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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
 

 
FORM 10-Q
 

 
 x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2014

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-31990

TEL-INSTRUMENT ELECTRONICS CORP.
(Exact name of registrant as specified in its charter)

New Jersey
 
22-1441806
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

One Branca Road
East Rutherford, NJ 07073
(Address of principal executive offices)

(201) 933-1600
(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 past 12 months, and (2) has been subject to such filing requirements for the past 90 days.  Yes ý   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 (§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 ý   No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or 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
¨
 
Smaller reporting company
ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨   No ý

As of November 12, 2014, there were 3,251,387 shares outstanding of the registrant’s common stock.
 
 
TEL-INSTRUMENT ELECTRONICS CORP.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
   
Page
Item 1.
 
   
3
Item 2.
 
   
14
Item 3.
 
   
18
Item 4.
 
   
18
PART II – OTHER INFORMATION
     
Item 1.
19
     
Item 1A.
19
     
Item 2.
19
     
Item 3.
19
     
Item 4.
19
     
Item 5.
20
     
Item 6.
20
     
21
 
 
PART I – FINANCIAL INFORMATION
Item 1.  Financial Statements.
 
TEL-INSTRUMENT ELECTRONICS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS

   
September 30,
2014
   
March 31,
2014
 
   
(unaudited)
       
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
 
$
243,146
     
232,118
 
Accounts receivable, net
   
542,624
     
2,095,640
 
Inventories, net
   
4,544,267
     
4,025,391
 
Prepaid expenses and other current assets
   
549,930
     
263,592
 
Deferred financing costs
   
102,303
     
108,321
 
Deferred income tax asset
   
1,089,538
     
1,089,538
 
Total current assets
   
7,071,808
     
7,814,600
 
                 
Equipment and leasehold improvements, net
   
353,583
     
450,873
 
Deferred financing costs – long-term
   
-
     
48,142
 
Deferred income tax asset – non-current
   
2,513,198
     
2,273,068
 
Other long-term assets
   
47,670
     
47,670
 
Total assets
   
9,986,259
     
 10,634,353
 
                 
LIABILITIES & STOCKHOLDERS’ EQUITY
               
                 
Current liabilities:
               
Current portion of long-term debt, net of debt discount
   
202,759
     
718,848
 
Capital lease obligations – current portion
   
20,895
     
53,608
 
Accounts payable and accrued liabilities
   
3,617,674
     
3,332,181
 
Progress billings
   
592,156
     
775,475
 
Deferred revenues – current portion
   
36,041
     
37,452
 
Accrued payroll, vacation pay and payroll taxes
   
491,953
     
444,238
 
Total current liabilities
   
4,961,478
     
5,361,802
 
                 
Subordinated notes payable - related parties
   
250,000
     
250,000
 
Capital lease obligations – long-term
   
13,231
     
21,320
 
Long-term debt
   
854,361
     
596,526
 
Deferred revenues – long-term
   
133,650
     
133,650
 
Warrant liability
   
460,389
     
354,309
 
Other long-term liabilities
   
51,900
     
56,100
 
Total liabilities
   
6,725,009
     
6,773,707
 
                 
Commitments
               
                 
Stockholders' equity:
               
Common stock, 4,000,000 shares authorized, par value $.10 per share,
3,253,887 and 3,251,387 shares issued and outstanding, respectively
   
325,386
     
325,136
 
Additional paid-in capital
   
8,019,654
     
7,987,100
 
Accumulated deficit
   
(5,083,790
)
   
(4,451,590
)
Total stockholders' equity
   
3,261,250
     
3,860,646
 
Total liabilities and stockholders' equity
 
$
9,986,259
   
$
10,634,353
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
TEL-INSTRUMENT ELECTRONICS CORP.
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
   
Three Months Ended
   
Six Months Ended
 
   
September 30,
2014
   
September 30,
2013
   
September 30,
2014
   
September 30,
2013
 
                         
Net sales
 
$
3,587,674
   
$
4,034,581
     
6,716,750
   
$
7,234,556
 
Cost of sales
   
2,718,330
     
2,758,832
     
4,727,189
     
4,772,649
 
                                 
Gross margin
   
869,344
     
1,275,749
     
1,989,561
     
2,461,907
 
                                 
Operating expenses:
                               
Selling, general and administrative
   
660,034
     
671,410
     
1,539,227
     
1,324,660
 
Engineering, research and development
   
497,726
     
448,572
     
981,622
     
928,949
 
Total operating expenses
   
1,157,760
     
1,119,982
     
2,520,849
     
2,253,609
 
                                 
Income (loss) from operations
   
(288,416
)
   
155,767
     
(531,288
)
   
208,298
 
                                 
Other income (expense):
                               
Amortization of debt discount
   
(30,061
)
   
(25,600
)
   
(60,935
)
   
(48,587
)
Loss on extinguishment of debt
   
-
     
-
     
-
     
(26,600
)
Amortization of deferred financing costs
   
(27,080
)
   
(27,080
)
   
(54,160
)
   
(54,160
)
Change in fair value of common stock warrants
   
27,801
     
(67,345
)
   
(106,080
)
   
(42,773
)
Interest income
   
-
     
34
     
-
     
34
 
Interest expense
   
(57,387
)
   
(97,390
)
   
(119,867
)
   
(201,467
)
Total other income (expense)
   
(86,727
)
   
(217,381
)
   
(341,042
)
   
(373,553
)
                                 
Loss before income taxes
   
(375,143
)
   
(61,614
)
   
(872,330
)
   
(165,255
)
                                 
Income tax expense (benefit)
   
(126,948
)
   
10,860
     
(240,130
)
   
(7,009
)
                                 
Net loss
 
$
(248,195
)
 
$
(72,474
)
 
$
(632,200
)
 
$
(158,246
)
                                 
Basic loss per common share
 
$
(0.08
)
 
$
(0.02
)
 
$
(0.19
)
 
$
(0.05
)
Diluted loss per common share
 
$
(0.08
)
 
$
(0.02
)
 
$
(0.19
)
 
$
(0.05
)
                                 
Weighted average shares outstanding:
                               
Basic
   
3,252,702
     
3,235,250
     
3,252,048
     
3,157,985
 
Diluted
   
3,252,702
     
3,235,250
     
3,252,048
     
3,157,985
 
 
See accompanying notes to condensed consolidated financial statements.

 
TEL-INSTRUMENT ELECTRONICS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
   
Six months ended
   
September 30,
2014
   
September 30,
2013
           
Cash flows from operating activities:
         
Net loss
 
$
(632,200
)
 
$
(158,246
)
Adjustments to reconcile net loss to net cash
used in operating activities:
               
Deferred income taxes
   
(240,130
)
   
(7,519
)
Depreciation and amortization
   
89,790
     
104,365
 
Provision for inventory obsolescence
   
5,000
     
-
 
Amortization of debt discount
   
60,935
     
48,587
 
Amortization of deferred financing costs
   
54,160
     
54,160
 
Loss on extinguishment of debt
   
-
     
26,600
 
Change in fair value of common stock warrant
   
106,080
     
42,773
 
Non-cash interest associated with conversion of note
   
-
     
21,003
 
Non-cash stock-based compensation
   
20,904
     
32,161
 
                 
Changes in assets and liabilities:
               
Decrease (increase) in accounts receivable
   
1,553,016
     
(810,779
)
(Increase) decrease in inventories, net
   
(509,865
)
   
1,529,141
 
Increase in prepaid expenses & other
   
(286,338
)
   
(31,144
)
Increase (decrease) in accounts payable and other accrued liabilities
   
297,393
     
(1,570,723
)
Increase (decrease) in accrued payroll, vacation pay & withholdings
   
47,715
     
(66,664
)
(Decrease) increase in deferred revenues
   
(1,411
)
   
4,635
 
(Decrease) increase in progress billings
   
(183,319
)
   
795,050
 
Decrease in other long-term liabilities
   
(4,200
)
   
-
 
Net cash provided by operating activities
   
377,530
     
13,400
 
                 
Cash flows from investing activities:
               
Purchases of equipment
   
(6,511
)
   
(11,226
)
Net cash used in investing activities
   
(6,511
)
   
(11,226
)
                 
Cash flows from financing activities:
               
Proceeds from note payable – related party
   
-
     
100,000
 
Repayment of long-term debt
   
(319,189
)
   
(229,750
)
Repayment of capitalized lease obligations
   
(40,802
)
   
(36,970
)
Net cash used in financing activities
   
(359,991
)
   
(166,720
)
                 
Net increase (decrease) in cash and cash equivalents
   
11,028
     
(164,546
)
Cash and cash equivalents at beginning of period
   
232,118
     
310,297
 
Cash and cash equivalents at end of period
 
$
243,146
   
$
145,751
 
                 
Supplemental cash flow information:
               
Taxes paid
 
$
20,500
   
$
 -
 
Interest paid
 
$
114,589
   
$
192,837
 
                 
Supplemental non-cash information:
               
Converted accounts payable to equity
   
11,900
     
-
 
Converted debt to equity
 
$
-
   
$
700,000
 
Converted accrued interest to equity
 
$
-
   
$
37,400
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 – Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of Tel-Instrument Electronics Corp (the “Company” or “TIC”) as of September 30, 2014, the results of operations for the three and six months ended September 30, 2014 and September 30, 2013, and statements of cash flows for the six months ended September 30, 2014 and September 30, 2013. These results are not necessarily indicative of the results to be expected for the full year.  The financial statements have been prepared in accordance with the requirements of Form 10-Q and consequently do not include disclosures normally made in an Annual Report on Form 10-K.  The March 31, 2014 balance sheet included herein was derived from the audited financial statements included in the Company’s Annual Report on Form 10-K as of that date.  Accordingly, the financial statements included herein should be reviewed in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2014 , as filed with the United States Securities and Exchange Commission (the “SEC”) on June 30, 2014.

Note 2 – Summary of Significant Accounting Policies

During the six months ended September 30, 2014, there have been no material changes in the Company’s significant accounting policies to those previously disclosed in the Company’s Annual Report on Form 10-K for the year ended March 31, 2014, as filed with the SEC on June 30, 2014.
 
Note 3 – Accounts Receivable, net

The following table sets forth the components of accounts receivable:

   
September 30,
2014
   
March 31,
2014
 
Government
 
$
422,255
   
$
1,982,215
 
Commercial
   
147,651
     
140,707
 
Less: Allowance for doubtful accounts
   
(27,282
)
   
(27,282
)
   
$
542,624
   
$
2,095,640
 
 
Note 4 – Inventories, net
 
Inventories consist of:
 
   
September 30,
2014
   
March 31,
2014
 
             
Purchased parts
 
$
3,375,294
   
$
3,085,070
 
Work-in-process
   
1,333,415
     
1,134,714
 
Finished goods
   
45,558
     
10,607
 
Less: Inventory reserve
   
(210,000
)
   
(205,000
)
   
$
4,544,267
   
$
4,025,391
 
 
Note 5 – Loss Per Share

Net loss per share has been computed according to FASB ASC 260, “Earnings per Share,” which requires a dual presentation of basic and diluted loss per share (“EPS”). Basic EPS represents net loss divided by the weighted average number of common shares outstanding during a reporting period. Diluted EPS reflects the potential dilution that could occur if securities, including warrants and options, were converted into common stock. The dilutive effect of outstanding warrants and options is reflected in earnings per share by use of the treasury stock method. In applying the treasury stock method for stock-based compensation arrangements, the assumed proceeds are computed as the sum of the amount the employee must pay upon exercise and the amounts of average unrecognized compensation costs attributed to future services.
 
 
TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 5 – Loss Per Share (continued)

Diluted loss per share for the three and six months ended September 30, 2014 and 2013 does not include common stock equivalents, as these stock equivalents would be anti-dilutive.

   
Three Months Ended
   
Three Months Ended
 
   
September 30,
2014
   
September 30,
2013
 
Basic net loss per share computation:
           
Net loss
 
$
(248,195
)
 
$
(72,474
)
Weighted-average common shares outstanding
   
3,252,702
     
3,235,250
 
Basic net loss per share
 
$
(0.08
)
 
$
(0.02
)
Diluted net loss  per share computation:
               
Net loss
 
$
(248,195
)
 
$
(72,474
)
Weighted-average common shares outstanding
   
3,252,702
     
3,235,250
 
Incremental shares attributable to the assumed exercise of outstanding stock options
   
-
     
-
 
Total adjusted weighted-average shares
   
3,252,702
     
3,235,250
 
Diluted net loss per share
 
$
(0.08
)
 
$
(0.02
)
 
   
Six Months Ended
   
Six Months Ended
 
   
September 30,
2014
   
September 30,
2013
 
Basic net loss per share computation:
           
Net loss
 
$
(632,200
)
 
$
(158,246
)
Weighted-average common shares outstanding
   
3,252,048
     
3,157,985
 
Basic net loss per share
 
$
(0.19
)
 
$
(0.05
)
Diluted net loss  per share computation:
               
Net loss
 
$
(632,200
)
 
$
(158,246
)
Weighted-average common shares outstanding
   
3,252,048
     
3,157,985
 
Incremental shares attributable to the assumed exercise of outstanding stock options
   
-
     
-
 
Total adjusted weighted-average shares
   
3,252,048
     
3,157,985
 
Diluted net loss per share
 
$
(0.19
)
 
$
(0.05
)

For the three and nine months ended September 30, 2014 and 2013, all outstanding warrants and options were excluded from the computation of diluted loss per share because their effect would be anti-dilutive.
 
Note 6 – Long-Term Debt

In September 2010, the Company entered into an agreement with BCA Mezzanine Fund LLP (“BCA”) to loan the Company $2,500,000 in the form of a Promissory Note (the “Note”).  The Note contains a number of affirmative and negative covenants which restrict our operations.  For the quarter ended September 30, 2014, the Company was not in compliance with certain financial covenants related to maintaining agreed upon financial ratios for fixed charges and debt service. In November 2014, in conjunction with the payoff of this debt (see Note 13), the Company received a waiver from BCA on each of the above mentioned covenants as well as the deferral of the monthly payment of principal due from the Company on September until the maturity of the Note. 
   

TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7 – Segment Information

In accordance with FASB ASC 280, “Disclosures about Segments of an Enterprise and related information,” the Company determined it has two reportable segments - avionics government and avionics commercial.  There are no inter-segment revenues.

The Company is organized primarily on the basis of its avionics products.  The avionics government segment consists primarily of the design, manufacture, and sale of test equipment to the U.S. and foreign governments and militaries either directly or through distributors.  The avionics commercial segment consists of design, manufacture, and sale of test equipment to domestic and foreign airlines, directly or through commercial distributors, and to general aviation repair and maintenance shops.  The Company develops and designs test equipment for the avionics industry and as such, the Company’s products and designs cross segments.

Management evaluates the performance of its segments and allocates resources to them based on gross margin.  The Company’s general and administrative costs and sales and marketing expenses, and engineering costs are not segment specific.  As a result, all operating expenses are not managed on a segment basis.  Net interest includes expenses on debt and income earned on cash balances, both maintained at the corporate level.
 
The table below presents information about reportable segments within the avionics business for the three and six month periods ending September 30, 2014 and 2013:
 
Three Months Ended
 September 30, 2014
 
Avionics
 Government
   
Avionics
 Commercial
   
Avionics
 Total
   
Corporate
 Items
   
Total
 
Net sales
 
$
3,026,728
   
$
560,946
   
$
3,587,674
     
-
   
$
3,587,674
 
Cost of sales
   
2,270,257
     
448,073
     
2,718,330
     
-
     
2,718,330
 
Gross margin
   
756,471
     
112,873
     
869,344
     
-
     
869,344
 
                                         
Engineering, research, and development
                   
497,726
     
-
     
497,726
 
Selling, general and administrative
                   
283,434
     
376,600
     
660,034
 
Amortization of debt discount
                   
-
     
30,061
     
30,061
 
Amortization of deferred financing costs
                   
-
     
27,080
     
27,080
 
Change in fair value of common stock warrants
                   
-
     
(27,801
)
   
(27,801
)
Interest expense, net
                   
-
     
57,387
     
57,387
 
Total expenses
                   
781,160
     
463,327
     
1,244,487
 
                                         
Income (loss) before income taxes
                 
$
88,184
   
$
(463,327
)
 
$
(375,143
)
 
Three Months Ended
 September 30, 2013
 
Avionics
Government
   
Avionics
Commercial
   
Avionics
Total
   
Corporate
Items
   
 
Total
 
Net sales
 
$
3,453,919
     
580,662
     
4,034,581
     
-
     
4,034,581
 
Cost of sales
   
2,419,505
     
339,327
     
2,758,832
     
-
     
2,758,832
 
Gross margin
   
1,034,414
     
241,335
     
1,275,749
     
-
     
1,275,749
 
                                         
Engineering, research, and development
                   
448,572
             
448,572
 
Selling, general, and administrative
                   
293,632
     
377,778
     
671,410
 
Amortization of debt discount
                           
25,600
     
25,600
 
Amortization of deferred financing costs
                   
  -
     
27,080
     
27,080
 
Change in fair value of common stock warrants
                   
  -
     
67,345
     
67,345
 
Interest (income) expense, net
                   
  -
     
97,356
     
97,356
 
Total expenses
                   
742,204
     
595,159
     
1,337,363
 
                                         
Income (loss) before income taxes
                 
$
533,545
     
(595,159
)    
(61,614
)
 

TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7 – Segment Information (continued)

Six Months Ended
 September 30, 2014
 
Avionics
 Government
   
Avionics
 Commercial
   
Avionics
 Total
   
Corporate
 Items
   
Total
 
Net sales
 
$
5,547,451
   
$
1,169,299
   
$
6,716,750
     
-
   
$
6,716,750
 
Cost of sales
   
3,784,672
     
942,517
     
4,727,189
     
-
     
4,727,189
 
Gross margin
   
1,762,779
     
226,782
     
1,989,561
     
-
     
1,989,561
 
                                         
Engineering, research, and development
                   
981,622
     
-
     
981,622
 
Selling, general and administrative
                   
575,717
     
963,510
     
1,539,227
 
Amortization of debt discount
                   
-
     
60,935
     
60,935
 
Amortization of deferred financing costs
                   
-
     
54,160
     
54,160
 
Change in fair value of common stock warrants
                   
-
     
106,080
 
   
106,080
 
Interest expense, net
                   
-
     
119,867
     
119,867
 
Total expenses
                   
1,557,339
     
1,304,552
     
2,861,891
 
                                         
Income (loss) before income taxes
                 
$
432,222
   
$
(1,304,552
)
 
$
(872,330
)

Six Months Ended
 September 30, 2013
 
Avionics
 Government
   
Avionics
 Commercial
   
Avionics
 Total
   
Corporate
 Items
   
Total
 
Net sales
   
6,256,761
     
977,795
     
7,234,556
     
-
     
7,234,556
 
Cost of Sales
   
4,081,751
     
690,898
     
4,772,649
     
-
     
4,772,649
 
Gross Margin
   
2,175,010
     
286,897
     
2,461,907
     
-
     
2,461,907
 
                                         
Engineering, research, and development
                   
928,949
             
928,949
 
Selling, general and administrative
                   
557,777
     
766,883
     
1,324,660
 
Amortization of debt discount
                           
48,587
     
48,587
 
Amortization of deferred financing costs
                           
54,160
     
54,160
 
Loss on extinguishment of debt
                           
26,600
     
26,600
 
Change in fair value of common stock warrants
                           
42,773
     
42,773
 
Interest expense, net
                           
201,433
     
201,433
 
Total expenses
                   
1,486,726
     
1,140,436
     
2,627,162
 
                                         
Income (loss) before income taxes
                   
975,181
     
(1,140,436
)
   
(165,255
)

Note 8 – Income Taxes

The Company adopted FASB ASC 740-10, Accounting for Uncertainty in Income Taxes, effective April 1, 2007 (“ASC 740-10”).  ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions.  The Company does not have any unrecognized tax benefits.

The tax effect of temporary differences, primarily net operating loss carryforwards, asset reserves and accrued liabilities, gave rise to the Company’s deferred tax asset in the accompanying September 30, 2014 and March 31, 2014 condensed consolidated balance sheets.  Deferred income taxes are recognized for the tax consequence of such temporary differences at the enacted tax rate expected to be in effect when the differences reverse. 
 
 
TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9 – Fair Value Measurements

FASB ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”) defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measurements.

As defined in ASC 820-10, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).  The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique.  These inputs can be readily observable, market corroborated, or generally unobservable.  The Company classifies fair value balances based on the observation of those inputs. ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement).

The three levels of the fair value hierarchy defined by ASC 820-10 are as follows:

·  
Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.  Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.

·  
Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date.  Level 2 includes those financial instruments that are valued using models or other valuation methodologies.  These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures.  Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.  Instruments in this category generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.

·  
Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources.  These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.
 
The valuation techniques that may be used to measure fair value are as follows:

·  
Market approach — Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

·  
Income approach — Uses valuation techniques to convert future amounts to a single present amount based on current market expectations about those future amounts, including present value techniques, option-pricing models and excess earnings method.

·  
Cost approach — Based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). 

The carrying value of the Company’s borrowings is a reasonable estimate of its fair value as borrowings under the Company’s credit facility reflect currently available terms and conditions for similar debt.
 
The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value as of September 30, 2014 and March 31, 2014.  As required by ASC 820-10, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
 
   TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9 – Fair Value Measurements (continued)

The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.
 
September 30, 2014
 
Level I
   
Level II
   
Level III
   
Total
 
Total Assets
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
Warrant liability
   
-
     
-
     
460,389
     
460,389
 
Total Liabilities
 
$
-
   
$
-
   
$
460,389
   
$
460,389
 

March 31, 2014
 
Level I
   
Level II
   
Level III
   
Total
 
Total Assets
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
Warrant liability
   
-
     
-
     
354,309
     
354,309
 
Total Liabilities
 
$
-
   
$
-
   
$
354,309
   
$
354,309
 
 
The Company adopted the guidance of ASC 815 “Derivative and Hedging”, which requires that we mark the value of our warrant liability to market and recognize the change in valuation in our statement of operations each reporting period. Determining the warrant liability to be recorded requires us to develop estimates to be used in calculating the fair value of the warrant.  The fair value of the warrants is calculated using the Black-Scholes valuation model.
 
The following table provides a summary of the changes in fair value of our Level 3 financial liabilities from March 31, 2014 through September 30, 2014, as well as the portion of gains or losses included in income attributable to unrealized gains or losses related to the liability held at September 30, 2014:

Level 3 Reconciliation
 
Beginning at beginning of period
   
Gains and losses for the period
(realized and unrealized)
   
Purchases, issuances, sales
and settlements, net
 
Transfers in or out of Level 3
   
Balance at the end of period
 
                               
Warrant liability
   
354,309
     
106,080
     
-
     
-
     
460,389
 
Total Liabilities
 
$
354,309
   
$
106,080
   
$
-
   
$
-
   
$
460,389
 
 
The common stock warrants were not issued with the intent of effectively hedging any future cash flow, fair value of any asset, liability or any net investment in a foreign corporation.  The warrants do not qualify for hedge accounting, and, as such, all changes in the fair value of these warrants are recognized as other income/expense in the statement of operations until such time as the warrants are exercised or expire.  Since these common stock warrants do not trade in an active securities market, the Company recognizes a warrant liability and estimates the fair value of these warrants using the Black-Scholes options model using the following assumptions:

Values at Inception
                                                                                                                              
Date of
Warrant
   
Expiration 
Date
   
Number of
Warrants
   
Exercise 
Price
   
Fair Market Value
Per Share
   
Expected
Volatility
   
Remaining 
Life in Years
   
Risk Free 
Interest Rate
   
Warrant 
Liability
 
 
09-10-2010
     
09-10-2019
     
136,920
   
$
6.70
   
$
6.70
     
28.51
%
   
9
     
2.81
%
 
$
267,848
 
 
09-10-2010
     
09-10-2015
     
10,416
   
$
6.70
   
$
6.70
     
28.51
%
   
5
     
1.59
%
 
$
13,808
 
 
07-26-2012
     
09-10-2019
     
50,000
   
$
3.35
   
$
3.90
     
42.04
%
   
7
     
0.94
%
 
$
66,193
 
 
07-26-2012
     
09-10-2019
     
20,000
   
$
3.35
   
$
3.90
     
42.04
%
   
7
     
0.94
%
 
$
26,477
 
 
11-20-2012
     
09-10-2019
     
20,000
   
$
3.56
   
$
3.50
     
42.45
%
   
6.83
     
1.09
%
 
$
21,441
 
 
02-14-2013
     
09-10-2019
     
20,000
   
$
3.58
   
$
3.80
     
41.25
%
   
6.58
     
1.43
%
 
$
23,714
 
 
07-12-2013
     
09-10-2019
     
20,000
   
$
3.33
   
$
3.32
     
40.26
%
   
6.17
     
2.00
%
 
$
19,523
 
 
08-12-2013
     
09-10-2019
     
20,000
   
$
3.69
   
$
3.69
     
40.20
%
   
6.08
     
2.01
%
 
$
21,587
 
 
 
TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
Note 9 – Fair Value Measurements (continued)
 
Values at March 31, 2014

Date of 
Warrant
   
Expiration
Date
   
Number of
Warrants
   
Exercise 
Price
   
Fair Market Value
Per Share
   
Expected
Volatility
 
Remaining
Life in Years
   
Risk Free
Interest Rate
 
Warrant
Liability
 
 
09-10-2010
     
09-10-2019
     
136,920
   
$
6.70
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
123,564
 
 
09-10-2010
     
09-10-2015
     
10,416
   
$
6.70
   
$
4.42
     
43.35
%
   
1.45
     
0.44
%
 
$
2,498
 
 
07-26-2012
     
09-10-2019
     
50,000
   
$
3.35
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
77,626
 
 
07-26-2012
     
09-10-2019
     
20,000
   
$
3.35
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
31,050
 
 
11-20-2012
     
09-10-2019
     
20,000
   
$
3.56
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
29,892
 
 
02-14-2013
     
09-10-2019
     
20,000
   
$
3.58
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
29,310
 
 
07-12-2013
     
09-10-2019
     
20,000
   
$
3.33
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
31,163
 
 
08-12-2013
     
09-10-2019
     
20,000
   
$
3.69
   
$
4.42
     
43.35
%
   
5.45
     
1.73
%
 
$
29,206
 
 
Values at September 30, 2014
 
Date of 
Warrant
   
Expiration
Date
   
Number of
Warrants
   
Exercise
Price
   
Fair Market Value
Per Share
   
Expected
Volatility
   
Remaining
Life in Years
   
Risk Free
Interest Rate
 
Warrant
Liability
 
 
09-10-2010
     
09-10-2019
     
136,920
   
$
6.70
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
160,990
 
 
09-10-2010
     
09-10-2015
     
10,416
   
$
6.70
   
$
5.34
     
41.86
%
   
0.95
     
0.13
%
 
$
3,199
 
 
07-26-2012
     
09-10-2019
     
50,000
   
$
3.35
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
100,668
 
 
07-26-2012
     
09-10-2019
     
20,000
   
$
3.35
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
40,267
 
 
11-20-2012
     
09-10-2019
     
20,000
   
$
3.56
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
38,818
 
 
02-14-2013
     
09-10-2019
     
20,000
   
$
3.58
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
38,085
 
 
07-12-2013
     
09-10-2019
     
20,000
   
$
3.33
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
40,409
 
 
08-12-2013
     
09-10-2019
     
20,000
   
$
3.69
   
$
5.34
     
41.86
%
   
4.95
     
1.78
%
 
$
37,953
 
 
The volatility calculation was based on the 57 months for the Company’s common stock price prior to the measurement date, utilizing January 1, 2010 as the initial period, as the Company believes that this is the best indicator of future performance, and the source of the risk free interest rate is the US Treasury rate.  The exercise price is per the agreement, the fair market value is the closing price of our stock on the date of measurement, and the expected life is based on management’s current estimate of when the warrants will be exercised.  All inputs to the Black-Scholes options model are evaluated each reporting period.
 
Note 10 – Reclassifications

Certain prior year and period amounts have been reclassified to conform to the current period presentation.

Note 11 – Litigation

On March 24, 2009, Aeroflex Wichita, Inc. (“Aeroflex”) filed a petition against the Company and two of its employees in the District Court, Sedgwick County, Kansas, Case No. 09 CV 1141 (the “Aeroflex Action”), alleging that the Company and its two employees misappropriated Aeroflex’s proprietary technology in connection with the Company winning a substantial contract from the U.S. Army (the “Award”), to develop new Mode-5 radar test sets and kits to upgrade the existing TS-4530 radar test sets to Mode 5. Aeroflex’s petition alleges that in connection with the Award, the Company and its named employees misappropriated Aeroflex’s trade secrets; tortiously interfered with its business relationship; conspired to harm Aeroflex and tortiously interfered with its contract and seeks injunctive relief and damages. The central basis of all the claims in the Aeroflex Action is that the Company misappropriated and used Aeroflex proprietary technology and confidential information in winning the Award. In February 2009, subsequent to the Company winning Award to the Company, Aeroflex filed a protest of the Award with the Government Accounting Office (“GAO”). In its protest, Aeroflex alleged, inter alia, that the Company used Aeroflex’s proprietary technology in order to win the Award, the same material allegations as were later alleged in the Aeroflex Action. On or about March 17, 2009, the U.S. Army Contracts Attorney and the U.S. Army Contracting Officer each filed a statement with the GAO, expressly rejecting Aeroflex’s allegations that the Company used or infringed Aeroflex proprietary technology in winning the Award, and concluding that the Company had used only its own proprietary technology. On April 6, 2009, Aeroflex withdrew its protest.
 
 
TEL-INSTRUMENT ELECTRONICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 11 – Litigation (continued)

In December 2009, the Kansas District Court dismissed the Aeroflex Action on jurisdiction grounds. Aeroflex appealed this decision. In May 2012, the Kansas Supreme Court reversed the decision and remanded the Aeroflex Action to the District Court for further proceedings. The Company has been in engaged in discovery and depositions for the last two quarters, which has resulted in substantially higher legal expense. The case is currently set for trial on May 19, 2015, but this date may continue to slip. The Company is optimistic as to the outcome of this litigation. However, the outcome of any litigation is unpredictable and an adverse decision in this matter could have a material adverse effect on our financial condition, results of operations or liquidity.

On October 9, 2013, the SEC notified the Company that it may be in violation of Section 16(a) for failure to accurately and timely file beneficial ownership reports (the “Filings”) for certain officers and directors.  The Company accepted responsibility for filing all such reports on behalf of each officer and director.

The Company apparently made certain coding errors with respect to certain of the Filings, in addition to not filing within two business days of a reportable transaction as reported by an officer or director. Based on the above, the SEC notified the Company that it may be in violation of Section 16(a). Currently, all transactions by the Holders have been disclosed with the SEC and the Company believes that the transactions which required timely Section 16(a) reports did not involve a material amount of equity securities.  Additionally, no sales were made by any officer or director and the violation is related to disclosure only.

The Company has made an Offer to Settle to the SEC and in September 2014 the SEC accepted such Offer. The Company has also revised its procedures for Section 16(a) reports to ensure complete compliance.

Other than the matters outlined above, we are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of executive officers of our Company, threatened against or affecting our Company, or our common stock in which an adverse decision could have a material effect.

Note 12 – New Accounting Pronouncements

In May 2014, the FASB issued Accounting Standard Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”). ASU 2014-09 outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services. This ASU is effective for annual reporting periods beginning after December 15, 2016 and early adoption is not permitted. Accordingly, the Company will adopt this ASU on April 1, 2017. Companies may use either a full retrospective or modified retrospective approach to adopt this ASU and management is currently evaluating which transition approach to use. The Company is currently assessing the impact that adopting this new accounting guidance will have on its condensed consolidated financial statements and footnote disclosures.

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)2014-15, "Presentation of Financial Statements - Going Concern", which requires management to evaluate whether conditions or events raise substantial doubt about the entity’s ability to continue as a going concern and, if so, to provide related footnote disclosures. The guidance is effective for annual or interim reporting periods beginning on or after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on the Company’s Consolidated Financial Statements.

No other recently issued accounting pronouncements had or are expected to have a material impact on the Company’s condensed consolidated financial statements.
 
Note 13 – Subsequent Event

In November 2014, the Company entered into loan agreement with a bank for $1,200,000. The proceeds from the loan will be used to pay off the remaining balance of the loan with BCA Mezzanine Fund, L.P. in the amount of $1,153,109, including accrued interest of $4,467.  The term of the loan is for 3 year and expires in November 2017. Monthly payments are at $36,551 including interest at 6%.
 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This quarterly report on Form 10-Q and other reports filed by the Company from time to time with the SEC (collectively the “Filings”) contain or may contain forward-looking statements (collectively the “Filings”) and information that are based upon beliefs of, and information currently available to, the Company’s management as well as estimates and assumptions made by Company’s management.  Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof.  When used in the Filings, the words “anticipate”, “believe”, “estimate”, “expect”, “future”, “intend”, “plan”, or the negative of these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements.  Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors, including the risks contained in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the year ended March 31, 2014, filed with the SEC on June 30, 2014, relating to the Company’s industry, the Company’s operations and results of operations, and any businesses that the Company may acquire.  Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements.  Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results.
 
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).  These accounting principles require us to make certain estimates, judgments and assumptions.  We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made.  These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented.  Our financial statements would be affected to the extent there are material differences between these estimates and actual results.  In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application.  There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.  The following discussion should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report.
 
Overview

As previously announced, the Company received full rate production approval for the U.S. Army TS-4530A KITS with expected deliveries of about $450k per month, which commenced in July 2014. The U.S. Army is still working to secure production approval for the complete SETS, but this could take several additional months. As of September 30, 2014, the Company has open orders for 1,997 kits and 687 sets, totaling $17.7 million. The Company also began shipping the first U.S. Navy ITATS production units in July 2014. As of September 30, 2014, the Company has open orders for the AN/ARM-206 (ITATS) for 99 units at a contract value of $5.6 million, including additional enhancements. The Company continues to ship the AN/USM-708 CRAFT test sets and should complete the shipment of all of the Ship in Place units by August 2014.  In October 2013, the Company received an additional contract for the CRAFT program with a maximum value of $9.5 million. The order is a not-to-exceed $9.5 million fixed-price, indefinite-delivery/indefinite-quantity (“IDIQ”) contract for the manufacture and delivery of communications/navigation radio frequency avionics flight line tester CRAFT AN/USM-708 and/or AN/USM-719. This contract is in support of the U.S. Navy, U.S. Marine Corps, U.S. Army and various Foreign Military Sales customers under the Foreign Military Sales program. This follow-on contract further strengthens our position in the industry as the predominant supplier of Mode 5 test equipment. The CRAFT unit has been well received by the end users and we look forward to working with the U.S. Navy on this program, and we believe our CRAFT unit will be the Mode 5 test set of choice for a number of years. The Company had received delivery orders against this new contract for the additional test sets at a total value of $4.1 million. In October 2014, the Company received an order under this contract for an additional $2.4 million. The Company currently has open orders for the AN/USM-708 and AN/USM-719 for 417 units, totaling $11.1 million, including this new order, and an option to purchase up to $3 million of additional units. During the quarter, the Company had a six week interruption in CRAFT deliveries due to delayed component shipments from vendors, and a technical issue with the U.S. Navy, which has now been resolved, which affected sales for these periods.  CRAFT shipments resumed in October.

As such, we anticipate improvement in revenues and profitability for the remainder of fiscal year 2015. We believe that the revenue increase from the TS-4530A and ITATS shipments will also enhance the Company’s liquidity position.
 
For the six months ended September 30, 2014, the Company recorded an operating loss of $531,288 as compared to an operating profit of $208,298 for the six months ended September 30, 2013. For the six months ended September 30, 2014, the Company recorded a loss before taxes of $872,330 as compared to a loss before taxes of $165,255 for the six months ended September 30, 2013. 
 
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Overview (continued)

As a result of the substantial operating losses incurred in fiscal year 2013, the Company was not in compliance with the NYSE-MKT’s (the “Exchange”) continued listing standards. The Company also received a letter from the staff of the Exchange that, based on the Company’s financial statements at March 31, 2013, the Company was no longer in compliance with the minimum stockholders’ equity requirement of $4.0 million, and had also reported net losses in three of its last four fiscal years, as set forth in Section 1003(a)(ii) of the NYSE MKT Company Guide. On July 17, 2014, based on the review of publicly available and Section 1009(f) of the NYSE MKT Company Guide, the Exchange has indicated that the Company had resolved the continued listing deficiencies with respect to both Sections 1003(a)(ii) and 1003(4)(iv) of the Company Guide, since it has reported net income for the fiscal year ended March 31, 2014 and demonstrated that it has remedied its financial impairment. As is the case with all listed issuers on the NYSE-MKT, the Company’s continued listing eligibility will be assessed on an ongoing basis.
 
On October 9, 2013, the SEC notified the Company that it may be in violation of Section 16(a) for failure to accurately and timely file beneficial ownership reports (the “Filings”) for certain officers and directors.  The Company accepted responsibility for filing all such reports on behalf of each officer and director.

The Company apparently made certain coding errors with respect to certain of the Filings, in addition to not filing within two business days of a reportable transaction as reported by an officer or director. Based on the above, the SEC notified the Company that it may be in violation of Section 16(a). Currently, all transactions by the Holders have been disclosed with the SEC and the Company believes that the transactions which required timely Section 16(a) reports did not involve a material amount of equity securities.  Additionally, no sales were made by any officer or director and the violation is related to disclosure only.

The Company has made an Offer to Settle to the SEC and the SEC accepted such Offer. The Company has also revised its procedures for Section 16(a) reports to ensure complete compliance.

At September 30, 2014, the Company’s backlog was approximately $34.0 million as compared to approximately $33.1 million at September 30, 2013.

In November 2014, the Company entered into loan agreement with a bank for $1,200,000. The proceeds from the loan will be used to pay off the remaining balance of the loan with BCA Mezzanine Fund, L.P. in the amount of $1,153,109, including accrued interest of $4,467.  The term of the loan is for 3 year and expires in November, 2017. Monthly payments are at $36,551 including interest at 6%.

Based on existing and expected production releases, the Company believes that it will have adequate liquidity, and backlog to fund operating plans for at least the next twelve months.  Currently, the Company has no material future capital expenditure requirements. However, there can be no assurances that the Company will achieve profitability or will not require additional financing.

Results of Operations
 
Sales

For the three and six months ended September 30, 2014, sales decreased $446,907 (11.1%) and $517,806 (7.2%) to $3,587,674 and $6,716,750, respectively, as compared to $4,034,581 and $7,234,556, respectively, for the three and six months ended September 30, 2013.
 
Avionics government sales decreased $427,191 (12.4%) and $709,310 (11.35%) to $3,026,728 and $5,547,451 for the three and six months ended September 30, 2014, respectively, as compared to $3,453,919 and $6,256,761 for the three and six months ended September 30, 2013. This decrease is mostly attributed to the lower shipments for the TS-4530A Sets for which the Company has not yet received a full production release, but such release is anticipated in the next few months. In the prior year, the Company was able to ship against a partial release from the U.S. Army. During the quarter the Company had a six week interruption in CRAFT deliveries due to delayed component shipments from vendors and a technical issue with the U.S. Navy, which has been resolved, which affected sales for these periods.  CRAFT shipments resumed in October. These decreases were partially offset by the shipment of the kits for the TS-4530A program for which the Company received a full production release from the U.S. Army for kits on June 29, 2014, and the commencement of shipments for the Company’s ITATS program.

Commercial sales decreased $19,721 (3.4%) to $560,946 for the three months ended September 30, 2014 as compared to $580,662 for the three months ended September 30, 2013.   The decrease is primarily attributed to lower sales from the overhaul and repairs business. Commercial sales increased  $191,504 (19.6%) to $1,169,299 for the six months ended September 30, 2014 as compared to $977,795 for the six months ended September 30, 2013. This increase in sales is primarily attributed to parts availability as the Company was able to reduce its backlog for its commercial products as well as increased sales from the overhaul and repairs business. The economic conditions in the commercial market remain depressed and, therefore, this increase in commercial sales cannot be considered a trend.   
 
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Gross Margin

Gross margin decreased $406,405 (31.9%) and $472,346 (19.2%) %) to $869,344 and $1,989,561, respectively, for the three and six months ended September 30, 2014 as compared to $1,275,749 and $2,461,907, respectively, for the three and six months ended September 30, 2013. Gross profit was affected by higher labor and overhead variances due in part to additional staffing associated with the startup of the TS-4530A and ITATS programs. The gross margin percentage for the three months ended September 30, 2014 was 24.2%, as compared to 31.6% for the three months ended September 30, 2013.  The gross margin percentage for the six months ended September 30, 2014 was 29.6%, as compared to 34.0% for the six months ended September 30, 2013.  

Operating Expenses

Selling, general and administrative expenses decreased $11,376 (1.7%) to $660,034 for the three months ended September 30, 2014 as compared to $671,410 for the three months ended September 30, 2013. This decrease was primarily attributed to lower professional fees. Selling, general and administrative expenses increased $214,567 (16.2%) to $1,539,227 for the six months ended September 30, 2014 as compared to $1,324,660 for the six months ended September 30, 2013. This increase was primarily attributed to higher professional fees associated with the Aeroflex litigation.

Engineering, research and development expenses increased $49,154 (11.0%) and $52,673 (5.7%) %) to $497,726 and $981,622, respectively, for the three and six months ended September 30, 2014 as compared to $448,572 and $928,949, respectively, for the three and six months ended September 30, 2013. While the Company has completed development on its major programs, research and development resources have now been focused on new product development, sustaining engineering and enhancements to existing products.

Income (Loss) From Operations

As a result of the above, the Company recorded an operating loss of $288,416 for the three months ended September 30, 2014, as compared to operating income of $155,767 for the three months ended September 30, 2013.  For the six months ended September 30, 2014, the Company recorded an operating loss of $531,288 as compared to operating income of $208,298 for the six months ended September 30, 2013.  

Other Income (Expense), Net

For the three months ended September 30, 2014, total other expense was $86,727 as compared to other expense of $217,381 for the three months ended September 30, 2013. This change is primarily due to the non-cash gain on the change in the valuation of common stock warrants for the three months ended September 30, 2014 as compared to a loss in the valuation of common stock warrants in same period in the prior year as well as lower interest expense. For the six months ended September 30, 2014, total other expense was $341,042 as compared to other expense of $373,553 for the six months ended September 30, 2013. This change is primarily due to lower interest expense offset partially by the higher non-cash loss on the change in the valuation of common stock warrants as compared to the same period last year.

Loss before Income Taxes

As a result of the above, the Company recorded losses before income taxes of $375,143 and $872,330 for the three and six months ended September 30, 2014 as compared to losses before taxes of $61,614 and $165,255 for the three and six months ended September 30, 2013.

Income Tax Benefit

For the three and six months ended September 30, 2014, the Company recorded income tax benefits of $126,948 and $240,130 as compared to income tax expense of $10,860 for the three months ended September 30, 2013 and an income tax benefit of $7,009 for the six months ended September 30, 2013.  These amounts represent the statutory federal and state tax rate on the Company’s loss before taxes. 

Net Loss

As a result of the above, the Company recorded net losses of $248,195 and $632,200 for the three and six months ended September 30, 2014, as compared to net losses of $72,474 and $158,246 for the three and six months ended September 30, 2013.
 
 
16

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Liquidity and Capital Resources

At September 30, 2014, the Company had net working capital of $2,110,330 as compared to $2,452,798 at March 31, 2014. This change is primarily the result of the decrease in accounts receivable and the increase in accounts payable and accrued liabilities offset partially by an increase in inventories and prepaid expenses.

During the six months ended September 30, 2014, the Company’s cash balance increased by $11,028 to $243,146.  The Company’s principal sources and uses of funds were as follows:

Cash provided by (used in) operating activities. For the six months ended September 30, 2014, the Company provided $377,530 in cash for operations as compared to providing $13,400 in cash for operations for the six months ended September 30, 2013.  This improvement is the result of the reduction in accounts receivable and increase in accounts payable and accrued liabilities offset partially by the increase in inventories, higher operating loss and increase in prepaid expenses.

Cash used in investing activities.  For the six months ended September 30, 2014, the Company used $6,511 of its cash for investing activities, as compared to $11,226 for the six months ended September 30, 2013 as result of lower purchases of equipment.
 
Cash used in financing activities. For the six months ended September 30, 2014, the Company used $359,991 in financing activities as compared to using $166,720 for the six months ended September 30, 2013.  This is the result of lower proceeds from notes payable and the increase in repayments of debt. For the six months ended September 30, 2013, the Company received net proceeds from a related party note payable in the amount of $100,000.

In November 2014, the Company entered into loan agreement with a bank for $1,200,000. The proceeds from the loan will be used to pay off the remaining balance of the loan with BCA Mezzanine Fund, L.P. in the amount of $1,153,109, including accrued interest of $4,467.  The term of the loan is for 3 year and expires in November 2017. Monthly payments are at $36,551 including interest at 6%.

Based on existing and expected production releases, the Company believes that it will have adequate liquidity, and backlog to fund operating plans for at least the next twelve months.  Currently, the Company has no material future capital expenditure requirements. However, there can be no assurances that the Company will achieve profitability or will not require additional financing.

There was no significant impact on the Company’s operations as a result of inflation for the six months ended September 30, 2014.

These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2014, filed with the SEC on June 30, 2014.
 
Off-Balance Sheet Arrangements

As of September 30, 2014, the Company had no off-balance sheet arrangements.

Critical Accounting Policies

Our critical accounting policies are described in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended March 31, 2014, as filed with the SEC on June 30, 2014. There have been no changes in our critical accounting policies. Our significant accounting policies are described in our notes to the 2014 consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2014, as filed with the SEC on June 30, 2014.
 
 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

We do not hold any derivative instruments and do not engage in any hedging activities.
 
Item 4.  Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures

The Company, including its principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this report (the “Evaluation Date”). Based upon the evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective. Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls include controls and procedures designed to reasonably ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
 
Changes in Internal Control over Financial Reporting  
 
The Company, including its principal executive officer and principal accounting officer, reviewed the Company’s internal control over financial reporting, pursuant to Rule 13(a)-15(e) under the Exchange Act and concluded that there was no change in the Company’s internal control over financial reporting during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 
PART II – OTHER INFORMATION
 
Item 1.  Legal Proceedings.

On March 24, 2009, Aeroflex Wichita, Inc. (“Aeroflex”) filed a petition against the Company and two of its employees in the District Court, Sedgwick County, Kansas, Case No. 09 CV 1141 (the “Aeroflex Action”), alleging that the Company and its two employees misappropriated Aeroflex’s proprietary technology in connection with the Company winning a substantial contract from the U.S. Army (the “Award”), to develop new Mode-5 radar test sets and kits to upgrade the existing TS-4530 radar test sets to Mode 5. Aeroflex’s petition alleges that in connection with the Award, the Company and its named employees misappropriated Aeroflex’s trade secrets; tortiously interfered with its business relationship; conspired to harm Aeroflex and tortiously interfered with its contract and seeks injunctive relief and damages. The central basis of all the claims in the Aeroflex Action is that the Company misappropriated and used Aeroflex proprietary technology and confidential information in winning the Award. In February 2009, subsequent to the Company winning Award to the Company, Aeroflex filed a protest of the Award with the Government Accounting Office (“GAO”). In its protest, Aeroflex alleged, inter alia, that the Company used Aeroflex’s proprietary technology in order to win the Award, the same material allegations as were later alleged in the Aeroflex Action. On or about March 17, 2009, the U.S. Army Contracts Attorney and the U.S. Army Contracting Officer each filed a statement with the GAO, expressly rejecting Aeroflex’s allegations that the Company used or infringed Aeroflex proprietary technology in winning the Award, and concluding that the Company had used only its own proprietary technology. On April 6, 2009, Aeroflex withdrew its protest.
 
In December 2009, the Kansas District Court dismissed the Aeroflex Action on jurisdiction grounds. Aeroflex appealed this decision. In May 2012, the Kansas Supreme Court reversed the decision and remanded the Aeroflex Action to the District Court for further proceedings. The Company has been in engaged in discovery and depositions for the last two quarters, which has resulted in substantially higher legal expense. The case is currently set for trial on May 19, 2015, but this date may continue to slip. The Company is optimistic as to the outcome of this litigation. However, the outcome of any litigation is unpredictable and an adverse decision in this matter could have a material adverse effect on our financial condition, results of operations or liquidity.

On October 9, 2013, the SEC notified the Company that it may be in violation of Section 16(a) for failure to accurately and timely file beneficial ownership reports (the “Filings”) for certain officers and directors.  The Company accepted responsibility for filing all such reports on behalf of each officer and director.

The Company apparently made certain coding errors with respect to certain of the Filings, in addition to, not filing within two business days of a reportable transaction as reported by an officer or director. Based on the above, the SEC notified the Company that it may be in violation of Section 16(a). Currently, all transactions by the Holders have been disclosed with the SEC and the Company believes that the transactions which required timely Section 16(a) reports did not involve a material amount of equity securities.  Additionally, no sales were made by any officer or director and the violation is related to disclosure only.

The Company has made an Offer to Settle to the SEC and in September 2014 the SEC accepted such Offer. The Company has also revised its procedures for Section 16(a) reports to ensure complete compliance.

Other than the matters outlined above, we are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of executive officers of our Company, threatened against or affecting our Company, or our common stock in which an adverse decision could have a material effect.
 
Item 1A.  Risk Factors.

We believe there are no changes that constitute material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2014, filed with the SEC on June 30, 2014.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

There were no unregistered sales of the Company’s equity securities during the quarter ended September 30, 2014, other than those previously reported in a Current Report on Form 8-K.

Item 3.  Defaults Upon Senior Securities.

There has been no default in the payment of principal, interest, sinking or purchase fund installment, or any other material default, with respect to any indebtedness of the Company.

Item 4.  Mine Safety Disclosures.

Not applicable. 
 

Item 5.  Other Information.

There is no other information required to be disclosed under this item which was not previously disclosed.
 
Item 6.  Exhibits.
 
Exhibit No.
 
Description
     
31.1
 
     
31.2
 
     
32.1
 
     
32.2
 
     
101.INS
 
XBRL Instance Document*
     
101.SCH
 
Taxonomy Extension Schema Document*
     
101.CAL
 
Taxonomy Extension Calculation Linkbase Document*
     
101.DEF
 
Taxonomy Extension Definition Linkbase Document*
     
101.LAB
 
Taxonomy Extension Label Linkbase Document*
     
101.PRE
 
Taxonomy Extension Presentation Linkbase Document*

* Filed herewith

 
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.
 
     
TEL-INSTRUMENT ELECTRONICS CORP.
           
           
Date: November 14, 2014
 
By:
 /s/ Jeffrey C. O’Hara
 
       
Name: Jeffrey C. O’Hara
 
       
Title:  Chief Executive Officer
           Principal Executive Officer
 

           
Date: November 14, 2014
 
By:
 /s/ Joseph P. Macaluso
 
       
Name: Joseph P. Macaluso