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
June 30,
2008
|
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the transition period from
__________to__________
COMMISSION
FILE NUMBER
1-8086
GENERAL
DATACOMM INDUSTRIES, INC.
(Exact
name of registrant as specified in its charter)
DELAWARE
|
|
06-0853856
|
(State
of other jurisdiction of incorporation or organization)
|
|
I.R.S.
Employer Identification No.)
|
6
Rubber Avenue, Naugatuck, CT
|
|
06770
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
Registrant’s
telephone number, including area code
203-729-0271
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
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 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
x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act):
As
of June 30, 2008, there were outstanding the following number of shares of each
of the issuer’s classes of common equity:
3,487,473
shares of common stock, par value $0.01 per share
634,615
shares of Class B stock, par value $0.01 per share
GENERAL
DAT
ACOM
M INDUSTRIES, INC.
INDEX
TO QUARTERLY REPORT ON FORM 10-Q
PART I
|
FINANCIAL
INFORMATION
|
|
Page
|
|
|
|
|
Item 1
.
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
4
|
|
|
|
.5
|
|
|
|
6
|
|
|
|
|
Item 2
.
|
|
|
12
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|
|
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|
Item
3.
|
|
|
25
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|
|
|
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Item
4.
|
|
|
26
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|
|
|
|
|
PART II
|
OTHER
INFORMATION
|
|
|
|
|
|
|
Item 3
.
|
|
|
26
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|
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|
Item 6
.
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|
|
26
|
PART
I. FIN
ANCI
AL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
General
DataComm Industries, Inc., and Subsidiaries
Condensed
Consolidated Balance Sheets
(in
thousands except shares)
|
|
June
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007*
|
|
|
|
(Unaudited)
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
152
|
|
|
$
|
1,296
|
|
Accounts
receivable, less allowance for doubtful accounts of $252 at June 30, 2008
and $250 at September 30, 2007
|
|
|
2,691
|
|
|
|
1,711
|
|
Inventories
|
|
|
2,980
|
|
|
|
2,766
|
|
Other
current assets
|
|
|
604
|
|
|
|
676
|
|
Total
current assets
|
|
|
6,427
|
|
|
|
6,449
|
|
Property,
plant and equipment, net
|
|
|
3,711
|
|
|
|
3,687
|
|
Total
Assets
|
|
|
10,138
|
|
|
|
10,136
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Deficit:
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Current
portion of long-term debt ($2,331 and $2,332 owed to related parties at
June 30, 2008 and September 30, 2007, respectively)
|
|
|
21,870
|
|
|
|
2,355
|
|
Accounts
payable
|
|
|
2,506
|
|
|
|
2,810
|
|
Accrued
payroll and payroll-related costs
|
|
|
553
|
|
|
|
565
|
|
Accrued
interest
|
|
|
9,465
|
|
|
|
466
|
|
Other
current liabilities
|
|
|
2,682
|
|
|
|
3,051
|
|
Total
current liabilities
|
|
|
37,076
|
|
|
|
9,247
|
|
Long-term
debt, less current portion
|
|
|
4,500
|
|
|
|
23,953
|
|
Accrued
interest
|
|
|
42
|
|
|
|
7,946
|
|
Other
liabilities
|
|
|
715
|
|
|
|
722
|
|
Total
Liabilities
|
|
|
42,333
|
|
|
|
41,868
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
deficit:
|
|
|
|
|
|
|
|
|
9%
Preferred stock, par value $1.00 per share, 3,000,000 shares authorized;
781,996 shares issued and outstanding at June 30, 2008
and September 30, 2007; $33.6 million liquidation preference,
including $14.1 million of cumulative dividend arrearages at June 30,
2008
|
|
|
782
|
|
|
|
782
|
|
Class
B stock, par value $.01 per share, 5,000,000 shares
authorized; 634,615 and 647,715 shares issued and
outstanding at June 30, 2008 and September 30, 2007,
respectively
|
|
|
6
|
|
|
|
6
|
|
Common
stock, par value $.01 per share, 25,000,000 shares authorized; 3,487,473
and 3,474,373 shares issued and outstanding at June 30, 2008 and September
30, 2007, respectively
|
|
|
35
|
|
|
|
35
|
|
Capital
in excess of par value
|
|
|
199,198
|
|
|
|
199,021
|
|
Accumulated
deficit
|
|
|
(232,253
|
)
|
|
|
(231,601
|
)
|
Accumulated
other comprehensive income
|
|
|
37
|
|
|
|
25
|
|
Total
Stockholders’ Deficit
|
|
|
(32,195
|
)
|
|
|
(31,732
|
)
|
Total
Liabilities and Stockholders’ Deficit
|
|
$
|
10,138
|
|
|
$
|
10,136
|
|
* Derived
from the Company’s audited consolidated balance sheet at September 30,
2007.
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
G
ene
ral DataComm Industries, Inc. and Subsidiaries
Condensed
Consolidated Statements of Operations (Unaudited)
(in
thousands except share data)
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
3,078
|
|
|
|
2,172
|
|
|
$
|
8,153
|
|
|
$
|
7,626
|
|
Service
|
|
|
523
|
|
|
|
613
|
|
|
|
1,594
|
|
|
|
1,776
|
|
Total
|
|
|
3,601
|
|
|
|
2,785
|
|
|
|
9,747
|
|
|
|
9,402
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
|
1,455
|
|
|
|
708
|
|
|
|
3,804
|
|
|
|
2865
|
|
Service
|
|
|
341
|
|
|
|
236
|
|
|
|
1,193
|
|
|
|
661
|
|
Total
|
|
|
1,796
|
|
|
|
944
|
|
|
|
4,997
|
|
|
|
3,526
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
margin
|
|
|
1,805
|
|
|
|
1,841
|
|
|
|
4,750
|
|
|
|
5,876
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
1,778
|
|
|
|
1,493
|
|
|
|
4,929
|
|
|
|
4,253
|
|
Research
and product development
|
|
|
904
|
|
|
|
628
|
|
|
|
2,410
|
|
|
|
1,851
|
|
|
|
|
2,682
|
|
|
|
2,121
|
|
|
|
7,339
|
|
|
|
6,104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(877
|
)
|
|
|
(280
|
)
|
|
|
(2,589
|
)
|
|
|
(228
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(699
|
)
|
|
|
(727
|
)
|
|
|
(2,213
|
)
|
|
|
(2,284
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
on sale of patents
|
|
|
--
|
|
|
|
--
|
|
|
|
3,891
|
|
|
|
--
|
|
Gain
on restructuring of debt
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
4,062
|
|
Other
,net
|
|
|
11
|
|
|
|
161
|
|
|
|
117
|
|
|
|
265
|
|
|
|
|
11
|
|
|
|
161
|
|
|
|
4,008
|
|
|
|
4,327
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) before income taxes
|
|
|
(1,565
|
)
|
|
|
(846
|
)
|
|
|
(794
|
)
|
|
|
1,815
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax provision (benefit)
|
|
|
3
|
|
|
|
(6
|
)
|
|
|
8
|
|
|
|
--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
(1,568
|
)
|
|
|
(840
|
)
|
|
|
(802
|
)
|
|
|
1,815
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
applicable to preferred stock
|
|
|
(440
|
)
|
|
|
(440
|
)
|
|
|
(1,320
|
)
|
|
|
(1,320
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) applicable to common and Class B stock
|
|
$
|
(2,008
|
)
|
|
$
|
(1,280
|
)
|
|
$
|
(2,122
|
)
|
|
$
|
495
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
– common stock
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.51
|
)
|
|
$
|
0.14
|
|
Diluted
– common stock
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.51
|
)
|
|
$
|
0.12
|
|
Basic
– Class B stock
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.51
|
)
|
|
$
|
0.11
|
|
Diluted
– Class B stock
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.51
|
)
|
|
$
|
0.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common and Class B shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
– common stock
|
|
|
3,487,473
|
|
|
|
3,474,373
|
|
|
|
3,481,592
|
|
|
|
3,472,899
|
|
Diluted
– common stock
|
|
|
3,487,473
|
|
|
|
3,474,373
|
|
|
|
3,481,592
|
|
|
|
4,122,088
|
|
Basic
– Class B stock
|
|
|
634,615
|
|
|
|
647,715
|
|
|
|
640,496
|
|
|
|
649,189
|
|
Diluted
- Class B stock
|
|
|
634,615
|
|
|
|
647,715
|
|
|
|
640,496
|
|
|
|
649,189
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these
condensed
consolidated financial statements.
G
en
eral DataComm Industries, Inc.
Condensed
Consolidated Statements of Cash Flows (Unaudited)
(In
thousands)
|
|
Nine
Months Ended
|
|
|
|
June
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(802
|
)
|
|
$
|
1,815
|
|
Adjustments
to reconcile net income (loss) to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
227
|
|
|
|
275
|
|
Stock
compensation expense
|
|
|
177
|
|
|
|
209
|
|
Gain
on restructuring of debt
|
|
|
--
|
|
|
|
(4,062
|
)
|
Gain
on sale of patents
|
|
|
(3,891
|
)
|
|
|
--
|
|
Changes
in:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(980
|
)
|
|
|
1056
|
|
Inventories
|
|
|
(214
|
)
|
|
|
(377
|
)
|
Accounts
payable
|
|
|
(304
|
)
|
|
|
214
|
|
Accrued
payroll and payroll-related costs
|
|
|
(12
|
)
|
|
|
(108
|
)
|
Accrued
interest
|
|
|
1,095
|
|
|
|
1667
|
|
Other
net current liabilities
|
|
|
(104
|
)
|
|
|
86
|
|
Other
net long-term assets
|
|
|
(20
|
)
|
|
|
15
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) operating activities
|
|
|
(4,828
|
)
|
|
|
790
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Acquisition
of property, plant and equipment, net
|
|
|
(257
|
)
|
|
|
(10
|
)
|
Net
proceeds from sale of patents
|
|
|
3,891
|
|
|
|
--
|
|
Net
cash provided by (used in) investing activities
|
|
|
3,634
|
|
|
|
(10
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from notes payable to related parties
|
|
|
375
|
|
|
|
270
|
|
Principal
payments on notes payable to related parties
|
|
|
(395
|
)
|
|
|
--
|
|
Proceeds
from other notes payable
|
|
|
226
|
|
|
|
222
|
|
Principal
payments on other notes payable
|
|
|
(156
|
)
|
|
|
(152
|
)
|
Principal
payments on term obligation
|
|
|
-
|
|
|
|
(844
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) financing activities
|
|
|
50
|
|
|
|
(504
|
)
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash
equivalents
|
|
|
(1,144
|
)
|
|
|
276
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
1,296
|
|
|
|
246
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
152
|
|
|
|
522
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
(including payments to related parties of $458 in 2008)
|
|
$
|
883
|
|
|
|
321
|
|
Income
and franchise taxes
|
|
$
|
6
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these
condensed
consolidated financial statements.
GENERAL
DAT
ACO
MM INDUSTRIES, INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
– Basis of Presentation and Liquidity
The
accompanying unaudited interim financial statements of General DataComm
Industries, Inc. (the “Company”) have been prepared on a going concern basis, in
accordance with generally accepted accounting principles in the United States
for interim financial information, 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 year end financial statements. In the opinion of management,
these statements include all adjustments, consisting of normal and recurring
adjustments, considered necessary for a fair presentation of the results for the
periods presented. The results of operations for the three and nine
months ended June 30, 2008 are not necessarily indicative of results which may
be achieved for the entire fiscal year ending September 30, 2008. The
unaudited interim financial statements should be read in conjunction with the
consolidated financial statements and notes thereto contained in the Company’s
annual report on Form 10-KSB for the fiscal year ended September 30, 2007 as
filed with the Securities and Exchange Commission.
On
November 2, 2001, General DataComm Industries, Inc. and its domestic
subsidiaries filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware. The Company continued in possession of its properties and
the management of its business as debtors in possession.
The
Company emerged from Chapter 11 effective on September 15, 2003 pursuant to a
court-approved plan of reorganization. Under this plan, the Company
was to pay all creditors 100% of their allowed claims based upon a five year
business plan. Debentures were issued to unsecured creditors as part
of the plan of reorganization. However, the Company has not met its
business plan objectives since emerging from Chapter 11 and, therefore, there
can be no assurance that any such outstanding claims will be paid.
The
Company incurred a net loss and used a significant amount of cash in its
operating activities for the nine months ended June 30, 2008. In
addition, at June 30, 2008 the Company had a stockholders’ deficit of
approximately $32.2 million, and a working capital deficit of approximately
$30.6 million, including debentures in the principal amount of $19.5 million,
together with accrued interest thereon ($9.3 million), which mature
on October 1, 2008. While a subordinated security agreement signed by
the indenture trustee on behalf of the debenture holders provides that no
payments may be made to debenture holders while senior secured debt is
outstanding, in the absence of such payment restrictions the Company does not
presently have the ability to repay the debentures. As of June 30,
2008, senior secured debt consists of notes payable to related parties and a
mortgage payable. A failure to pay the debentures when they become
due and payable as described above, could result in an event of default being
declared under the indenture governing the debentures. Together with the
other conditions described in this paragraph, such condition raises
substantial doubt about the Company’s ability to continue as a going
concern.
Management
has responded to its liquidity and cash flow risks by replacing its senior debt
in 2007 with mortgage debt on more favorable terms and by selling patents in
February 2008 for $4,000,000 while retaining rights to use the patented
technologies (See Note 7). In addition, management has implemented operational
changes: reducing certain salaries, restructuring the sales force, increasing
factory and office shutdown time, constraining expenses, and reducing and
reallocating the employee workforce (See Note 11). The Company
also continues to pursue the sale or lease of its headquarters land and building
in Naugatuck, CT.
While the
Company is aggressively pursuing opportunities and corrective actions, there can
be no assurance that the Company will be successful in its efforts to generate
sufficient cash from operations or asset sales, or obtain additional funding
sources or resolve the repayment of the debentures. The accompanying
consolidated financial statements have been prepared assuming that the Company
will continue as a going concern and do not include any adjustments that may
result from the outcome of this uncertainty.
2.
– Earnings (Loss) Per Share
Basic
earnings per share is computed by allocating net income available to common
stockholders and to Class B shareholders based on their contractual
participation rights to share in such net income as if all the income for the
year had been distributed. Such allocation reflects that common stock
is entitled to cash dividends, if and when paid, 11.11% higher per share than
Class B stock. However, a net loss is allocated evenly to all
shares. The income (loss) allocated to each security is divided by
the respective weighted average number of common and Class B shares outstanding
during the period. Diluted earnings per common share assumes the
conversion of Class B stock into common stock. Diluted earnings per
share gives effect to all potential dilutive common shares outstanding during
the period. In computing diluted earnings per share, which only
applies in the event there is net income, the average price of the Company’s
common stock for the period is used in determining the number of shares assumed
to be purchased from exercise of stock options and
warrants. Dividends applicable to preferred stock represent
accumulating dividends that are not declared or accrued. The
following table sets forth the computation of basic and diluted earnings (loss)
applicable to common and Class B stock for the three and nine months ended June
30, 2008 and 2007 (in thousands, except shares and per share data):
|
|
Three Months Ended June 30,
|
|
|
Nine Months Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,568
|
)
|
|
$
|
(840
|
)
|
|
$
|
(802
|
)
|
|
$
|
1,815
|
|
Dividends
applicable to preferred stock
|
|
|
(440
|
)
|
|
|
(440
|
)
|
|
|
(1,320
|
)
|
|
|
1,320
|
|
Net
income (loss) applicable to common and Class B stock
|
|
$
|
(2,008
|
)
|
|
$
|
(1,280
|
)
|
|
$
|
(2,122
|
)
|
|
$
|
495
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) applicable to common stock-basic
|
|
$
|
(1,695
|
)
|
|
$
|
(1079
|
)
|
|
$
|
(1,792
|
)
|
|
$
|
424
|
|
Net
income (loss) applicable to Class B stock-basic and
diluted
|
|
$
|
(313
|
)
|
|
$
|
(201
|
)
|
|
$
|
(330
|
)
|
|
$
|
71
|
|
|
|
Three Months Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
Common Stock
|
|
|
Class B Stock
|
|
Numerator
for basic earnings per share - net income (loss)
|
|
$
|
(1,695
|
)
|
|
$
|
(1.079
|
)
|
|
$
|
(313
|
)
|
|
$
|
(201
|
)
|
Reallocation
of net income for potential dilutive common shares
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Numerator
for diluted earnings per share - net income
|
|
|
(1,695
|
)
|
|
|
(1,079
|
)
|
|
|
(313
|
)
|
|
|
(201
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share - weighted average outstanding
shares
|
|
|
3,487,473
|
|
|
|
3,473,373
|
|
|
|
634,615
|
|
|
|
647,715
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class
B stock
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Denominator
for diluted earnings per share
|
|
|
3,487,473
|
|
|
|
3,473,373
|
|
|
|
634,615
|
|
|
|
647,715
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
Diluted earnings
per share
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.49
|
)
|
|
$
|
(0.31
|
)
|
|
|
Nine Months Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
Common Stock
|
|
|
Class B Stock
|
|
Numerator
for basic earnings per share - net income (loss)
|
|
$
|
(1,792
|
)
|
|
$
|
424
|
|
|
$
|
(330
|
)
|
|
$
|
71
|
|
Reallocation
of net income for potential dilutive common shares
|
|
|
--
|
|
|
|
71
|
|
|
|
--
|
|
|
|
--
|
|
Numerator
for diluted earnings per share - net
income (loss)
|
|
|
(1,792
|
)
|
|
|
495
|
|
|
|
(330
|
)
|
|
|
71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share - weighted average outstanding
shares
|
|
|
3,481,592
|
|
|
|
3,472,899
|
|
|
|
640,496
|
|
|
|
649,189
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class
B stock
|
|
|
|
|
|
|
649,189
|
|
|
|
|
|
|
|
-
|
|
Denominator
for diluted earnings per share
|
|
|
3,481,592
|
|
|
|
4,122,088
|
|
|
|
640,496
|
|
|
|
649,189
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share
|
|
$
|
(0.51
|
)
|
|
$
|
0.14
|
|
|
$
|
(0.51
|
)
|
|
$
|
0.11
|
|
Diluted earnings
per share
|
|
$
|
(0.51
|
)
|
|
$
|
0.12
|
|
|
$
|
(0.51
|
)
|
|
$
|
0.11
|
|
In the
nine months ended June 30, 2008 and 2007, no effect has been given to certain
outstanding options and warrants, convertible securities and contingently
issuable shares in computing diluted income (loss) per share as their effect
would be antidilutive. Such share amounts which could potentially
dilute basic earnings per share are as follows:
|
|
No. of Shares
|
|
|
|
Nine Months Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
Stock
warrants
|
|
|
4,093,251
|
|
|
|
4,093,251
|
|
Stock
options
|
|
|
3,461,631
|
|
|
|
2,636,167
|
|
Convertible
preferred stock
|
|
|
143,223
|
|
|
|
143,223
|
|
Contingently
issuable shares*
|
|
|
-
|
|
|
|
2,198,946
|
|
Total
|
|
|
7,698,105
|
|
|
|
9,071,587
|
|
* Common
stock contingently issuable to the Company’s senior secured lenders in the event
of default or if certain payment terms were not met are excluded from the
computation of earnings per share because the contingency defined in the loan
agreement had not taken place. Such contingency was cancelled when
the senior loan to which that provision relates was paid off on July 30,
2007.
3. Inventories
Inventories
consist of (in thousands):
|
|
June
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
Raw
materials
|
|
$
|
315
|
|
|
$
|
665
|
|
Work-in-process
|
|
|
1,216
|
|
|
|
1,020
|
|
Finished
goods
|
|
|
1,449
|
|
|
|
1,081
|
|
|
|
$
|
2,980
|
|
|
$
|
2,766
|
|
Inventories
are stated at the lower of cost or market using a first-in, first-out
method. Reserves in the amount of $3,009,000 and
$2,883,000 were recorded at June 30, 2008 and September 30, 2007, respectively,
for excess and obsolete inventories.
4. Long-Term
Debt
Long-term
debt consists of (in thousands):
|
|
June
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Notes
Payable to Related Parties, net of debt discount of $19 at
September 30, 2007 (none at June 30, 2008)
|
|
|
2,331
|
|
|
|
2,332
|
|
Other
Note Payable
|
|
|
86
|
|
|
|
23
|
|
Debentures
mature October 1, 2008
|
|
|
19,453
|
|
|
|
19,453
|
|
Real
Estate Mortgage due July 31, 2009
|
|
|
4,500
|
|
|
|
4,500
|
|
|
|
|
26,370
|
|
|
|
26,308
|
|
Less
current portion
|
|
|
21,870
|
|
|
|
2,355
|
|
|
|
$
|
4,500
|
|
|
$
|
23,953
|
|
Long-term
debt has matured or will mature in amounts totaling $21,870,000 in the twelve
months ending June 30, 2009, of which $19,453,000 in debentures mature October
1, 2008. In the following twelve months, the real estate mortgage in
the amount of $4,500,000 is due July 31, 2009.
Notes
Payable to Related Parties
On
December 9, 2005, Mr. Howard S. Modlin, Chairman of the Board and Chief
Executive Officer, and Mr. John Segall, a Director, restructured existing loans
and entered into new senior secured loans with the Company in the principal
amounts of $1,198,418 and $632,527, respectively. Interest accrues at
the rate of 10% per annum. In connection with the transactions,
Mr. Modlin and Mr. Segall each received seven year warrants expiring December 8,
2012 to purchase common stock at $0.575 per share covering 2,084,204 shares and
1,100,047 shares, respectively.
On
February 17, 2006, the Company borrowed $250,000 from Mr. Modlin in the form of
a demand note which bore interest at the rate of 10% per annum. On
April 20, 2006, the Corporation entered into an amendment of its loan
arrangement with Mr. Modlin whereby the $250,000 demand loan made by Mr. Modlin
on February 17, 2006 was amended and restated into a term note, 50% of which was
payable February 17, 2007 and 50% of which was payable February 17, 2008 (such
payments were deferred indefinitely in agreement with Mr.
Modlin). Mr. Modlin received a seven year warrant expiring April 19,
2013 to purchase 909,000 shares of common stock at $0.275 per
share. The warrant, valued at $69,000, was recorded as debt discount
and was amortized as additional interest expense over the initial term of the
debt.
In the
quarters ended March 31, 2007 and December 31, 2007, Mr. Modlin made demand
loans to the Company totaling $270,000 and $125,000, respectively, and which
bore interest at the annual rate of 10%. Such loans were paid off in
the quarter ended March 31, 2008. On April 30 and May 13, 2008, Mr.
Modlin made demand loans to the Company in the amount of $175,000 and $75,000,
respectively, to be used for working capital purposes. Such loans
bear interest at the annual rate of 10%. See Note 11, “Subsequent
Events” for reference to a loan made by Mr. Modlin to the Company after June 30,
2008.
Accrued
interest on all such loans amounted to $53,113 and $389,748 at June 30, 2008 and
September 30, 2007, respectively. All loans made by Mr. Modlin and
Mr. Segall are collateralized by all the assets of the Company.
Debentures
Debentures
together with accrued interest mature on October 1, 2008. The
debentures were issued to unsecured creditors in 2003 as part of the Company’s
plan of reorganization. No principal or interest is payable on the
debentures until the senior secured lenders’ claims are paid in full and no
principal or interest has been paid through June 30, 2008. Interest
accrues at the annual rate of 10% and totaled $9,338,938 at June 30,
2008. See Note 1 “Basis of Presentation and Liquidity.”
Real
Estate Mortgage
The real
estate mortgage entered into July 30, 2007 in the amount of $4,500,000 is
secured by the Company’s premises in Naugatuck, CT. The mortgage
requires monthly payments of interest at the rate of 30-day LIBOR plus 6% (such
interest rate was 8.38% at June 30, 2008). No principal payments are
required until the full amount of the mortgage matures on July 30,
2009. The mortgage contains no financial performance
covenants.
5. Accounting
for Stock-Based Compensation
Effective
October 1, 2006, the Company adopted the fair value recognition provisions of
SFAS No. 123 (R) “Accounting for Stock-Based Compensation” (“SFAS No. 123R”)
using the modified prospective method. Under that transition method,
compensation cost recognized includes: (a) compensation cost for all share-based
payments (including stock options) granted prior to, but not yet vested as of
October 1, 2006, based on the grant date fair value estimated in accordance with
the original provisions of SFAS No. 123, and (b) compensation cost for all
share-based payments granted subsequent to October 1, 2006, based on the
grant-date fair value estimated in accordance with the provisions of
SFAS No. 123R. Results for prior periods were not
restated. Compensation cost is recorded over the stock options’
vesting periods. As a result of adopting SFAS No. 123R, compensation
cost recognized in the quarter ended June 30, 2008 and 2007 was $54,000 and
$60,000, respectively. Compensation cost recognized in the nine months ended
June 30, 2008 and 2007 was $177,000 and $209,000, respectively.
6. Employee
Incentive Plans
The
Company has adopted a 2003 Stock and Bonus Plan (“2003 Plan”) reserving 459,268
shares of Class B stock and 459,268 shares of common stock and a 2005 Stock and
Bonus Plan (“2005 Plan”) reserving 2,400,000 shares of common
stock. No shares of Class B stock are authorized under the 2005 Plan
and no further shares of Class B are available under the 2003
Plan. Officers and key employees may be granted incentive stock
options at an exercise price equal to or greater than the market price on the
date of grant and non-incentive stock options at an exercise price equal to,
greater than or less than the market price on the date of
grant. While individual options can be issued under various
provisions, most options, once granted, generally vest in increments of 20% per
year over a five-year period and expire within ten years. At June 30, 2008 there
were 353,136 options available for future issuance under the plans.
On
October 11, 2007, the Stock Option Committee of the Board of Directors granted
stock options pursuant to the Company’s 2005 Plan to purchase 312,900 shares of
common stock at the quoted market price of $.25 per share, including grants of
30,000 shares to Aletta Richards and John L. Segall, Directors, William G.
Henry, Vice President, Finance and Administration and Principal Financial
Officer and George Gray, Vice President, Operations and Chief Technology
Officer, and an aggregate of 192,900 of such options to all of its employees
other than its officers and directors. The Committee also granted to
Howard S. Modlin, Chairman and Chief Executive Officer, a stock option with
terms similar to options granted under the 2005 Plan to purchase 551,121 shares
at $.275 a share. All such options vest in increments of 20% per year
over a five year period and expire ten years after grant.
A summary
of stock options outstanding under the Company’s stock plans as of September 30,
2007 and changes during the nine months ended June 30, 2008 are presented
below:
|
|
Shares
|
|
|
Weighted Average Exercise
Price
|
|
|
Weighted Average Remaining Contractual Term
(Yrs)
|
|
|
Aggregate Intrinsic Value
|
|
Options
outstanding, September 30, 2007
|
|
|
2,635,807
|
|
|
0.77
|
|
|
|
|
|
|
|
Options
granted
|
|
|
864,021
|
|
|
|
0.27
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
--
|
|
|
|
--
|
|
|
|
|
|
|
|
Options
cancelled or expired
|
|
|
(38,197
|
)
|
|
|
6.56
|
|
|
|
|
|
|
|
Options
outstanding, June 30, 2008
|
|
|
3,461,631
|
|
|
|
0.59
|
|
|
|
7.84
|
|
|
$
|
0
|
|
Vested
or expected to vest at June 30, 2008
|
|
|
3,100,716
|
|
|
|
0.54
|
|
|
|
7.76
|
|
|
|
0
|
|
Exercisable
at June 30, 2008
|
|
|
1,117,654
|
|
|
|
1.12
|
|
|
|
7.02
|
|
|
|
0
|
|
As of
June 30, 2008, there was $300,871 of total unrecognized compensation cost
related to nonvested options which is expected to be recognized over a
weighted-average period of 1.69 years.
The
weighted-average grant-date fair value of options granted during the nine months
ended June 30, 2008 was $0.23 per share, which was estimated using the Black
Scholes model and the following weighted average assumptions:
Risk-free
interest rate (%)
|
|
3.76%
|
Volatility
(%)
|
|
133%
|
Expected
life (in years)
|
|
6.50
|
Dividend
yield rate
|
|
Nil
|
Expected
volatility is based on historical volatility in the Company’s stock price over
the expected life of the options. The risk-free interest rate is
based on the annual yield on the measurement date of a zero coupon U.S. Treasury
Bond, the maturity of which equals the options’ expected life. The
weighted average expected life of 6.50 years reflects the alternative simplified
method permitted by SEC Staff Accounting Bulletin No. 107, which defines the
expected life as the average of the contractual term of the options and the
weighted average vesting period for all option tranches. The dividend
yield assumption is based on the Company’s intent not to issue a
dividend.
7. Gain
on Sale of Patents
On
February 5, 2008, the Company completed the sale of selected patents and patent
applications to Fournier Assets Limited Liability Company for proceeds of
$4,000,000. The patents and patent applications sold relate to the Company’s
product lines, and the Company retains a non-exclusive, royalty-free license
under the patents for all its product lines.
As a
result of the sale, the Company recorded a gain in the amount of $3,891,000 in
the quarter ended March 31, 2008. The Company used the funds for
general corporate purposes, including payment of debt and interest and for
working capital.
8. Gain
on Restructuring of Debt
On
January 17, 2007, pursuant to an amendment to the senior loan agreement, the
Company and its senior lender agreed, among other matters, to the following
changes:
|
(a)
|
to
reduce and fix the outstanding amount of a term note obligation, including
principal and interest, at $3,000,000 as of January 16,
2007;
|
|
(b)
|
to
provide for certain affiliates of the senior lender to sell
debentures with a face value approximating $2,471,000 together
with accrued interest of $824,694 to the Company for consideration of
$1.00.
|
As a
result of the debenture purchase and the adjustment to the term note obligation,
the Company recorded a gain on restructuring of debt in the amount of $4,062,000
in the quarter ended March 31, 2007.
9. Contingencies
Component
Supply
On
December 19, 2007, a sole supplier of a proprietary component critical to one of
the Company’s products announced the discontinuation of the component and
rejected previously accepted orders that had been placed for the component by
the Company. Thereafter, the Company filed a legal claim in
Connecticut Superior Court against the supplier. On July 7, 2008, a
financial settlement was reached with the supplier, the financial impact of
which is not expected to be significant.
The
Company believes that it has a plan in place to allow for a transition to a new
component without a disruption in customer deliveries. However, the
Company has incurred and expects to further incur increased product development
costs by reason of such transition plans. In the event that the
Company is unable to transition to the new component in time to meet its
customer requirements and/or is unable to generate the liquidity required to pay
the increased costs, such events could have a material adverse effect
on the Company’s business, financial condition and results of
operations.
Litigation
A former
employee has filed a lawsuit in a French court claiming additional compensation
owed relating to his dismissal, in the approximate amount of 560,000 Euros (or
$900,000 U.S. dollars). The Company believes that the claims are
without merit and the Company’s French counsel has advised that the claims are
unjustified and abusive.
10. Recent
Accounting Pronouncements
On
October 1, 2007, the Company adopted the provisions of FASB Interpretation No.
48 (“FIN 48”),
“Accounting for
Uncertainty in Income Taxes,”
which clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with FASB Statement No. 109,
“
Accounting for Income Taxes”
.
FIN 48 provides guidance
on the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures, and transition. Prior to implementation
of FIN 48, the Company had a liability for unrecognized foreign and state tax
benefits amounting to $313,000 provided in its balance sheet all of which, if
recognized, would affect the Company’s effective tax rate. In
adopting FIN 48, the liability for unrecognized tax benefits was reduced by
$180,000 and accrued interest through September 30, 2007 and penalties
aggregating $30,000 related to unrecognized tax benefits
were accrued resulting in a net reduction of $150,000 to the
accumulated deficit at October 1, 2007. The Company files a consolidated federal
income tax return with its subsidiaries. In addition, the Company and/or its
subsidiaries file in various states and foreign jurisdictions. The
Company is no longer subject to examinations by taxing authorities for fiscal
years before September 30, 2004. The Company classifies interest and
penalties as selling, general and administrative expenses. Interest
and penalties recognized in the three and nine months ended June 30, 2008
amounted to $1,000 and $3,100, respectively, and accrued interest and penalties
included in the balance sheet at June 30, 2008 amounted to
approximately $153,100.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157,
“Fair Value
Measurements”
. SFAS No. 157 defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair
value. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of
this standard on the consolidated financial statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 159,
“The Fair
Value Option for Financial Assets and Financial
Liabilities”
, SFAS No. 159 provides an option to report
selected financial assets and financial liabilities using fair
value. The standard establishes required presentation and disclosures
to facilitate comparisons with companies that use different measurements for
similar assets and liabilities. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007, with early adoption allowed only if
SFAS No. 157 is also adopted. The Company is currently evaluating the
impact of this standard on the consolidated financial statements.
11. Subsequent
Events
On July
9, 2008, Mr. Howard S. Modlin, Chairman of the Board and Chief Executive
Officer, made an interest-free demand loan to the Company in the amount of
$110,000 to be used for working capital purposes. Such loan was
repaid on July 17, 2008.
Effective
August 11, 2008, the Company implemented employee compensation reductions,
including a combination of salary reductions, shortened work week and job
eliminations for an anticipated annual savings of approximately $1.2
million.
ITEM
2. MAN
AG
EMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE
FOLLOWING DISCUSSION AND ANALYSIS OF THE COMPANY’S FINANCIAL CONDITION
AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND RELATED NOTES APPEARING ELSEWHERE IN THIS QUARTERLY
REPORT ON FORM 10-Q AND IN THE COMPANY’S ANNUAL REPORT ON FORM 10-KSB FOR THE
YEAR ENDED SEPTEMBER 30, 2007 AS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION.
THIS
REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. FOR
THIS PURPOSE, STATEMENTS CONTAINED HEREIN THAT ARE NOT STATEMENTS OF HISTORICAL
FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING
THE FOREGOING, THE WORDS “BELIEVES”, “ANTICIPATES”, “PLANS”, “EXPECTS” AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES AND ARE NOT GUARANTEES OF FUTURE PERFORMANCE. ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS INCLUDING, BUT NOT LIMITED TO, THOSE
SET FORTH UNDER THE HEADING “RISK FACTORS” BELOW. UNLESS REQUIRED BY
LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING
STATEMENTS OR REASONS WHY ACTUAL RESULTS MAY DIFFER.
Unless
otherwise stated, all references to “Notes” in the following discussion of
“Results of Operations” and “Liquidity and Capital Resources” are to the “Notes
to Condensed Consolidated Financial Statements included in Item 1 in this Form
10-Q.
RESULTS
OF OPERATIONS
Revenues
|
|
Three Months Ended June 30,
|
|
|
Nine Months Ended June 30,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
3,078
|
|
|
$
|
2,172
|
|
|
$
|
8,153
|
|
|
$
|
7,626
|
|
Service
|
|
|
523
|
|
|
|
613
|
|
|
|
1,594
|
|
|
|
1,776
|
|
Total
Revenues
|
|
$
|
3,601
|
|
|
$
|
2,785
|
|
|
$
|
9,747
|
|
|
$
|
9,402
|
|
Revenues
for the three months ended June 30, 2008 increased $816,000, or 29.3%, to
$3,601,000 from $2,785,000 reported for the three months ended June 30,
2007. Product revenues increased $906,000, or 41.7%, while service
revenues decreased by $90,000, or 14.7%.
The
product sales increase in the quarter-to-quarter comparison was due to increased
sales of high-end multi-service switches. A major network expansion
for an existing customer contributed $1,200,000 of the increase and alone
represented 39% of the total product sales in the current
quarter. This was partially offset by reduced sales ($308,000) for a
network transport system application to an integrator in Europe which had a
large network rollout in the prior year.
Sales of
the multi-service switch product line constituted 67% of product sales, while
the network access product line, which stayed about level in the quarter,
constituted 33% of product sales.
The
decrease in service revenues in the quarter was due primarily to a specific
foreign contract for a one-time project in the prior year that did not repeat
itself in the current quarter.
Revenues
for the nine months ended June 30, 2008 increased $345,000 or 3.6%, to
$9,747,000 from $9,402,000 reported for the six months ended June 30,
2007. Product revenues increased $527,000, or 6.9%, while service
revenues decreased by $182,000, or 10.2%.
Sales of
high-end multi-service switches increased approximately $600,000, primarily due
to expansion of networks of existing customers. Furthermore, the
Company realized increased sales of $227,000 from its line of security software
products. These increases were offset by a reduction of approximately
$500,000 resulting from continued net declines in sales of network access
products to large telecommunications carriers and to integrators for specific
projects.
In the
nine months ended June 30, 2008, the multi-service switch product line
constituted 58% of product sales while the network access and security product
lines constituted 42% of product sales. Furthermore, the largest two
customers represented 36% of product revenue and the largest six customers
represented 71% of product revenue, reflecting a high concentration of business
in a limited number of customers.
The
decrease in service revenues was due primarily to a one-time project in the
prior year that did not repeat, offset in part by support services sold along
with security software products.
Foreign
sales accounted for 31% and 44% of revenue for the nine months ended June 30,
2008 and 2007, respectively.
The
Company anticipates that demand for its legacy network access products will
continue to decline and due to the “Risk Factors” mentioned below, there can be
no assurance that orders for new products and products with enhanced features
will increase to offset this decline. Accordingly, the ability to
forecast future revenue trends in the current environment is
difficult.
Gross
Margin
|
|
Three Months Ended June 30,
|
|
|
Nine Months Ended June 30,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
1,623
|
|
|
$
|
1,464
|
|
|
$
|
4,349
|
|
|
$
|
4,761
|
|
Service
|
|
|
182
|
|
|
|
377
|
|
|
|
401
|
|
|
|
1,115
|
|
Total
Gross Margin
|
|
$
|
1,805
|
|
|
$
|
1,841
|
|
|
$
|
4,750
|
|
|
$
|
5,876
|
|
Percentage
of Product Revenues
|
|
|
52.7
|
%
|
|
|
67.4
|
%
|
|
|
53.3
|
%
|
|
|
62.4
|
%
|
Percentage
of Service Revenues
|
|
|
34.8
|
%
|
|
|
61.5
|
%
|
|
|
25.2
|
%
|
|
|
62.8
|
%
|
Percentage
of Total Revenues
|
|
|
50.1
|
%
|
|
|
66.1
|
%
|
|
|
48.7
|
%
|
|
|
62.5
|
%
|
Gross
margin, as a percentage of revenues in the three months ended June 30, 2008, was
50.1% as compared to 66.1% in the three months ended June 30, 2007, a decrease
of 16.0%.
Product
gross margin, as a percentage of product revenues, decreased
14.7%. This decrease was due to a reduction of the favorable impact
in the prior year of selling inventories previously written down
(-21.2%). Offsetting this reduction is the Company’s successful
procurement of components at reduced prices (+4.7%) and other net items
contributed 1.2%.
Service
gross margin, as a percentage of revenues, declined 26.7%. In the
prior quarter ended December 31, 2007, the Company started a new business
venture in Texas to target sub-contract service work from major
telecommunication providers. The cost of this venture, with limited
revenue, reduced gross margin by 24.9%. The balance of the reduction
(-1.8%) resulted from compensation and other cost increases.
Gross
margin, as a percentage of revenues in the nine months ended June 30, 2008, was
48.7% as compared to 62.5% in the nine months ended June 30, 2007, a decrease of
13.8%.
Product
gross margin, as a percentage of product revenues, decreased
9.1%. This decrease was due primarily to the favorable impact in the
prior year of selling inventories previously written down (-6.1%) and low margin
sales of security software products (-8.5%). Offsetting these
decreases was the successful procurement of components at reduced prices (+4.3%)
and other net items contributing 1.8%.
Service
gross margin, as a percentage of revenues declined 37.6%. This
decrease was due to the impact of start up costs for the Texas operation
(-20.3%), to additional strategic investments made in the area of professional
services (-9.9%), the results of the lower revenue (-7.6%) and other net
increases (+.02%).
In future
periods, the Company’s gross margin will vary depending upon a number of
factors, including the mix of products sold, the cost of products manufactured
at subcontract facilities, the channels of distribution, the price of products
sold, discounting practices, price competition, increases in material costs, the
costs of the service organization and changes in other components of cost of
sales. As and to the extent the Company introduces new products and
services, it is possible that such products and services may have lower gross
profit margins than other established products in higher volume production and
than traditional service offerings. Accordingly, gross margin as a
percentage of revenues is expected to vary.
Selling,
General and Administrative
|
|
Three Months Ended June 30,
|
|
|
Nine Months Ended June
30,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
$
|
1,778
|
|
|
$
|
1,493
5
|
|
|
$
|
4,929
|
|
|
$
|
4,253
|
|
Percentage
of revenues
|
|
|
49.4
|
%
|
|
|
53.6
|
%
|
|
|
50.6
|
%
|
|
|
45.2
|
%
|
The
Company’s selling, general and administrative expenses (“SG&A”) increased to
$1,778,000, or 49.4% of revenues in the three months ended June 30, 2008 from
$1,493,000, or 53.6% of revenues in the three months ended June 30,
2007. The increase in spending in the quarter of $285,000, or 19.1%
was a result of higher compensation costs of $129,000 due to new hires in the
sales force and salary increases, increased legal costs which were primarily
responsible for a $114,000 increase in professional fees, and result from an
increased level of litigation and higher travel costs of $55,000 mostly
involving European business. Other items were a net decrease of
$13,000.
For the
nine months ended June 30, 2008, SG&A expenses increased to $4,929,000, or
50.6% of revenues from $4,253,000, or 45.2% of revenues in the nine months ended
June 30, 2007. The increase in spending in the nine months of
$676,000, or 15.9%, was due primarily to higher compensation costs of $524,000
and increased legal costs of $221,000, offset by a gain of $108,000 resulting
from the favorable resolution of a property tax liability and other net
reductions of $24,000.
Research
and Product Development
|
|
Three Months Ended June 30,
|
|
|
Nine Months Ended June 30,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and product development
|
|
$
|
904
|
|
|
$
|
628
|
|
|
$
|
2,410
|
|
|
$
|
1,851
|
|
Percentage
of revenues
|
|
|
25.1
|
%
|
|
|
22.5
|
%
|
|
|
24.7
|
%
|
|
|
19.7
|
%
|
Research
and product development (“R&D”) expenses increased to $904,000, or 25.1% of
revenues in the three months ended June 30, 2008, as compared to $628,000, or
22.5% of revenues, in the three months ended June 30, 2007. The
increase of $276,000, or 43.9%, was due to additions to the staff and salary
adjustments which resulted in an increase in engineering compensation costs of
$215,000, an increase in the use of contract engineers of $65,000 and other net
decreases of $4,000. Both the additions to staff and the contract
engineers were required to accelerate the completion of critical and strategic
product development programs.
R & D
expenses increased to $2,410,000, or 24.7% of revenues, in the nine months ended
June 30, 2008, as compared to $1,851,000, or 19.7% of revenues, in the nine
months ended June 30, 2007. The increase of $559,000, or 30.2%, was
due to an increase in engineering compensation costs of $459,000 and an increase
in the use of contract engineers of $105,000, offset by other net decreases of
$5,000.
Interest
Expense
Interest
expense decreased to $699,000 in the three months ended June 30, 2008 from
$727,000 in the three months ended June 30, 2007. Interest expense
decreased to $2,213,000 in the nine months ended June 30, 2008 from $2,284,000
in the nine months ended June 30, 2007. The lower interest charges
resulted primarily from a reduction in debt levels due to a repurchase of
debentures in 2007 and lower variable interest rates in 2008.
Other
Income (Expense)
Other
income (expense) for the three months ended June 30, 2008 and 2007 totaled
$11,000 and $161,000, respectively. The 2008 quarterly amount
includes $19,000 received from a tradename license, $20,000 in realized foreign
exchange losses and $12,000 in other net income items. The 2007
quarterly amount includes $101,000 resulting from settlement of a Canadian sales
tax audit, $21,000 from a settlement with a component supplier, $12,000 from a
tradename license, and $27,000 of other net items.
Other
income (expense) for the nine months ended June 30, 2008 and 2007 totaled
$4,008,000 and $4,327,000, respectively. The 2008 amount includes
$3,891,000 from the gain on the sale of patents, $45,000 received from a
tradename license and $100,000 from a negotiated professional fee reduction,
offset by $28,000 in other net losses. The 2007 amount includes
$4,062,000 from restructuring of debt, $101,000 resulting from settlement of a
Canadian sales tax audit, $62,000 received from a tradename license, $46,000 in
sales of components no longer used, $21,000 from a settlement with a component
supplier and $35,000 of other net items.
Provision
for Income Taxes
Income
tax provisions for each of the three and nine months ended June 30, 2008 and
2007 reflect current state tax provisions only. No federal income tax
provisions were provided in the three and nine months ended June 30, 2008 and
2007 due to the valuation allowance provided against deferred tax assets and to
the utilization of net operating loss carryforwards in 2007. The
Company established a full valuation allowance against its net deferred tax
assets due to the uncertainty of realization of benefits of the net operating
loss carryforwards from prior years and the operating losses in fiscal
2008. The Company has federal tax credit and net operating loss
carryforwards of approximately $11.9 million and $214.3 million, respectively,
as of September 30, 2007.
Liquidity
and Capital Resources
|
|
June 30,
|
|
|
September
30,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
152
|
|
|
$
|
1,296
|
|
Working
capital (deficit)
|
|
|
(30,649
|
)
|
|
|
(2,798
|
)
|
Total
assets
|
|
|
10,138
|
|
|
|
10,136
|
|
Long-term
debt, including current portion
|
|
|
26,368
|
|
|
|
26,308
|
|
Total
liabilities
|
|
|
42,333
|
|
|
|
41,868
|
|
|
|
Nine Months Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in):
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
(4,828
|
)
|
|
$
|
790
|
|
Investing
activities
|
|
|
3,634
|
|
|
|
(10
|
)
|
Financing
activities
|
|
|
50
|
|
|
|
(504
|
)
|
Note: Significant
risk factors exist due to the Company’s limited financial resources and its
present inability to repay its debentures which mature on October 1,
2008. See “Risk Factors” below for further
discussion.
Cash
Flows
Net cash
used in operating activities totaled $4,828,000 in the nine months ended June
30, 2008. The net loss in the period was
$802,000. Included in this net loss were a net gain of $3,891,000
related to the sale of patents and non-cash expenses for depreciation and
amortization of $227,000 and stock compensation expense of
$177,000. A net increase of accrued interest resulted from additional
interest charges of $1,978,000 reduced by interest payments to related parties
of $458,000, and to others of $425,000. An increase in accounts
receivable due to a large collection that occurred at the end of the fiscal year
and did not repeat itself resulted in a use of cash of
$980,000. Other net uses of cash included a reduction in accounts
payable and accrued expenses of $255,000 due to payments made to professionals,
suppliers and others, annual cash payments of pre-petition tax claims of
$178,000, property tax payments of $189,000 and favorable resolution of a
property tax liability of $108,000. Other sources of cash totaled
$76,000.
Net cash
provided by operating activities totaled $790,000 in the nine months ended June
30, 2007. The net income in the period was
$1,815,000. Included in this net income were a non-cash gain of
$4,062,000 resulting from an amendment of the Company’s senior loan agreement,
and non-cash expenses for depreciation and amortization of $275,000 and stock
compensation expense of $209,000. A decrease in accounts receivable
due to customer collections being higher than new sales levels resulted in a
source of cash of $1,056,000. Inventories were higher and resulted in
a use of cash of $377,000 as the Company was preparing to ship a large
international order. Unpaid interest which accrued on the
Company’s debt increased $1,667,000 as a source of cash. The Company
received the proceeds of a prior year legal settlement ($213,000), a final
settlement of claims in a subsidiary liquidation ($137,000) and a final
settlement of a Canadian sales tax audit ($101,000). The Company paid
the third of six installments of prior year tax claims in the amount of
$223,000. All other changes net to a use of funds of
$21,000.
Net cash
provided by investing activities in the nine months ended June 30, 2008 was
$3,634,000 and net cash used by investing activities was $10,000 in
2007. The 2008 nine month period included net proceeds from the sale
of patents of $3,891,000.
Net cash
provided by financing activities in the nine months ended June 30, 2008 was
$50,000. Proceeds from notes payable of $226,000 and proceeds of
notes payable to related parties of $375,000 were offset by payments on notes to
related parties of $395,000 and payments of notes payable of
$156,000.
Cash used
in financing activities in the nine months ended June 30, 2007 of $504,000 is
comprised of payments on notes payable of $152,000 and on secured debt of
$844,000, offset in part by proceeds from notes payable to related parties of
$270,000 and proceeds from notes payable of $222,000.
Liquidity
The Company incurred a net
loss and used a significant amount of cash in its operating activities for
the nine months ended June 30, 2008.
The Company has no current ability
to borrow additional funds. It must, therefore, fund operations from
cash balances, cash generated from operating activities and any cash that may be
generated from the sale of non-core assets such as real estate and
others. As discussed in the “Risk Factors” section that follows, at
June 30, 2008 the Company has outstanding $19.5 million of debentures and
accrued interest thereon of $9.3 million which mature on October 1,
2008.
The
liquidity risks described above, raise substantial doubt about the Company’s
ability to continue as a going concern.
Management
has responded to its liquidity and cash flow risks in 2007 by replacing its
senior debt with mortgage debt on more favorable terms. Such mortgage
financing requires payments of interest (only) and contains no financial
covenants. In addition, management has implemented operational
changes: reducing certain salaries, restructuring the sales force,
increasing factory and office shutdown time, constraining expenses, and reducing
and reallocating the employee workforce. The Company also continues
to pursue the sale or lease of its headquarters land and building in Naugatuck,
CT. Furthermore, on February 5, 2008 the Company completed the sale
of certain patents for proceeds of $4,000,000 and received a royalty-free
license to continue to use the patented technologies in its
products.
Critical
Accounting Policies
The
Company’s financial statements and accompanying notes are prepared in accordance
with generally accepted accounting principles in the United States, the
instructions to Form 10-Q and Article 8 of Regulation S-X. Preparing
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and
expenses. Management bases its estimates and judgements on historical
experience and on various other factors that are believed to be reasonable under
the circumstances. Due to the inherent uncertainty involved in making
estimates, actual results reported in future periods might be based upon amounts
that differ from those estimates. The following represent what the
Company believes are among the critical accounting policies most affected by
significant management estimates and judgements. See Note 2 in Notes
to Consolidated Financial Statements in Item 7 in Form 10-KSB for the year ended
September 30, 2007 as filed with the Securities and Exchange Commission for a
summary of the Company’s significant accounting policies.
Revenue
Recognition
. The Company recognizes a sale when the product is
shipped and the following four criteria are met upon shipment: (1)
persuasive evidence of an arrangement exists; (2) title and risk of loss
transfers to the customer; (3) the selling price is fixed or determinable; and
(4) collectibility is reasonably assured. A reserve for future
product returns is established at the time of the sale based on historical
return rates and return policies including stock rotation for sales to
distributors that stock the Company’s products. Service revenue is
recognized either when the service is performed or, in the case of maintenance
contracts, on a straight-line basis over the term of the contract.
Warranty Reserves.
The
Company offers warranties of various lengths to its customers depending on the
specific product and the terms of its customer purchase
agreements. Standard warranties require the Company to repair or
replace defective product returned during the warranty period at no cost to the
customer. An estimate for warranty related costs is recorded based on
actual historical return rates and repair costs at the time of
sale. On an on-going basis, management reviews these estimates
against actual expenses and makes adjustments when necessary. While
warranty costs have historically been within expectations of the provision
established, there is no guarantee that the Company will continue to experience
the same warranty return rates or repair costs as in the past. A
significant increase in product return rates or the costs to repair our products
would have a material adverse impact on the Company’s operating
results.
Allowance for Doubtful
Accounts.
The Company estimates losses resulting from the
inability of its customers to make payments for amounts billed. The
collectability of outstanding invoices is continually
assessed. Assumptions are made regarding the customers ability and
intent to pay, and are based on historical trends, general economic conditions
and current customer data. Should our actual experience with respect
to collections differ from these assessments, there could be adjustments to our
allowance for doubtful accounts.
Inventories
. The
Company values inventory at the lower of cost or market. Cost is
computed using standard cost, which approximates actual cost on a first-in,
first-out basis. Agreements with certain customers provide for return
rights. The Company is able to reasonably estimate these returns and
they are accrued for at the time of shipment. Inventory quantities on
hand are reviewed on a quarterly basis and a provision for excess and obsolete
inventory is recorded based primarily on product demand for the
preceding twelve months. Historical product demand may prove to be an
inaccurate indicator of future demand in which case the Company may increase or
decrease the provision required for excess and obsolete inventory in future
periods. Furthermore, if the Company is able to sell inventory in the
future that has been previously written down or off, such sales will result in
higher than normal gross margin.
Deferred Tax
Assets.
The Company has provided a full valuation allowance
related to its deferred tax assets. In the future, if sufficient
evidence of the Company’s ability to generate sufficient future taxable income
in certain tax jurisdictions becomes apparent, the Company will be required to
reduce its valuation allowances, resulting in income tax benefits in the
Company’s consolidated statement of operations. Management evaluates
the realizability of the deferred tax assets and assesses the need for the
valuation allowance each period.
Impairment of Long-Lived
Assets
. The Company assesses the impairment of long-lived
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable under the guidance prescribed by SFAS No.
144. The Company's long-lived assets consist of real estate, property
and equipment. At both June 30, 2008 and September 30, 2007, real
estate represented the only significant remaining long-lived asset that has not
been fully written down for impairment.
Recent
Accounting Pronouncements
On
October 1, 2007, the Company adopted the provisions of FASB Interpretation No.
48 (“FIN 48”),
“Accounting for
Uncertainty in Income Taxes,”
which clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with FASB Statement No. 109,
“
Accounting for Income Taxes”
.
FIN 48 provides guidance
on the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures, and transition. Prior to implementation
of FIN 48, the Company had a liability for unrecognized foreign and state tax
benefits amounting to $313,000 provided in its balance sheet, all of which, if
recognized, would affect the Company’s effective tax
rate. . In adopting FIN 48, the liability for unrecognized
tax benefits was reduced by $180,000 and interest and penalties as of September
30, 2007 aggregating $30,000 related to unrecognized tax
benefits were accrued, resulting in a net reduction of $150,000 to
the accumulated deficit at October 1, 2007. The Company files a consolidated
federal income tax return with its subsidiaries. In addition, the Company and/or
its subsidiaries file in various states and foreign
jurisdictions. The Company is no longer subject to examinations by
taxing authorities for fiscal years before September 30, 2004. The
Company classifies interest and penalties as selling, general and administrative
expenses. Interest and penalties recognized in the three and nine
months ended June 30, 2008 amounted to approximately $1,000 and $3,100,
respectively, and accrued interest and penalties included in the balance sheet
at June 30, 2008 amounted to approximately $153,100.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157,
“Fair Value
Measurements”
. SFAS No. 157 defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair
value. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of
this standard on the consolidated financial statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 159,
“The Fair
Value Option for Financial Assets and Financial
Liabilities”
, SFAS No. 159 provides an option to report
selected financial assets and financial liabilities using fair
value. The standard establishes required presentation and disclosures
to facilitate comparisons with companies that use different measurements for
similar assets and liabilities. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007, with early adoption allowed only if
SFAS No. 157 is also adopted. The Company is currently evaluating the
impact of this standard on the consolidated financial statements.
RISK FACTORS
GDC
Negative Operating History Since Emerging from Bankruptcy.
The Company
emerged from Bankruptcy on September 15, 2003. The Company had voluntarily filed
for protection under Chapter 11 of the US Bankruptcy Code on November 2, 2001,
after incurring seven consecutive years of losses and selling three of its four
operating divisions in 2001. Accordingly, an investor in the Company’s
common stock must evaluate the risks, uncertainties, and difficulties frequently
encountered by a company emerging from Chapter 11 and that operates in rapidly
evolving markets such as the telecommunications equipment
industry.
Due to
the Company’s limited and negative operating history and poor performance since
emergence, the Company may not successfully implement any of its strategies or
successfully address these risks and uncertainties. As described by the
following factors, past financial performance should not be considered to be a
reliable indicator of future performance, and investors should not use
historical trends to anticipate results or trends in future
periods.
Potential
Default on Debentures.
At June 30, 2008, the Company has
outstanding debentures in the principal amount of $19.5 million, together with
accrued interest thereon of $9.3 million, which mature on October 1,
2008. While a subordinated security agreement signed by the indenture
trustee on behalf of the debenture holders provides that no payments may be made
to debenture holders while senior secured debt, including debt owed to Mr.
Modlin and Mr. Segall (Chairman and Chief Executive Officer, and Director,
respectively), is outstanding, in the absence of such payment restrictions the
Company does not presently have the ability to repay the
debentures. A failure to pay the debentures when they become due and
payable as described above, could result in an event of default being declared
under the indenture governing the debentures. Together with the
other conditions described in the Liquidity section above, such condition
raises substantial doubt about the Company’s ability to continue as a going
concern.
Dependence
on Legacy and Recently Introduced Products and New Product Development.
The Company’s future results of operations are dependent on market
acceptance of existing and future applications for the Company’s current
products and new products in development. Sales of the Company’s legacy
products, primarily the digital service unit and V.34 lines, declined to
approximately 30% of product sales in fiscal 2007 from 44% in fiscal 2006. The
Company anticipates that net sales from legacy products will decline over the
next several years and net sales of new products will increase at the same time,
with significant quarterly fluctuations possible, and without assurance that
sales of new products will increase at the same time.
Market
acceptance of the Company’s recently introduced and future product lines is
dependent on a number of factors, not all of which are in the Company’s control,
including the continued growth in the use of bandwidth intensive applications,
continued deployment of new telecommunication services, market acceptance of
multiservice access devices, the availability and price of competing products
and technologies, and the success of the Company’s sales and marketing efforts.
Failure of the Company’s products to achieve market acceptance would have a
material adverse effect on the Company’s business, financial condition and
results of operations. Failure to introduce new products in a timely manner in
order to replace sales of legacy products could cause customers to purchase
products from competitors and have a material adverse effect on the Company’s
business, financial condition and results of operations.
New
products under development may require additional development work, enhancement
and testing or further refinement before the Company can make them commercially
available. The Company has in the past experienced delays in the introduction of
new products, product applications and enhancements due to a variety of internal
factors, such as reallocation of priorities, financial constraints, difficulty
in hiring sufficient qualified personnel, and unforeseen technical obstacles, as
well as changes in customer requirements. Such delays have deferred the receipt
of revenue from the products involved. If the Company’s products have
performance, reliability or quality shortcomings, then the Company may
experience reduced
orders, higher
manufacturing costs, delays in collecting accounts receivable, and additional
warranty and service expenses.
Customer
Concentration.
The Company’s customers include the former Regional Bell
Operating Companies, long distance service providers, wireless service
providers, and resellers who sell to these customers. The market for the
services provided by the majority of these service providers has been influenced
largely by the passage and interpretation of the Telecommunications Act of 1996
(the “1996 Act”). Service providers require substantial capital for the
development, construction, and expansion of their networks and the introduction
of their services. The ability of service providers to fund such
expenditures often depends on their ability to budget or obtain sufficient
capital resources. In the past, resources made available by
these customers for capital acquisitions have declined, particularly due to
recent negative market conditions in the United States. If the Company’s
current or potential service provider customers cannot successfully raise the
necessary funds, or if they experience any other adverse effects with respect to
their operating results or profitability, their capital spending programs may be
adversely impacted which could materially adversely affect the Company’s
business, financial condition and results of operations.
A small number of customers have
historically accounted for a majority of the Company’s sales. Sales
to the Company’s top five customers accounted for approximately 67% and 45% of
revenues in fiscal 2007 and 2006, respectively, and one customer accounted for
approximately 30% of revenues in fiscal 2007. There can be no
assurance that the Company’s current customers will continue to place orders
with the Company, that orders by existing customers will continue at the levels
of previous periods, or that the Company will be able to obtain orders from new
customers. The Company expects the economic climate and conditions in the
telecommunication equipment industry to remain unpredictable in fiscal 2008, and
possibly beyond. The loss of one or more service provider customers, such as
occurred during past years through industry consolidation or otherwise, could
have a material adverse effect on our sales and operating results. A bankruptcy
filing by one or more of the Company’s major customers could materially
adversely affect the Company’s business, financial condition and results of
operations
.
Dependence
on Key Personnel.
The Company’s future success will depend to a large
extent on the continued contributions of its executive officers and key
management, sales, and technical personnel. Each of the Company’s executive
officers, and key management, sales and technical personnel would be difficult
to replace. The Company does not have employment contracts with its key
employees. The Company implemented significant cost and staff reductions in
recent years, which may make it more difficult to attract and retain key
personnel. The loss of the services of one or more of the Company’s executive
officers or key personnel, or the inability to attract qualified personnel,
could delay product development cycles or otherwise could have a material
adverse effect on the Company’s business, financial condition and results of
operations.
Dependence
on Key Suppliers and Component Availability.
The Company generally relies
upon several contract manufacturers to assemble finished and semi-finished
goods. The Company’s products use certain components, such as microprocessors,
memory chips and pre-formed enclosures that are acquired or available from one
or a limited number of sources. Component parts that are incorporated
into board assemblies are sourced directly by the Company from
suppliers. The Company has generally been able to procure adequate
supplies of these components in a timely manner from existing
sources.
In
December 2007, a sole supplier of a proprietary component critical to one of the
Company’s products announced the discontinuation of the component and rejected
previously accepted orders that had been placed for the component by the
Company. The Company believes that it has a plan in place to allow
for a transition to a new component without a disruption in customer
deliveries. However, the Company has incurred and expects to further
incur increased product development costs by reason of such transition
plans. In the event that the Company is unable to transition to
the new component in time to meet its customer requirements and/or is
unable to generate the liquidity required to pay the increased costs, such
events could have a material adverse effect on the Company’s business, financial
condition and results of operations.
While
most other components are standard items, certain application-specific
integrated circuit chips used in many of the Company’s products are customized
to the Company’s specifications. Except for the sole supplier noted above, none
of the suppliers of components operate under contract. Additionally,
availability of some standard components may be affected by market shortages and
allocations. The Company’s inability to obtain a sufficient quantity
of components when required, or to develop alternative sources due to lack of
availability or degradation of quality, at acceptable prices and within a
reasonable time, could result in delays or reductions in product shipments which
could materially affect the Company’s operating results in any given
period. In addition, as referenced above the Company relies heavily
on outsourcing subcontractors for production. The inability of such
subcontractors to deliver products in a timely fashion or in accordance with the
Company’s quality standards could materially adversely affect the Company’s
operating results and business.
The
Company uses internal forecasts to manage its general finished goods and
components requirements. Lead times for materials and components may vary
significantly, and depend on factors such as specific supplier performance,
contract terms, and general market demand for components. If orders vary from
forecasts, the Company may experience excess or inadequate inventory of certain
materials and components, and suppliers may demand longer lead times and higher
prices. From time to time, the Company has experienced shortages and allocations
of certain components, resulting in delays in fulfillment of customer orders.
Such shortages and allocations may occur in the future, and could have a
material adverse effect on the Company’s business, financial condition and
results of operations.
Fluctuations
in Quarterly Operating Results.
The Company’s sales are subject to
quarterly and annual fluctuations due to a number of factors resulting in more
variability and less predictability in the Company’s quarter-to-quarter sales
and operating results. As a small number of customers have historically
accounted for a majority of the Company’s sales, order volatility by any of
these major customers has had and may have an impact on the Company in the
prior, current and future fiscal years.
Most of
the Company’s sales require short delivery times. The Company’s ability to
affect and judge the timing of individual customer orders is limited. Large
fluctuations in sales from quarter-to-quarter could be due to a wide variety of
factors, such as delay, cancellation or acceleration of customer projects, and
other factors discussed below. The Company’s sales for a given quarter may
depend to a significant degree upon planned product shipments to a single
customer, often related to specific equipment or service deployment projects.
The Company has experienced both acceleration and slowdown in orders related to
such projects, causing changes in the sales level of a given quarter relative to
both the preceding and subsequent quarters.
Delays or
lost sales can be caused by other factors beyond the Company’s control,
including late deliveries by the third party subcontractors the Company is using
to outsource its manufacturing operations and by vendors of components used in a
customer’s products, slower than anticipated growth in demand for the Company’s
products for specific projects or delays in implementation of projects by
customers and delays in obtaining regulatory approvals for new services and
products. Delays and lost sales have occurred in the past and may occur in the
future. The Company believes that sales in the past have been adversely impacted
by merger and restructuring activities by some of its top customers. These and
similar delays or lost sales could materially adversely affect the Company’s
business, financial condition and results of operations
.
See “Customer Concentration”
and “Dependence on Key Suppliers and Component Availability”.
The
Company’s backlog at the beginning of each quarter typically is not sufficient
to achieve expected sales for that quarter. To achieve its sales objectives, the
Company is dependent upon obtaining orders in a quarter for shipment in that
quarter. Furthermore, the Company’s agreements with certain of its customers
typically provide that they may change delivery schedules and cancel orders
within specified timeframes, typically up to 30 days prior to the scheduled
shipment date, without significant penalty. Some of the Company’s customers have
in the past built, and may in the future build, significant inventory in order
to facilitate more rapid deployment of anticipated major projects or for other
reasons. Decisions by such customers to reduce their inventory levels could lead
to reductions in purchases from the Company in certain periods. These
reductions, in turn, could cause fluctuations in the Company’s operating results
and could have an adverse effect on the Company’s business, financial condition
and results of operations in the periods in which the inventory is
reduced.
Operating
results may also fluctuate due to a variety of factors, including market
acceptance of the Company’s new lines of products, delays in new product
introductions by the Company, market acceptance of new products and feature
enhancements introduced by the Company, changes in the mix of products and or
customers, the gain or loss of a significant customer, competitive price
pressures, changes in expenses related to operations, research and development
and marketing associated with existing and new products, and the general
condition of the economy.
All of
the above factors are difficult for the Company to forecast, and these or other
factors can materially and adversely affect the Company’s business, financial
condition and results of operations for one quarter or a series of quarters. The
Company’s expense levels are based in part on its expectations regarding future
sales and are fixed in the short term to a certain extent. Therefore, the
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected shortfall in sales. Any significant decline in demand relative to
the Company’s expectations or any material delay of customer orders could have
a
material adverse effect on the
Company’s business, financial condition, and results of operations
. There
can be no assurance that the Company will be able to sustain profitability on a
quarterly or annual basis. In addition, the Company has had, and in some future
quarter may have operating results below the expectations of public market
analysts and investors. In
such event, the price of
the Company’s common stock would likely be materially and adversely affected.
See “Potential Volatility of Stock Price”.
Competition.
The
markets for telecommunications network access and multi-service equipment
addressed by the Company’s products can be characterized as highly
competitive, with intensive equipment price pressure. These markets are subject
to rapid technological change, wide-ranging regulatory requirements, the
entrance of low cost manufacturers and the presence of formidable competitors
that have greater name recognition and financial resources. Certain technology
such as the V.34 and digital service units portion of the SpectraComm line are
not considered new and the market has experienced decline in recent
years.
Industry
consolidation could lead to competition with fewer, but stronger competitors. In
addition, advanced termination products are emerging, which represent both new
market opportunities, as well as a threat to the Company’s current products.
Furthermore, basic line termination functions are increasingly being integrated
by competitors, such as Cisco, Alcatel/Lucent, and Nortel Networks, into other
equipment such as routers and switches. To the extent that current or potential
competitors can expand their current offerings to include products that have
functionality similar to the Company’s products and planned products, the
Company’s business, financial condition and results of operations could be
materially adversely affected. Many of the Company’s current and
potential competitors have substantially greater technical, financial,
manufacturing and marketing resources than the Company. In addition, many of the
Company’s competitors have long-established relationships with network service
providers. There can be no assurance that the Company will have the financial
resources, technical expertise, manufacturing, marketing, distribution and
support capabilities to compete successfully in the future.
Rapid Technological
Change.
The network access
and telecommunications equipment markets are characterized by rapidly changing
technologies and frequent new product introductions. The rapid development of
new technologies increases the risk that current or new competitors could
develop products that would reduce the competitiveness of the Company’s
products. The Company’s success will depend to a substantial degree upon its
ability to respond to changes in technology and customer requirements. This will
require the timely selection, development and marketing of new products and
enhancements on a cost-effective basis. The development of new, technologically
advanced products is a complex and uncertain process, requiring high levels of
innovation. The Company may need to supplement its internal expertise and
resources with specialized expertise or intellectual property from third parties
to develop new products.
Furthermore,
the communications industry is characterized by the need to design products that
meet industry standards for safety, emissions and network interconnection. With
new and emerging technologies and service offerings from network service
providers, such standards are often changing or unavailable. As a result, there
is a potential for product development delays due to the need for compliance
with new or modified standards. The introduction of new and enhanced products
also requires that the Company manage transitions from older products in order
to minimize disruptions in customer orders, avoid excess inventory of old
products and ensure that adequate supplies of new products can be delivered to
meet customer orders. There can be no assurance that the Company will be
successful in developing, introducing or managing the transition to new or
enhanced products, or that any such products will be responsive to technological
changes or will gain market acceptance. The Company’s business, financial
condition and results of operations would be materially adversely affected if
the Company were to be unsuccessful, or to incur significant delays in
developing and introducing such new products or enhancements. See “Dependence on
Legacy and Recently Introduced Products and New Product
Development”.
Compliance with Regulations
and Evolving Industry Standards.
The market for the Company’s products is
characterized by the need to meet a significant number of communications
regulations and standards, some of which are evolving as new technologies are
deployed. In the United States, the Company’s products must comply with various
regulations defined by the Federal Communications Commission and standards
established by Underwriters Laboratories and Bell Communications Research and
certain new products introduced, for example in the SpectraComm line, will need
to be NEBS Certified. As standards continue to evolve, the Company will be
required to modify its products or develop and support new versions of its
products. The failure of the Company’s products to comply, or delays in
compliance, with the various existing and evolving industry standards, could
delay introduction of the Company’s products, which could have a material
adverse effect on the Company’s business, financial condition and results of
operations.
GDC
Will Require Additional Funding to Sustain Operations.
The Company
emerged from Chapter 11 bankruptcy on September 15, 2003. Under the plan of
reorganization, the Company was to pay all creditors 100% of their allowed
claims based upon a five year business plan. However, the company has not met
its business plan objectives since emerging from Chapter 11. The
ability to meet the objectives of this business plan is directly affected by the
factors described in this “Risk Factors” section. The Company cannot assure
investors that it will be able to obtain new customers or to generate the
increased revenues required to meet our business plan objectives. In addition,
in order to execute the business plan, the Company may need to seek additional
funding through public or private equity offerings, debt financings or
commercial partners. The Company cannot assure investors that it will obtain
funding on acceptable terms, if at all. If the Company is unable to generate
sufficient revenues or access capital on acceptable terms, it may be required to
(a) obtain funds on unfavorable terms that may require the Company to relinquish
rights to certain of our technologies or that would significantly dilute our
stockholders and/or (b) significantly scale back current operations. Either of
these two possibilities would have a material adverse effect on the Company’s
business, financial condition and results of operations.
Risks
Associated with Entry into International Markets
. The Company
has limited experience in international markets with the exception of a few
direct customers and resellers/integrators and sales into Western Europe through
its France subsidiary, which was acquired by the Company on June 30,
2005. The Company intends to expand sales of its products outside of
North America and to enter certain international markets, which will require
significant management attention and financial resources. Conducting
business outside of North America is subject to certain risks, including longer
payment cycles, unexpected changes in regulatory requirements and tariffs,
difficulty in supporting foreign customers, greater difficulty in accounts
receivable collection and potentially adverse tax consequences. To
the extent any Company sales are denominated in foreign currency, the Company’s
sales and results of operations may also be directly affected by fluctuation in
foreign currency exchange rates. In order to sell its products
internationally, the Company must meet standards established by
telecommunications authorities in various countries. A delay in
obtaining, or the failure to obtain, certification of its products in countries
outside the United States, could delay or preclude the Company’s marketing and
sales efforts in such countries, which could have a material adverse effect on
the Company’s business, financial condition and results of
operations.
Risk of Third Party Claims of
Infringement.
The network access and telecommunications equipment
industries are characterized by the existence of a large number of patents and
frequent litigation based on allegations of patent infringement. From time to
time, third parties may assert exclusive patent, copyright, trademark and other
intellectual property rights to technologies that are important to the Company.
The Company has not conducted a formal patent search relating to the technology
used in its products, due in part to the high cost and limited benefits of a
formal search. In addition, since patent applications in the United States are
not publicly disclosed until the related patent is issued and foreign patent
applications generally are not publicly disclosed for at least a portion of the
time that they are pending, applications may have been filed which, if issued as
patents, could relate to the Company’s products. Software comprises a
substantial portion of the technology in the Company’s products. The scope of
protection accorded to patents covering software-related inventions is evolving
and is subject to a degree of uncertainty which may increase the risk and cost
to the Company if the Company discovers third party patents related to its
software products or if such patents are asserted against the Company in the
future.
The
Company may receive communications from third parties asserting that the
Company’s products infringe or may infringe the proprietary rights of third
parties. In its distribution agreements, the Company typically agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In the
event of litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company’s
technical and management personnel from productive tasks. In the event of an
adverse ruling in such litigation, the Company might be required to discontinue
the use and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses from third parties. There can be no
assurance that licenses from third parties would be available on acceptable
terms, if at all. In the event of a successful claim against the Company and the
failure of the Company to develop or license a substitute technology, the
Company’s business, financial condition, and results of operations could be
materially adversely affected.
Limited Protection of
Intellectual Property.
The Company relies upon a combination of patent,
trade secret, copyright, and trademark laws and contractual restrictions to
establish and protect proprietary rights in its products and technologies. The
Company has been issued certain U.S., Canadian and European technology
patents. Most of these patents were sold in February 2008 and the
Company retained a royalty-free right to continue to use the patent
technologies. There can be no assurance that third parties have
not or will not develop equivalent technologies or products without infringing
the Company’s patents and licensed patents or that a court having jurisdiction
over a dispute involving such patents would hold the Company’s patents and
licensed patents valid, enforceable and infringed. The Company also typically
enters into confidentiality and invention assignment agreements with its
employees and independent contractors, and non-disclosure agreements with its
suppliers, distributors and appropriate customers so as to limit access to and
disclosure of its proprietary information. There can be no assurance that these
statutory and contractual arrangements will deter misappropriation of the
Company’s technologies or discourage independent third-party development of
similar technologies. In the event such arrangements are insufficient, the
Company’s business, financial condition and results of operations could be
materially adversely affected. The laws of certain foreign countries in which
the Company’s products are or may be developed, manufactured or sold may not
protect the Company’s products or intellectual property rights to the same
extent as do the laws of the United States and thus, make the possibility of
misappropriation of the Company’s technology and products more likely.
Potential Volatility of Stock
Price.
The trading price of the Company’s common stock may be subject to
wide fluctuations in response to quarter-to-quarter variations in operating
results, announcements of technological innovations or new products by the
Company or its competitors, developments with respect to patents or proprietary
rights, general conditions in the telecommunication network access and equipment
industries, changes in earnings estimates by analysts, or other events or
factors. In addition, the stock market has experienced extreme price and volume
fluctuations, which have particularly affected the market prices of many
technology companies and which have often been unrelated to the operating
performance of such companies. Company-specific factors or broad market
fluctuations may materially adversely affect the market price of the Company’s
common stock. The Company has experienced significant fluctuations in its stock
price and share trading volume in the past and may continue to do
so.
The
Company is Controlled by a Small Number of Stockholders and Certain
Creditors
. In particular, Mr. Howard Modlin, Chairman of the
Board and Chief Executive Officer, and President of Weisman Celler Spett &
Modlin, P.C., legal counsel for the Company, owns approximately 71% of the
Company’s outstanding shares of Class B stock and has out of the money (above
market) stock options and warrants that would allow him to acquire approximately
57% of the Company’s common stock. Furthermore, Mr. Modlin is also
trustee for the benefit of the children of Mr. Charles P. Johnson, the former
Chairman of the Board and Chief Executive Officer, and such trust holds
approximately 12% of the outstanding shares of Class B stock. Class B
stock under certain circumstances has 10 votes per share in the election of
Directors. The Board of Directors is to consist of no less than three
and no more than thirteen directors, one of which was designated by the
Creditors Committee (and thereafter may be designated by the Debenture
Trustee). The holders of the 9% Preferred Stock are presently
entitled to designate two directors until all arrears on the dividends on such
9% Preferred Stock are paid in full. In the event of a payment
default under the Debentures which is not cured within 60 days after written
notice, the Debenture Trustee shall be entitled to select a majority of the
Board of Directors. Accordingly, in absence of a default under the
Debentures, Mr. Modlin may be able to elect all members of the Board of
Directors not designated by the holders of the 9% Preferred Stock and the
Debenture Trustee and determine the outcome of certain corporate actions
requiring stockholder approval, such as mergers and acquisitions of the
Company. This level of ownership by such persons and entities could
have the effect of making it more difficult for a third party to acquire, or
of
discouraging a
third party from attempting to acquire, control of the Company. Such
provisions could limit the price that certain investors might be willing to pay
in the future for shares of Company’s common stock, thereby making it less
likely that a stockholder will receive a premium in any
sales of
shares. To date, the holders of the 9% Preferred Stock have not
designated any directors.
ITEM
3. QUA
NTITA
TIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
The
Company is exposed to certain market risks, including foreign currency
fluctuations and interest rate fluctuations.
The
Company is exposed to foreign currency exchange risk primarily through
transactions denominated in foreign currencies. The vast majority of
the Company’s foreign transactions are denominated in U. S. dollars and,
therefore, an adverse change in foreign currency exchange rates is
not expected to have a direct material effect on the Company’s results of
operations, financial position or cash flows. However, there could be
a negative impact on future sales orders if, as a result of such a change in
foreign exchange rates, customers determined that the Company’s sales prices
were not competitive. The Company cannot quantify the impact on
orders or reduced margins thereon in the event customers object to such
prices.
The
Company is exposed to interest rate fluctuations on its variable rate,
LIBOR-based mortgage loan. A one-percent increase or decrease in
30-day LIBOR would result in an increase or decrease in interest expense of
$45,000 on an annualized basis.
ITEM
4. CO
NTR
OLS AND PROCEDURES
For the
period covered by this report, the Company carried out an evaluation, under the
supervision and with the participation of the Company’s management, including
the Company’s Chairman and Chief Executive Officer, and Vice President and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon that evaluation, the Company’s Chairman and Chief
Executive Officer, and Vice President and Chief Financial Officer, have
concluded that the Company’s disclosure controls and procedures are effective to
ensure the information required to be disclosed in reports filed or submitted
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms. There have been no significant changes in the
Company’s internal controls over financial reporting that occurred during the
period covered by this quarterly report on Form 10-Q that has materially
affected, or is reasonably likely to materially affect, the Company’s internal
control over financial reporting.
PART
II. OTHER INFORMATION
ITEM
3. DEF
AUL
TS UPON SENIOR SECURITIES
Payment
of dividends on the 9% Cumulative Convertible Exchangeable Preferred Stock were
suspended June 30, 2000. Such dividend arrearages total $14,075,928
as of June 30, 2008.
(a) Exhibits
Index:
Exhibit Number
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Description of Exhibit
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Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of 1934.
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Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
under the Securities Exchange Act of 1934
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Certification
of Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
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GENERAL
DATACOMM INDUSTRIES INC.
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August 14,
2008
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/s/ William G.
Henry
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William
G. Henry
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Vice
President, Finance and Administration
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Chief
Financial Officer
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