development resulting in less hardware prototyping expense being incurred.
Sales and Marketing
Sales and marketing expenses principally include salaries, commissions, travel, tradeshows and promotional materials and warranty expenses. Sales and marketing expenses for the quarter ended September 30, 2009 were $660,000, or 21% of net sales, an increase of approximately $33,000 over $627,000, or 15% of net sales, for the quarter ended September 30, 2008. The minimal increase in sales and marketing expenses reflected continuing marketing efforts and travel expenses related to sales.
Sales and marketing expenses for the nine months ended September 30, 2009 were $1.9 million, or 28% of net sales, an increase of approximately $61,000 over $1.9 million, or 21% of net sales, for the nine months ended September 30, 2008. The minimal increase in sales and marketing expenses reflected additional sales personnel.
General and Administrative
General and administrative expenses principally include salaries, other compensation, professional fees, facility rentals and information systems related to general management functions. General and administrative expenses for the quarter ended September 30, 2009 decreased by approximately $26,000 to $258,000, or 8% of net sales, from approximately $284,000, or 7% of net sales, for the quarter ended September 30, 2008. The decrease reflects a reduction in accounting fees and insurance costs.
General and administrative expenses for the nine months ended September 30, 2009 decreased by approximately $100,000 to $748,000, or 11% of net sales, from approximately $848,000, or 10% of net sales, for the nine months ended September 30, 2008. The decrease reflects a reduction in accounting fees and insurance costs.
Other Expense, Net
Other expense, net for the quarter ended September 30, 2009 was approximately $187,000, a decrease of $173,000 as compared to other expense, net of approximately $360,000 for the quarter ended September 30, 2008. Other expense, net for the nine months ended September 30, 2009 was approximately $654,000, a decrease of approximately $912,000 as compared to other expense, net of approximately $1.6 million for the quarter ended September 30, 2008. The decrease was primarily attributable to reduced interest expense due to the Optel loan restructuring that resulted in lower interest rates.
Net Profit (Loss)
Net profit for the quarter ended September 30, 2009 was approximately $204,000 or $0.00 per diluted share, compared to net profit of approximately $370,000, or $0.00 per diluted share, for the quarter ended September 30, 2008, for the reasons discussed above. Net loss for the nine months ended September 30, 2009 was approximately $1.5 million or $0.01 per diluted share, compared to net loss of approximately $1.7 million, or $0.01 per diluted share, for the nine months ended September 30, 2008, for the reasons discussed above.
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LIQUIDITY AND CAPITAL RESOURCES
On April 4, 2008, the Company and Optel entered into the Credit Agreement pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of approximately $28.0 million of principal, which bore interest at 10% per annum, and accrued interest thereon of approximately $7.7 million, all of which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to make a $2.5 million revolving credit facility available to the Company. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.
Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and, together with the Restated Note, the Notes). As of September 30, 2009, the principal balances of the Restated Note and New Commitment Note were $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus 1.0% per annum and are secured by substantially all the Companys assets pursuant to an amended and restated security agreement (the Security Agreement). Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010.
All the indebtedness evidenced by the Notes is convertible into common stock of the Company at the option of Optel at any time following approval of the conversion feature by the disinterested stockholders at a conversion price based on the average trading price of the stock during the five-day period preceding the date of any conversion. The Company and Optel have made it a condition to the indebtedness evidenced by the Notes becoming convertible, that the conversion feature be approved by the holders of a majority of the outstanding shares of common stock of the Company who are not affiliated with Optel or any of its affiliates at the Companys 2009 annual meeting of stockholders. If such holders do not approve the conversion feature, the outstanding debt and accrued interest would immediately become due and payable in full upon demand by Optel at any time after the stockholders meeting. The Company has not yet held its 2009 annual meeting of stockholders.
The Companys ability to meet cash requirements and maintain sufficient liquidity over the next 12 months is dependent on the Companys ability to obtain additional financing from funding sources which may include, but may not be limited to, Optel. Optel currently is and continues to be the principal source of financing for the Company. The Company has not identified any funding source other than Optel that would be prepared to provide current or future financing to the Company. If the Company is not able to obtain additional financing, it expects that it will not have sufficient cash to fund its working capital and capital expenditure requirements for the near term and will not have the resources required for the payment of its current liabilities when they become due. The Company cannot assure that it will be able to obtain adequate financing, that it will achieve profitability or, if it achieves profitability that the profitability will be sustainable or that it will continue as a going concern.
On March 26, 2009, March 30, 2009, June 25, 2009, June 29, 2009 and July 22, 2009 the Company borrowed $200,000, $225,000, $75,000, $213,000 and $350,000, respectively from Optel to fund its working capital requirements. The loans were made outside the Credit Agreement and are evidenced by secured promissory notes that bear interest at 10.0% per annum and are secured by a security interest in substantially all of the Companys assets. Principal and any accrued but unpaid interest under the secured promissory notes are currently due and payable upon demand by Optel.
Operating Activities
Net cash used in operating activities for the nine months ended September 30, 2009 was approximately $1.7 million. This was primarily the result of the net loss of $1.5 million being offset in part by net changes in working capital, a decrease in inventory of $651,000 and a decrease in accounts payable of approximately $862,000.
Off Balance Sheet Arrangements
There were no off balance sheet arrangements for the nine months ended September 30, 2009.
Investing Activities
Investing activities for the nine months ended September 30, 2009 resulted from the sale of trade show fixed assets, which provided net cash of $12,000.
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Financing Activities
Net cash provided by financing activities for the three- and nine- months ended September 30, 2009 was a result of $350,000, and $2.0 million, respectively, for additional financing provided by Optel Capital, LLC.
Liquidity
At September 30, 2009, the Company had outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $1.0 million.
SUBSEQUENT EVENTS
On October 14, 2009, a group of stockholders controlled by Dr. Bryan J. Zwan, the Companys chairman of the board of directors who controls 91.1% of the outstanding shares of the Company, filed a Schedule 13E-3 with the Securities and Exchange Commission disclosing that such stockholders will cause the Company to merge with a newly formed corporation, Optel Acquisition Corp. (OAC), in a going private transaction whereby the Company will emerge as a privately held corporation. Under Delaware law, the transaction does not require the approval of the Companys board of directors or stockholders, other than OAC. The merger will not be consummated any sooner than November 13, 2009. Pursuant to the terms of a merger and contribution agreement the Companys stockholders (other than OAC) will be entitled to receive $0.055 in cash per share of outstanding common stock.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
We are not exposed to material fluctuations in currency exchange rates because the majority of our sales and expenses are denominated in U.S. dollars. As of September 30, 2009, the related party notes have an interest rate based upon LIBOR. As of September 30, 2009, a 1% change in LIBOR would have a $382,000 annual impact on interest expense.
Item 4(T). | Controls and Procedures. |
Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our principal executive officer and principal financial officer concluded that, (1) our disclosure controls and procedures are not effective pursuant to the requirements of the Sarbanes-Oxley Act of 2002 for companies our size, (2) information to be disclosed in reports we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the rules and forms promulgated under the Exchange Act, and (3) information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to the principal executive officer and principal financial officer as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There was no material change in the Companys internal control over financial reporting that occurred during the nine months ended September 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1. | Legal Proceedings. |
The Company from time to time may be involved in lawsuits and actions by third parties arising in the ordinary course of business. The Company is not aware of any pending litigation, claims or assessments that could have a material adverse effect on the Companys business, financial condition and results of operations.
Item 1A. | Risk Factors. |
There have been no material changes from the risk factors previously disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2008 in response to Item 1A to Part 1 of Form 10-K.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
None.
Item 3. | Defaults Upon Senior Securities. |
None.
Item 4. | Submission of Matters to a Vote of Security Holders. |
None.
Item 5. | Other Information. |
None.
Item 6. | Exhibits and Reports on Form 8-K. |
A list of exhibits is set forth in the Exhibit Index found on page 22 of this report.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Digital Lightwave, Inc. | ||
(Registrant) | ||
By: | /S/ KENNETH T. MYERS | |
President and Chief Executive Officer | ||
(Principal Executive Officer) | ||
Date: November 12, 2009 | ||
By: | /S/ KENNETH T. MYERS | |
Interim Chief Accounting Officer | ||
(Principal Financial Officer) | ||
Date: November 12, 2009 |
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Exhibit Number |
Description | |
3.1* | Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.02 to the Quarterly Report on Form 10-Q filed by the Company on August 14, 2002). | |
3.2* | Certificate of Amendment of Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K filed by the Company on February 16, 2004). | |
3.3* | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.03 to the Quarterly Report on Form 10-Q filed by the Company on August 14, 2002). | |
4.1* | Specimen Certificate for Common Stock (incorporated by reference to Exhibit 4.01 to the Companys Registration Statement on Form S-1 (File No. 333-09457), declared effective by the Securities and Exchange Commission on February 5, 1997). | |
10.1* | Credit and Restructuring Agreement, between the Digital Lightwave, Inc. and Optel Capital, LLC. dated April 4, 2008 (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed by the Company on April 10, 2008). | |
10.2* | Secured Convertible Promissory Noted (Restated Noted), issued by Digital Lightwave, Inc. to Optel. Capital, LLC dated April 4, 2008 (incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K filed by the Company on April 10, 2008). | |
10.3* | Secured Convertible Promissory Noted (New Commitment Loans) issued by Digital Lightwave, Inc. to Optel Captial, LLC dated April 4, 2008, (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K filed by the Company on April 10, 2008). | |
10.4* | Amended and Restated Security Agreement, between Digital Lightwave, Inc. and Optel Capital, LLC dated April 4, 2008 (incorporated by reference to Exhibit 10.4 to the Current Report on Form 8-K filed by the Company on April 10, 2008). | |
10.5* | Registration Rights Agreement, between Digital Lightwave, Inc. and Optel Capital, LLC. dated April 4, 2008 (incorporated by reference to Exhibit 10.5 to the Current Report on Form 8-K filed by the Company on April 10, 2008). | |
10.6* | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated June 25, 2009, | |
10.7* | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated June 29, 2009, | |
10.7* | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated July 22, 2009, | |
31.1+ | Certification by the Chief Executive Officer pursuant to Section 302 of the SarbanesOxley Act of 2002. | |
31.2+ | Certification by the Principal Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002. | |
32.1+ | Certification by the Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the SarbanesOxley Act of 2002. |
* | Such exhibits are incorporated by reference. |
+ | Filed herewith. |
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