SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
quarterly period ended March 31, 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 0-8460
PORTA
SYSTEMS CORP.
(Exact
name of registrant as specified in its charter)
Delaware
|
11-2203988
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
incorporation
or organization)
|
Identification
No.)
|
6851
Jericho Turnpike, Suite 170, Syosset, New York 11791
(Address
of principal executive offices, including ZIP Code)
516-364-9300
(Company’s
telephone number, including area code)
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be
filed by
Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding
12
months
(or for such shorter period that the registrant was required to file such
reports),
and (2) has been subject to such filing requirements for the past 90
days
Yes
x
No
___
Indicate
by a check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, see definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of Exchange Act. Check
one:
Large
accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller
reporting company x
Indicate
by a check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes __No x
Indicate
the number of shares outstanding of each of the issuer’s classes of common stock
as of the latest practicable date:
Common
stock (par value $0.01) 10,053,617 shares as of May 9, 2008.
PART
I.- FINANCIAL INFORMATION
Item
1- Financial
Statements
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Consolidated
Balance Sheets
(In
thousands, except shares and par value)
|
|
Unaudited
|
|
|
|
|
|
March
31,
|
|
December
31,
|
|
|
|
2008
|
|
2007
|
|
Assets
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
315
|
|
$
|
494
|
|
Accounts
receivable - trade,
less
allowance for doubtful accounts of $25 in 2008 and $50 in
2007
|
|
|
5,462
|
|
|
5,098
|
|
Inventories
|
|
|
7,098
|
|
|
6,411
|
|
Prepaid
expenses and other current assets
|
|
|
503
|
|
|
203
|
|
Total
current assets
|
|
|
13,378
|
|
|
12,206
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
1,645
|
|
|
1,678
|
|
Goodwill
|
|
|
2,961
|
|
|
2,961
|
|
Other
assets
|
|
|
54
|
|
|
54
|
|
Total
assets
|
|
$
|
18,038
|
|
$
|
16,899
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Deficit
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Senior
debt
|
|
$
|
24,373
|
|
$
|
24,373
|
|
Subordinated
notes
|
|
|
6,144
|
|
|
6,144
|
|
6%
Convertible subordinated debentures
|
|
|
385
|
|
|
385
|
|
Accounts
payable
|
|
|
6,289
|
|
|
5,523
|
|
Accrued
expenses and other
|
|
|
2,855
|
|
|
2,447
|
|
Other
accrued interest payable
|
|
|
8,436
|
|
|
7,847
|
|
Total
current liabilities
|
|
|
48,482
|
|
|
46,719
|
|
|
|
|
|
|
|
|
|
Deferred
compensation and other long term liabilities
|
|
|
704
|
|
|
707
|
|
Total
liabilities
|
|
|
49,186
|
|
|
47,426
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
deficit:
|
|
|
|
|
|
|
|
Preferred
stock, no par value; authorized 1,000,000 shares, none
issued
|
|
|
-
|
|
|
-
|
|
Common
stock, par value $.01; authorized 20,000,000 shares, issued 10,084,557
shares in 2008 and 2007
|
|
|
101
|
|
|
101
|
|
Additional
paid-in capital
|
|
|
76,125
|
|
|
76,125
|
|
Accumulated
deficit
|
|
|
(100,994
|
)
|
|
(100,457
|
)
|
Accumulated
other comprehensive loss:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
(4,442
|
)
|
|
(4,358
|
)
|
|
|
|
(29,210
|
)
|
|
(28,589
|
)
|
Treasury
stock, at cost, 30,940 shares
|
|
|
(1,938
|
)
|
|
(1,938
|
)
|
Total
stockholders’ deficit
|
|
|
(31,148
|
)
|
|
(30,527
|
)
|
Total
liabilities and stockholders’ deficit
|
|
$
|
18,038
|
|
$
|
16,899
|
|
See
accompanying notes to unaudited consolidated financial
statements
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Operations and Comprehensive Income
(In
thousands, except per share amounts)
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
March
31,
|
|
|
|
2008
|
|
2007
|
|
Sales
|
|
$
|
6,545
|
|
$
|
8,202
|
|
Cost
of sales
|
|
|
4,708
|
|
|
5,582
|
|
Gross
profit
|
|
|
1,837
|
|
|
2,620
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
1,342
|
|
|
1,581
|
|
Research
and development expenses
|
|
|
424
|
|
|
373
|
|
Total
expenses
|
|
|
1,766
|
|
|
1,954
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
71
|
|
|
666
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(591
|
)
|
|
(440
|
)
|
Other
income (expense), net
|
|
|
8
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before income taxes
|
|
|
(512
|
)
|
|
225
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(25
|
)
|
|
(26
|
)
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
|
|
(537
|
)
|
|
199
|
|
|
|
|
|
|
|
|
|
Discontinued
operations:
|
|
|
|
|
|
|
|
Loss
from discontinued operations (net of taxes of zero)
|
|
|
--
|
|
|
(34
|
)
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(537
|
)
|
$
|
165
|
|
|
|
|
|
|
|
|
|
Other
comprehensive loss:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
(84
|
)
|
|
(73
|
)
|
|
|
|
|
|
|
|
|
Comprehensive
income (loss)
|
|
$
|
(621
|
)
|
$
|
92
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per share of common stock
|
|
$
|
(0.05
|
)
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,054
|
|
|
10,054
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per share of common stock
|
|
$
|
(0.05
|
)
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
10,054
|
|
|
10,054
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
Unaudited
Consolidated Statements of Cash Flows
(In
thousands)
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
March
31,
|
|
|
|
2008
|
|
2007
|
|
Cash
flows from operating activities of continuing operations:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(537
|
)
|
$
|
165
|
|
Loss
from discontinued operations
|
|
|
--
|
|
|
34
|
|
Adjustments
to reconcile net income (loss) to net cash
|
|
|
|
|
|
|
|
(used
in) operating activities of continuing operations:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
79
|
|
|
71
|
|
Inventory
reserves
|
|
|
(177
|
)
|
|
-
|
|
Allowance
for bad debt
|
|
|
(25
|
)
|
|
-
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(333
|
)
|
|
(1,738
|
)
|
Inventories
|
|
|
(514
|
)
|
|
(1,661
|
)
|
Prepaid
expenses and other current assets
|
|
|
(265
|
)
|
|
(23
|
)
|
Other
assets
|
|
|
(2
|
)
|
|
(9
|
)
|
Accounts
payable, accrued expenses and other liabilities
|
|
|
1,657
|
|
|
1,769
|
|
Net
cash used in by continuing operations
|
|
|
(117
|
)
|
|
(1,392
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures, net
|
|
|
(22
|
)
|
|
(144
|
)
|
Net
cash used in investing activities
|
|
|
(22
|
)
|
|
(144
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Increase
in debt
|
|
|
--
|
|
|
191
|
|
Repayments
of senior debt
|
|
|
--
|
|
|
(150
|
)
|
Net
cash provided by financing activities
|
|
|
--
|
|
|
41
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash
|
|
|
(40
|
)
|
|
(43
|
)
|
|
|
|
|
|
|
|
|
Decrease
in cash and cash equivalents
|
|
|
(179
|
)
|
|
(1,538
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - beginning of the year
|
|
|
494
|
|
|
2,102
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - end of the period
|
|
$
|
315
|
|
$
|
564
|
|
|
|
|
|
|
|
|
|
Supplemental
cash flow disclosure:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for interest expense
|
|
$
|
--
|
|
$
|
24
|
|
|
|
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
2
|
|
$
|
--
|
|
|
|
|
|
|
|
|
|
Schedule
of noncash transactions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition
of leased equipment
|
|
$
|
34
|
|
$
|
--
|
|
See
accompanying notes to unaudited consolidated financial statements.
PORTA
SYSTEMS CORP. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note
1: |
Management’s
Responsibility For Interim Financial Statements Including All
Adjustments
Necessary For Fair
Presentation
|
Management
acknowledges its responsibility for the preparation of the accompanying interim
consolidated financial statements which reflect all adjustments, consisting
of
normal recurring adjustments, considered necessary in its opinion for a fair
statement of its consolidated financial position and the results of its
operations for the interim period presented. These consolidated financial
statements should be read in conjunction with the summary of significant
accounting policies and notes to consolidated financial statements included
in
the Company’s Form 10-K annual report for the year ended December 31, 2007.
These financial statements have been prepared assuming that the Company will
continue as a going concern and, accordingly, do not include any adjustments
that might result from the outcome of the uncertainties described within. The
audit opinion included in the December 31, 2007 Form 10-K annual report
contained an explanatory paragraph regarding the Company’s ability to continue
as a going concern. The factors which resulted in the explanatory paragraph
are
continuing. Results for the first quarter of 2008 are not necessarily indicative
of results for the year. Certain
reclassifications have been made to the prior consolidated financial statements
to conform to the current year presentation.
Note
2: Inventories
Inventories
are stated at the lower of cost (on the average or first-in, first-out method)
or market. The composition of inventories at the end of the respective periods
is as follows (net of reserve of $1,775,000 for 2008 and $1,952,000 for
2007):
|
|
March
31, 2008
|
|
December
31, 2007
|
|
Parts
and components
|
|
$
|
4,075,000
|
|
$
|
3,669,000
|
|
Work-in-process
|
|
|
892,000
|
|
|
858,000
|
|
Finished
goods
|
|
|
2,131,000
|
|
|
1,884,000
|
|
|
|
$
|
7,098,000
|
|
$
|
6,411,000
|
|
Note
3: Senior and Subordinated Debt
Senior
Debt:
On
March
31, 2008 and December 31, 2007, the Company’s senior debt consisted of principal
in the amount of $24,373,000. Substantially all of the Company’s assets are
pledged as collateral for the senior debt. The current agreement with the holder
of the senior debt will expire on September 1, 2008 and, accordingly, the senior
debt has been classified as a current liability. Senior debt, at both March
31,
2008 and December 31, 2007 includes $1,000,000 which the Company borrowed from
the holder of the senior debt in October 2007 in order to meet its current
working capital needs. The Company does not accrue interest on the entire amount
of the senior debt under the terms of its agreement with the senior debt holder.
Interest has accrued from February 7, 2007 on $10,000,000 of the senior debt
at
12.5% as a result of the terms of the February 7, 2007 extension of the maturity
of our senior debt. In addition, we accrue interest on the $1,000,000 note
issued in October 2007 at a rate of LIBOR plus 10%, which was approximately
14.74% for the quarter ended March 31, 2008. The holder of the senior debt
prohibited the Company from making any payments on indebtedness to any
subordinated creditors or from paying any dividends on common stock, but the
Company is not prohibited from paying accounts payable in the ordinary course
of
business. The holder of the senior debt has no obligation to make any further
loans to the Company.
Any
adverse event, including declines in business, could have an effect on the
decision of the senior debt holder to extend or demand payment on the debt.
If
the senior debt holder does not extend the maturity of the Company’s senior debt
beyond September 1, 2008 or if the senior debt holder demands payment of all
or
a significant portion of the senior debt when due, the Company will not be
able
to continue in business, and it is likely that it will seek protection under
the
Bankruptcy Code.
Subordinated
Notes:
As
of
March 31, 2008 and December 31, 2007, subordinated notes in the principal amount
of $6,144,000 were outstanding. The interest rate on the subordinated notes
increased to 15% as a result of our failure to pay the subordinated notes when
due on July 3, 2001. As of March 31, 2008, $7,131,000 of accrued interest was
also due and payable and is included in other accrued interest payable. However,
the Company does not have the resources to pay either the $6,144,000 principal
or the $7,131,000 interest due on the subordinated notes. In addition, the
holder of its senior debt has precluded the Company from making payments on
the
subordinated debt.
Convertible
Subordinated Debentures:
As
of
March 31, 2008 and December 31, 2007, the Company had outstanding $385,000
principal amount of its convertible subordinated debentures due July 1, 2002
(the “Debentures”). The interest rate on these debentures increased from the
stated interest rate of 6% to 8.26% as a result of our failure to make interest
payments on the debentures since July 1, 2000 and our failure to pay principal
on July 2, 2002. The Company has not paid interest on these Debentures since
July 2000, and the holder of its senior debt prohibits it from making any
payments of principal and interest. At March 31, 2008 and December 31, 2007,
accrued interest, including additional assessments due to the default, on the
debentures was $300,000 and $291,000, respectively, and is included in other
accrued interest payable. The trustee of the Debentures gave notice to the
Company that the non-payment caused an event of default. The convertibility
feature associated with the Debentures expired upon their stated maturity date,
which was July 1, 2002. The holder of the senior debt has precluded the Company
from making payments on the debentures.
Note
4: Accounting for Stock Based Compensation
For
the
three months ended March 31, 2008 and 2007, the Company did not issue any stock
options and, therefore did not recognize non-cash compensation expense
attributable to stock options granted during the quarter. The Company uses
the
Black-Scholes valuation model and straight-line amortization of compensation
expense over the requisite service period when granting stock options. All
options previously granted are fully vested.
Note
5: Segment Data
The
Company develops, designs, manufactures and markets a range of standard and
proprietary telecommunications equipment for sale domestically and
internationally. Its core products, focused on ensuring communications for
service providers worldwide, fall principally into two categories:
Voice
and Data Connection and Protection Equipment.
These
products are used to connect copper wire lines, Automated Digital Subscriber
Lines, wireless networks, fiber connection/protection lines, and security
networks; and to protect equipment from voltage surges. The Company markets
its
connection and protection products to telephone operating companies, customer
premise providers and installers and security providers and installers
throughout the world.
Signal
Processing Equipment. Signal
Processing products are sold principally for use in defense and aerospace
applications, and support copper wire-based communications systems. Customers
for signal processing equipment are major aircraft, naval ship and ground-based
vehicle manufacturers, as well as their third party sub-tier
partners.
The
Company formerly had a third reportable segment - Operating Support Systems
(“OSS”), which was engaged in the business of marketing, manufacturing and
selling products that automated the testing, provisioning, maintenance and
administration of communication networks and the management of support personnel
and equipment. The Company’s operations in this segment were discontinued as of
June 30, 2007.
The
operation of this segment for the quarter ended March 31, 2007 are reflected
as
Loss from discontinued operations.
The
factors used to determine the above segments focused primarily on the types
of
products and services provided, and the type of customer served. Each of these
segments is managed separately from the others, and management evaluates segment
performance based on operating income.
There
has
been no significant change, from December 31, 2007, in the basis of measurement
of segment revenues and profit or loss, and no significant change in the
Company’s assets for the Line and Signal reporting segments.
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
March
31,
|
|
|
|
2008
|
|
2007
|
|
Sales:
|
|
|
|
|
|
Line
|
|
$
|
5,392,000
|
|
$
|
6,814,000
|
|
Signal
|
|
|
1,153,000
|
|
|
1,388,000
|
|
Total
of Continuing Operations
|
|
$
|
6,545,000
|
|
$
|
8,202,000
|
|
|
|
|
|
|
|
|
|
Segment
profit from operations:
|
|
|
|
|
|
|
|
Line
|
|
$
|
447,000
|
|
$
|
1,062,000
|
|
Signal
|
|
|
241,000
|
|
|
418,000
|
|
Total
of Continuing Operations
|
|
$
|
688,000
|
|
$
|
1,480,000
|
|
|
|
|
|
|
|
|
|
The
following table reconciles segment totals to consolidated
totals:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income:
|
|
|
|
|
|
|
|
Total
segment income
|
|
|
|
|
|
|
|
for
reportable segments
|
|
$
|
688,000
|
|
$
|
1,480,000
|
|
Corporate
and unallocated
|
|
|
(617,000
|
)
|
|
(814,000
|
)
|
Consolidated
total operating income
|
|
$
|
71,000
|
|
$
|
666,000
|
|
Note
6: Adoption
of New Accounting Standards
The
terms
“FAS” and “FASB” used in these notes refer to Statements of Financial Accounting
Standards issued by the United States Financial Accounting Standards
Board.
SFAS
157
(a)
Fair
Value Measurement
We
adopted FAS 157, Fair Value Measurements (“FAS 157”), effective
January 1, 2008. Under this standard, fair value is defined as the price
that would be received to sell an asset or paid to transfer a liability (i.e.
the “exit price”) in an orderly transaction between market participants at the
measurement date.
In
determining fair value, we use various valuation approaches, including market
and income approaches. FAS 157 establishes a hierarchy for inputs used in
measuring fair value that maximizes the use of observable inputs and minimizes
the use of unobservable inputs by requiring that the most observable inputs
be
used when available. The hierarchy is broken down into three levels based on
the
reliability of inputs as follows:
|
•
|
|
Level
1—Valuations based on quoted prices in active markets for identical
assets
or liabilities that we have the ability to access. Valuation adjustments
and block discounts are not applied to Level 1 instruments. Since
valuations are based on quoted prices that are readily and regularly
available in an active market, valuation of these products does not
entail
a significant degree of judgment.
|
Assets
and liabilities utilizing Level 1 inputs include: exchange-traded equity
securities and listed derivatives that are actively traded.
|
•
|
|
Level
2—Valuations based on quoted prices in markets that are not active
or for
which significant inputs are observable (e.g. interest rates, yield
curves, prepayment speeds, default rates, loss severities, etc.)
or can be
corroborated by observable market
data.
|
Assets
and liabilities utilizing Level 2 inputs include: exchange-traded equity
securities and listed derivatives that are not actively traded; U.S. government
and agency securities; non-U.S. government obligations; corporate and municipal
bonds; mortgage-backed securities (“MBS”) and asset-backed securities (“ABS”);
and over-the-counter (“OTC”) derivatives (e.g. foreign currency options and
forward contracts).
|
•
|
|
Level
3—Valuations based on inputs that are unobservable and significant
to the
overall fair value measurements. The unobservable inputs reflect
our own
assumptions about assumptions that market participants might
use.
|
Assets
and liabilities utilizing Level 3 inputs include: insurance and reinsurance
derivative contracts; hedge funds with partial transparency; and collateralized
loan obligation (“CLO”) - equity tranche securities, credit funds and short
duration high yield funds that are traded in less liquid markets.
The
availability of observable inputs can vary from financial instrument to
financial instruments and is affected by a wide variety of factors, including,
for example, the type of financial instrument, whether the financial instrument
is new and not yet established in the marketplace, and other characteristics
particular to the transaction. To the extent that valuation is based on models
or inputs that are less observable or unobservable in the market, the
determination of fair value requires significantly more judgment. Accordingly,
the degree of judgment exercised by management in determining fair value is
greatest for instruments categorized on Level 3. We use prices and inputs that
are current as of the measurement date including during periods of market
dislocation. In periods of market dislocation, the observability of prices
and
inputs may be reduced for many instruments. This condition could cause an
instrument to be reclassified between levels.
The
adoption of FAS 157 did not result in any cumulative-effect adjustment to our
beginning retained earnings at January 1, 2008, or any material impact on out
results of operations, financial position of liquidity. In February 2008, the
FASB issued FASP FAS 157-2, Effective
date of FASB Statement No. 157
(“FSP
FAS 157-2”), which permits a one-year deferral of the application of FAS 157 for
all non-financial assets and non-financial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). Accordingly, we have also adopted FSPFAS 157-2
effective January 1, 2008 and FAS 157 will not be applied to our goodwill and
other intangible assets measured annually for impairment testing purpose only.
We will adopt FAS 157 for non-financial assets and non-financial liabilities
on
January 1, 2009 and we do not anticipate this adoption will have a material
impact on our results of operations, financial position or liquidity.
SFAS
159
The
Company adopted FAS 159, The Fair Value Option for Financial Assets and
Financial Liabilities (“FAS 159”), effective January 1, 2008. SFAS 159
allows entities the option of measuring eligible financial instruments at fair
value as of specified dates. Such election, which may be applied on an
instrument by instrument basis, is typically irrevocable once elected. The
adoption of this statement did not have a material effect on the Company’s
financial position or results of operations.
EITF
07-3
In
the
first quarter 2008, the Company adopted the Emerging Issues Task Force issued
EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or
Services Received for Use in Future Research and Development Activities” (“EITF
07-3”). EITF 07-3 requires that nonrefundable advance payments for goods or
services that will be used or rendered for future research and development
activities be deferred and capitalized and recognized as an expense as the
goods
are delivered or the related services are performed. EITF 07-3 did not have
a
material impact on the Company’s financial position or results of
operations
.
Note
7: Discontinued
operations
In
December, 2003, the Company decided to wind down its OSS business. This decision
was made because of continuing losses combined
with difficulties in marketing OSS products in view of the Company’s financial
condition. As of June 30, 2007, the Company discontinued operating this
business. Accordingly, as of June 30, 2007, the OSS net assets of $434,000
were
written off and the operations of the segment are reported in the Consolidated
Financial Statements as a discontinued operation in fiscal 2007.
Results
of operations for OSS have been segregated from continuing operations and are
reflected as discontinued operations approximately as follows:
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
--
|
|
$
|
72,000
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations
|
|
|
--
|
|
|
(34,000
|
)
|
Note
8: Significant
Customers
British
Telecommunications PLC and its systems integrators represent the Company’s
largest customers and accounted for approximately $2,926,000, or 45% of sales,
in the first quarter of 2008, and approximately $4,455,000, or 54% of sales,
in
the first quarter of 2007.
Note
9: Subsequent
events
On
May 8,
2008, the Company entered into an agreement with the holder of our senior debt
which contemplates a restructure of our senior and subordinated debt and our
obligations to certain other creditors. The senior debt holder presently holds
two notes -- a note in the principal amount of $23,373,000 at March 31, 2008
(the “Old Note”), and a note (the “New Note”) in the principal amount of
$1,000,000, which the Company issued in October 2007. Both the Old Note and
the
New Note mature on September 1, 2008. Pursuant to this agreement:
· |
The
Company’s board of directors approved a one-for-11.11 reverse split of the
Company’s
common
stock, subject to stockholder
approval.
|
· |
The
holder of the senior debt agreed to exchange the principal of the
Old Note
in excess of $10,000,000 for 70% of the Company’s common stock. Any unpaid
interest on the $10,000,000 principal amount accrued through June
30,
2008, which is estimated at $1,250,000, will be added to
principal.
|
· |
The
Company will issue a modified promissory note in favor of the senior
debt
holder for the remaining $11,250,000 principal amount of the Old
Note to
provide for payments of interest of $351,156 on September 30, 2008
and
December 31, 2008 and thereafter at 12½% per annum on the outstanding
principal amount, payable quarterly in arrears, and payments of principal
in twelve quarterly installments each in the amount of $250,000,
with the
first payment of principal becoming due on December 31, 2008, followed
by
13 quarterly installments of principal each in the amount of $500,000,
with a final payment of $1,750,000 becoming due on March 31, 2015.
If the
accrued interest to the closing date is an amount other than $1,250,000,
the final payment will be adjusted accordingly. The Old Note, as
reduced
and modified pursuant to this Agreement, is referred to as the “Amended
Note.”
|
· |
The
maturity date of the New Note will be extended from September 1,
2008 to
September 1, 2010 on the same terms. Principal and interest payments
shall
be payable on the first day of each calendar month commencing on
August 1,
2008 in the amount equal to the amount by which the excess of the
average
cash balance of the Company exceeds $250,000, exclusive of the proceeds
of
the New Note, for the three full Business Weeks ending immediately
prior
to such Payment Date. Interest shall accrue and be payable on the
outstanding principal balance of the New Note at an amount equal
to the
six-month rate of LIBOR. Any interest due on a Payment Date which
remains
unpaid shall be added to principal and shall bear interest at the
same
rate as provided in the New Note.
|
· |
Until
completion of the debt restructuring, the senior debt holder shall
have
the right to designate two members to the Company’s board of
directors, each of whom shall be an independent director as defined
by the
rule of the Nasdaq Stock Market.
|
· |
The
debt restructuring is subject to stockholder approval of the reverse
split
and the debt restructuring and the approval by the holders of the
Company’s subordinated notes in the principal amount of $6,144,000,
together with interest, which was $7,131,000 at March 31, 2008, for
notes
in the principal amount of $1,750,000 and 14% of the Company’s outstanding
common stock, after giving effect to the reverse split. These notes
bear
interest at 10% per annum, are amortized based on a 25-year amortization
schedule and mature 7½ years after issuance. We have obtained the
agreement of more than 95% of the holders of the subordinated
notes to these terms.
|
· |
The
debt restructuring is also subject to agreements of other creditors
accepting reduced amounts for money due to them. These creditors
have
agreed to the reductions.
|
· |
The
agreement also provides that the Company will offer the holders of
its
debentures in the principal amount of $385,000 the right to exchange
their
debentures for their proportionate share of notes in the aggregate
principal amount of $100,000 plus 1% of the Company’s common stock after
giving effect to the reverse split.
|
· |
The
Company has agreed to issue to its key employees 6% of the Company’s
common stock, after giving effect to the reverse split.
|
Item
2. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The
Company’s consolidated statements of operations for the periods indicated below,
shown as a percentage of sales, are as follows:
|
|
|
Three
Months Ended
|
|
|
|
|
March
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
100
|
%
|
|
100
|
%
|
Cost
of sales
|
|
|
72
|
%
|
|
68
|
%
|
Gross
profit
|
|
|
28
|
%
|
|
32
|
%
|
Selling,
general and administrative expenses
|
|
|
21
|
%
|
|
19
|
%
|
Research
and development expenses
|
|
|
6
|
%
|
|
5
|
%
|
Operating
income
|
|
|
1
|
%
|
|
8
|
%
|
Interest
expense - net
|
|
|
(9
|
%)
|
|
(6
|
%)
|
Income
(loss) from continuing operations
|
|
|
(8
|
%)
|
|
2
|
%
|
Net
(loss) income
|
|
|
(8
|
%)
|
|
2
|
%
|
The
Company’s sales, from continuing operations, by product line for the periods
ended March 31, 2008 and 2007 are as follows:
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
2008
|
|
|
|
2007
|
|
|
|
Line
|
|
$
|
5,392,000
|
|
|
82
|
%
|
$
|
6,814,000
|
|
|
83
|
%
|
Signal
|
|
|
1,153,000
|
|
|
18
|
%
|
|
1,388,000
|
|
|
17
|
%
|
|
|
$
|
6,545,000
|
|
|
100
|
%
|
$
|
8,202,000
|
|
|
100
|
%
|
Overview
Our
connection and protection equipment includes a variety of connector blocks,
protector modules, building entrance terminals, category 5E and 6 cable
connectors and protectors, frames used in telephone central switching offices,
voice and data installations, multiple dwelling units and customer premises
applications. The connector products are used by telephone companies and
installers of voice and data transmission equipment to interconnect copper
and
fiber subscriber lines. The protector modules are used to protect from
electrical surges the equipment and personnel of telephone companies, voice
and
data transmission providers and customer premises equipment providers. The
need
for protection products has increased as a result of the worldwide move to
digital technology, wireless and broadband, which is extremely sensitive to
damage by electrical overloads. Moreover, private owners
of
telecommunications equipment now have the responsibility to protect their
equipment, personnel and buildings from damage caused by electrical surges.
We
also
have developed a range of security products for use in Closed Circuit TV (CCTV)
installations. Our CCTV video balun products allow full motion color or
monochrome video transmission via cost-effective UTP CAT 3 or better cable
eliminating expensive and bulky coax cable. The Company’s CCTV surge protectors
provide protection against voltage spikes and current surges that can disable
and permanently damage expensive video equipment, including cameras and
recorders, resulting in loss of important information and reduced
security.
Our
connection and protection products are used by international telephone service
providers as well as many of the regional telecommunication service providers
as
well as independent telecommunication service providers in the United States,
and by owners of private telecommunications equipment providing communications
and data transmission facilities and equipment. These products are also
purchased by equipment manufacturers for integration with their systems. In
addition, our telecommunications connection products have been sold to telephone
operating companies in various foreign countries. This equipment is compatible
with existing telephone systems both within and outside the United States and
can generally be used without modification, although we do custom-design
modifications to accommodate the specific needs of our customers.
Our
Signal Processing products include data bus components, cable assemblies and
wideband transformers. Our data bus components provide network infrastructure
that connects remote terminals used in military data transmission applications,
where an extremely high level of reliability and performance is required. Our
wideband video isolation transformers are used by the television and broadcast,
medical imaging, in-flight entertainment and industrial process control
industries to reduce ground noise, interference and improve picture quality.
Our
wideband products are also used by test and measurement engineers in the
characterization of data transmission networks.
Our
Line
division generated net income from operations for the three months ended March
31, 2008 and the comparable period of 2007. The
Signal division generated net income from operations for the three months ended
March 31, 2008 and the comparable period of 2007. We recognize revenue from
Line
and Signal products when the product is shipped.
On
March
31, 2008, our liability to our senior debt holder was $24,373,000 plus accrued
interest of $1,002,000. On
February 7, 2007, Cheyne Special Situation Fund L.P. (“Cheyne”) purchased our
senior debt of $23,400,000 from SHF IX, LLC and subsequently extended the
maturity of our senior debt to September 1, 2008. In October 2007, Cheyne lent
us an additional $1,000,000 which is due on September 1, 2008. We cannot give
any assurance that our senior debt holder will extend the maturity date beyond
September 1, 2008. Any adverse event, including declines in business, could
have
an effect on the decision of our senior debt holder to extend or demand payment
on the notes. If our senior debt holder does not extend the maturity of our
senior debt beyond September 1, 2008 or if our senior debt holder demands
payment of all or a significant portion of the senior debt when due, we will
not
be able to continue in business, and it is likely that we will seek protection
under the Bankruptcy Code.
We
are
very dependent upon our continued sales to British Telecommunications and its
systems integrators. Our
sales
to British Telecommunications and its systems integrators declined $1,529,000,
or 34%, from $4,455,000 for the three months ended March 31, 2007 to $2,926,000
for the three months ended March 31, 2008. Sales to British Telecommunications
and its systems integrators represented 51% of sales in the first quarter of
2008 and 45% of sales for the first quarter of 2007. The decline was primarily
due to decreased sales of connector products of $2,729,000, partially offset
by
increased sales of protection modules of $1,200,000. To the extent that British
Telecommunications reduces its purchases from, or purchases products at a price
which results in a reduced gross margin, our ability to operate profitably
will
be impaired. This decline in sales is the principal reason for the reduction
of
profit on continuing operations of $71,000 as compared to income of $666,000
for
the comparable period of 2007. We may not be able to replace this business
from
other customers and we cannot give any assurance that British Telecommunications
will increase its purchases from us in the future or that we will be able to
improve our margins on these sales.
We
have
entered agreements with Cheyne and the holders of our subordinated notes and
certain creditors regarding the restructuring of our debt. Any such
restructuring, if approved by our stockholders, would result in both a reduction
of senior debt, subordinated debt and other liabilities and a significant
dilution to our common stock stockholders. Regardless of whether we implement
the debt restructure, if we are unable to increase our sales to a level where
we
can operate profitably it is likely that we will seek protection under the
Bankruptcy Code.
Results
of Operations
Line
equipment sales for the three months ended March 31,
2008,
compared to the three months ended March 31, 2007, decreased by $1,422,000
(20.9%) from $6,814,000 to $5,392,000.
The
decline was primarily due to decreased sales of connector products to British
Telecommunications and its systems integrators of approximately $2,729,000,
partially offset by increased sales of protection modules of $1,200,000.
A
significant percentage of our revenues are derived from British
Telecommunications and its installers. Any continuation of the significant
reduction in the level of business from British Telecommunications and its
installers could continue to have a material adverse effect upon both our
revenue and net income.
Signal
sales for the three months ended March 31, 2008 compared to the comparable
period in 2007, decreased by $235,000 (16.9%) from $1,388,000 to $1,153,000.
The
decline in Signal revenue was primarily due to the failure of the military
sector to place orders due to the delay in Congress’ approval of the U.S.
military budget until late 2007.
Gross
margin for the quarter ended March
31,
2008 was 28% compared to 32% for the quarter ended March 31, 2007. The decrease
for the quarter is primarily related to excess capacity in our Mexico facility
due to lower production levels as compared to the same quarter in 2007.
Selling,
general and administrative expenses decreased by $239,000 (15.1%) from
$1,581,000 to $1,342,000 for the quarter ended March 31, 2008 compared to 2007.
Selling expenses decreased in the first quarter primarily due to a reduction
in
advertising expenses and a reduction in the allowance for bad debt, when
compared to the 2007 quarter. General and administrative costs decreased, for
the first quarter of 2008 compared to 2007, primarily due to a reduction of
costs associated with our negotiations relating to a proposed debt restructuring
in the first quarter of 2008.
For
the
quarter ended March 31, 2008 compared to 2007, research and development expenses
increased by $51,000 (13.7%) to $424,000 from $373,000. The increase for the
quarter resulted primarily from increased spending by our line division to
enhance our existing line products and develop new products.
As
a
result of the foregoing, for the quarter ended March 31, 2008, we had operating
income from continuing operations of $71,000 compared with an operating income
of $666,000 in the same period of 2007.
Interest
expense, net, for the three months ended March 31, 2008 was $591,000 compared
to
$440,000 for the comparable period last year. This increase of $151,000 is
primarily related to interest on our senior debt under the terms of our
extension agreement with the senior debt holder. We do not accrue interest
on
the entire amount of the senior debt of $24,373,000 under the terms of our
agreement with the holder of our senior debt. Interest has accrued from February
7, 2007 on $10,000,000 of the senior debt at 12.5% as a result of the terms
of
extension of the maturity of our senior debt to September 1, 2008. In addition,
we accrue interest on the $1,000,000 loan to us by our senior lender in October,
2007 at a rate of LIBOR plus 10%, approximately 14.74% for the first quarter
2008. This $1,000,000 loan is due on September 1, 2008.
Income
tax expense for the quarter ended March 31, 2008 relates to state and foreign
taxes. No federal income tax expense has been provided due to the loss from
continuing operations and the availability of net operating loss carry
forwards.
As
a
result of the foregoing, we generated a loss from continuing operations of
$537,000, for the three months ended March 31, 2008, compared with income from
continuing operations of $199,000 for the comparable quarter in
2007.
During
the first quarter of 2007, we had a loss from discontinued operations of
$34,000. Since these operations were discontinued as of June 30, 2007, there
was
no income or loss from discontinued operations for the first quarter of
2008.
For
the
quarter ended March 31, 2008, we sustained a net loss of $537,000, or $0.05
per
share (basic and diluted) as compared with net income of $165,000, or $0.02
per
share (basic and diluted) for the first quarter of 2007.
Liquidity
and Capital Resources
At
March
31, 2008, we had cash and cash equivalents of $315,000 compared with $494,000
at
December 31, 2007. The reduction in our cash position primarily reflects
increases of $330,000 in accounts receivable and $514,000 in inventory, offset
by an increase of $1,680,000 in accounts payable and accrued expense. These
factors were also reflected in our working capital deficit at March 31, 2008
of
$35,104,000 as compared with a working capital deficit of $34,513,000 at
December 31, 2007, an increase of $591,000 in our working capital deficit.
During
the three months of 2008, we were unable to pay interest or principal to our
senior and subordinated debt holders.
During
both the quarter ended March 31, 2008 and 2007, our only investing activities
were capital expenditures of $22,000 and $144,000, respectively. Our financing
activities of $191,000 were primarily an assessment due to the default on the
convertible subordinated debentures in the first quarter of 2007. We made
payments of principal of $150,000 on the senior debt in the first quarter of
2007.
As
of
March 31, 2008, our senior debt includes $24,373,000 of principal and $1,002,000
of accrued interest, which matures on September 1, 2008; and $6,529,000 of
principal and $7,431,000 of accrued interest on our subordinated notes and
6%
debentures that became due on July 3, 2001 and July 2, 2002, respectively.
We
are prohibited by our senior debt holder from paying principal or interest
on
any of the subordinated debt. During the quarter ended March 31, 2008, we did
not make any payments on principal or interest on the senior debt. At March
31,
2008, we did not have sufficient resources to repay either the senior lender
or
the subordinated lenders.
As
of
June 30, 2007, the Company discontinued operating the OSS division. Accordingly,
as of June 30, 2007, the OSS net assets of $434,000 were written off and the
operations of the OSS segment are reported in the Consolidated Financial
Statements as a discontinued operation in fiscal 2007.
We
are
seeking to address our working capital and liquidity problems by seeking a
restructuring of our senior and subordinated debt as well as significant amounts
of unsecured debt due to third parties, as described below. Although the debt
restructuring, if implemented, will reduce our working capital deficiency,
it
will not provide us with any additional cash for our operations. Our only source
of funds other than normal operations is Cheyne, which advanced us $1,000,000
in
October 2007. However, our continuing losses and the uncertainty of any
significant increase in business from British Telecommunications will increase
the difficulties in obtaining financings from other sources, and we cannot
give
any assurance that Cheyne will provide us with any additional funding if the
need arises. Any restructuring of our Company will result in very significant
dilution to the holders of our common stock and will require the approval of
the
holders of our common stock. If we do not restructure our debt and the senior
lender does not extend the maturity of our senior debt beyond September 1,
2008,
or if our senior debt holder demands payment of all or a significant portion
of
the senior debt when due, whether on September 1, 2008 or upon the expiration
of
a subsequent extension, we will not be able to continue in business, and it
is
likely that we will seek protection under the Bankruptcy Code.
We
have
in the past, and may in the future, consider the sale of one or more of our
divisions. However, all of our past discussions terminated without any agreement
and we cannot give any assurance that we would be able to effect any sale of
our
business or that such a sale would not be part of a bankruptcy
reorganization.
On
May 8,
2008, we entered into an agreement with Cheyne that contemplates a restructure
of our senior and subordinated debt and our obligations to certain other
creditors. Cheyne presently holds two notes - a note in the principal amount
of
$23,373,000 at March 31, 2008 (the “Old Note”), and a note (the “New Note”) in
the principal amount of $1,000,000, which we issued in October 2007. Both the
Old Note and the New Note mature on September 1, 2008. Pursuant to this
agreement:
· |
Our
board of directors approved a one-for-11.11 reverse split of our
common
stock, subject to stockholder
approval.
|
· |
Cheyne
agreed to exchange the principal of the Old Note in excess of $10,000,000
for 70% of our common stock. Any unpaid interest on the $10,000,000
principal amount accrued through June 30, 2008, which is estimated
at
$1,250,000, will be added to
principal.
|
· |
The
Company will issue a modified promissory note in favor of the senior
debt
holder for the remaining $11,250,000 principal amount of the Old
Note to
provide for payments of interest of $351,156 on September 30, 2008
and
December 31, 2008 and thereafter at 12½% per annum on the outstanding
principal amount, payable quarterly in arrears, and payments of principal
in twelve quarterly installments each in the amount of $250,000,
with the
first payment of principal becoming due on December 31, 2008, followed
by
13 quarterly installments of principal each in the amount of $500,000,
with a final payment of $1,750,000 becoming due on March 31, 2015.
If the
accrued interest to the closing date is an amount other than $1,250,000,
the final payment will be adjusted accordingly. The Old Note, as
reduced
and modified pursuant to this Agreement, is referred to as the “Amended
Note.”
|
· |
The
maturity date of the New Note will be extended from September 1,
2008 to
September 1, 2010 on the same terms. Principal and interest payments
shall
be payable on the first day of each calendar month commencing on
August 1,
2008 in the amount equal to the amount by which the excess of our
average
cash balance exceeds $250,000, exclusive of the proceeds of the New
Note,
for the three full business weeks ending immediately prior to such
payment
date. Interest shall accrue and be payable on the outstanding principal
balance of the New Note at an amount equal to the six-month rate
of LIBOR.
Any interest due on a payment date which remains unpaid shall be
added to
principal and shall bear interest at the same rate as provided in
the New
Note.
|
· |
Until
completion of the debt restructuring, Cheyne shall have the right
to
designate two members to our board of directors, each of whom shall
be an independent director as defined by the rule of the Nasdaq Stock
Market.
|
· |
The
debt restructuring is subject to stockholder approval of the reverse
split
and the debt restructuring and the approval by the holders of our
subordinated notes in the principal amount of $6,144,000, together
with
interest, which was $7,131,000 at March 31, 2008, for notes in the
principal amount of $1,750,000 and 14% of our outstanding common
stock,
after giving effect to the reverse split. These notes bear interest
at 10%
per annum, are amortized based on a 25-year amortization schedule
and
mature 7½ years after issuance. We have obtained the agreement of more
than 95% of the holders of the subordinated notes to these
terms.
|
· |
The
debt restructuring is also subject to agreements of other creditors
accepting reduced amounts for money due to them. These creditors
have
agreed to the reductions.
|
· |
The
agreement also provides that we will offer the holders of our debentures
in the principal amount of $385,000 the right to exchange their debentures
for their proportionate share of notes in the aggregate principal
amount
of $100,000 plus 1% of the Company’s common stock after giving effect to
the reverse split.
|
· |
We
have agreed to issue to our key employees 6% of the Company’s common
stock, after giving effect to the reverse split.
|
Forward
Looking Statements
Statements
contained in this Form 10-Q include forward-looking statements that are subject
to risks and uncertainties. In particular, statements in this Form 10-Q that
state our intentions, beliefs, expectations, strategies, predictions or any
other statements relating to our future activities or other future events or
conditions are “forward-looking statements.” Forward-looking statements are
subject to risks, uncertainties and other factors, including, but not limited
to, those identified under “Risk Factors,” in our Form 10-K for the year ended
December 31, 2007 and in the Form 10-Q and those described in “Management's
Discussion and Analysis of Financial Conditions and Results of Operations” in
our Form 10-K and this Form 10-Q, and those described in any other filings
by us
with the Securities and Exchange Commission, as well as general economic
conditions and economic conditions affecting the telecommunications industry,
any one or more of which could cause actual results to differ materially from
those stated in such statements. Such
statements could be affected by risks and uncertainties related to our financial
conditions, our relationship with the holder of our senior and subordinated
debt, including the willingness or unwillingness of the holder of the senior
debt to extend the maturity date of the senior debt and the amount and timing
of
any payments which the holder of the senior debt may require, our ability to
sell any or all of our divisions or effect a restructure of our business and
our
debt and equity structure on terms acceptable to the holder of the senior debt,
our relationship with British Telecommunications including its continued
requirements for our products, factors which affect the telecommunications
industry, market and customer acceptance, our access to current technology,
competition, domestic and foreign government regulations and requirements and
pricing, as well as general industry and market conditions and growth rates,
and
general economic conditions. Any forward-looking statements speak only as of
the
date on which they are made, and we do not undertake any obligation to update
any forward-looking statement to reflect events or circumstances after the
date
of this Form 10-Q.
Item
3. Quantitative
and Qualitative Disclosure About Market Risk.
We
conduct certain operations outside the United States. A substantial portion
of
our revenue and expenses from our United Kingdom operations are denominated
in
Sterling. Any Sterling-denominated receipts are promptly converted into United
States dollars. We do not engage in any hedging or other currency
transactions.
Item
4. Controls
and Procedures
Evaluation
of disclosure controls and procedures
Disclosure
controls and procedures are controls and procedures that are designed to ensure
that information required to be disclosed by us in reports that we file or
submit under the Exchange Act is recorded, processed, summarized and timely
reported as provided in SEC rules and forms. We periodically review the design
and effectiveness of our disclosure controls and procedures, including
compliance with various laws and regulations that apply to our operations.
We
make modifications to improve the design and effectiveness of our disclosure
controls and procedures, and may take other corrective action, if our reviews
identify a need for such modifications or actions. In designing and evaluating
the disclosure controls and procedures, we recognize that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives.
The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company’s reports under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms, and that such information is
accumulated and communicated to management, including the Company’s chief
executive officer, who is also the chief financial officer, as appropriate
to
allow timely decisions regarding required disclosure. The Company’s management,
with participation of the Company’s Chief Executive and Financial Officer, has
conducted an evaluation of the effectiveness of the Company’s disclosure
controls and procedures (as defined in the Securities Exchange Act of 1934
Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
Quarterly Report on Form 10-Q.
As
previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal
year ended December 31, 2007, the Company determined that, as of the end of
the
fiscal year 2007, there was a material weakness affecting its internal control
over financial reporting in respect to Information Technology (as described
below) and, as a result of the material weaknesses, the Company’s disclosure
controls and procedures were not effective. The Company is continuing to
evaluate a change in the information system platform for the Company’s financial
and operational systems which will remediate the material weaknesses. The
selection and implementation of a new system is expected to be completed over
the next few years as a result of current cash constrains of the Company.
Consequently, based on the evaluation described above, the Company’s management,
including its Chief Executive and Financial Officer, has concluded that, as
of
the end of the first quarter of fiscal year 2008, the Company’s disclosure
controls and procedures were not effective.
Internal
Control over Financial Reporting
During
the first quarter of fiscal year 2008, the Company was engaged in the assessment
and evaluation of its internal control over financial reporting for fiscal
year
2007. As previously reported in form 10-K for the year ended December 31, 2007,
management identified significant deficiencies that when aggregated may give
rise to a material weakness specifically relating to a) program change
management in the Company’s PROCOMM system, b) lack of integrated modules with
the general ledger and c) excessive manual adjustments to the inventory module
are required.
Management’s
Plan of Remediation
Management
plans to evaluate, select and install a new integrated ERP system that will
include a complete general ledger and reporting package to eliminate the need
for manual updates and significantly reduce the need for journal entries in
the
financial reporting process. Specific remediation actions used in 2008 to
address our material weakness in internal control over financial reporting
in
respect to Information Technology include the following:
In-depth
review of all perpetual inventory reports
Analyzing
of production reporting in respect to ending inventory
Re-computation
of reports on a test basis
Changes
in Internal Control over Financial Reporting
There
have been no changes in our internal control over financial reporting during
the
most recently completed fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
The
certification of our chief executive and chief financial officer, which is
included as Exhibit 31.1 to this Quarterly Report on Form 10-Q, includes,
in paragraph 4 of such certification, information concerning our disclosure
controls and procedures and internal control over financial reporting. Such
certification should be read in conjunction with the information contained
in
this Item 4 - Controls and Procedures for a more complete understanding of
the
matters covered by such certification.
PART
II - OTHER INFORMATION
Item
1 A. Risk
Factors
In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition or future results. The risks described
in our Annual Report on Form 10-K and in this Form 10-Q are not the only risks
facing our Company.
During
the three months ended March 31, 2008, we sustained declines in revenue from
our
largest customer, British Telecommunications, from the comparable three month
period of 2007, and, based on a change in the product mix, our gross margin
declined on our sales to British Telecommunications. Due to our reliance on
significant business from British Telecommunications, our revenue and net income
could be impaired by any material reduction of sales to British
Telecommunications or any material reduction in the gross margin on sales to
British Telecommunications.
In
May
2008, we entered into a debt restructuring agreement with Cheyne. This agreement
requires, as a condition to the implementation of the debt restructure, that
we
obtain stockholder approval for a one-for-11.11 reverse split and the debt
restructuring. The approval of the reverse split requires the affirmative vote
of the holders of a majority of the outstanding shares of common stock. We
cannot assure you that we will obtain stockholder approval. If we do not obtain
stockholder approval, it is likely that we will seek protection under the
Bankruptcy Code. Further, even if we do obtain stockholder approval and
implement the debt restructuring, we may still seek protection under the
Bankruptcy Code if we cannot generate income from our business.
Additional
risks and uncertainties not currently known to us or that we currently deem
to
be immaterial also may materially adversely affect our business, financial
condition and/or operating results.
Item
3. Defaults Upon Senior Securities.
See
Note
3 of Notes to Unaudited Consolidated Financial Statements and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources” for information concerning defaults on our
subordinated debt.
Item
5. Other Information
On
May 8,
2008, we entered into an agreement with Cheyne which contemplates a restructure
of our senior and subordinated debt and our obligations to certain other
creditors. Cheyne presently holds two notes - a note in the principal amount
of
$23,373,000 at March 31, 2008 (the “Old Note”), and a note (the “New Note”) in
the principal amount of $1,000,000, which we issued in October 2007. Both the
Old Note and the New Note mature on September 1, 2008. Pursuant to this
agreement:
· |
Our
board of directors approved a one-for-11.11 reverse split of our
common
stock, subject to stockholder
approval.
|
· |
Cheyne
agreed to exchange the principal of the Old Note in excess of $10,000,000
for 70% of our common stock. Any unpaid interest on the $10,000,000
principal amount accrued through June 30, 2008, which is estimated
at
$1,250,000, will be added to
principal.
|
· |
The
Company will issue a modified promissory note in favor of the senior
debt
holder for the remaining $11,250,000 principal amount of the Old
Note to
provide for payments of interest of $351,156 on September 30, 2008
and
December 31, 2008 and thereafter at 12½% per annum on the outstanding
principal amount, payable quarterly in arrears, and payments of principal
in twelve quarterly installments each in the amount of $250,000,
with the
first payment of principal becoming due on December 31, 2008, followed
by
13 quarterly installments of principal each in the amount of $500,000,
with a final payment of $1,750,000 becoming due on March 31, 2015.
If the
accrued interest to the closing date is an amount other than $1,250,000,
the final payment will be adjusted accordingly.
|
· |
The
maturity date of the New Note will be extended from September 1,
2008 to
September 1, 2010 on the same terms. Principal and interest payments
shall
be payable on the first day of each calendar month commencing on
August 1,
2008 in the amount equal to the amount by which the excess of our
average
cash balance exceeds $250,000, exclusive of the proceeds of the New
Note,
for the three full business weeks ending immediately prior to such
payment
date. Interest shall accrue and be payable on the outstanding principal
balance of the New Note at an amount equal to the six-month rate
of LIBOR.
Any interest due on a payment date which remains unpaid shall be
added to
principal and shall bear interest at the same rate as provided in
the New
Note.
|
· |
Until
completion of the debt restructuring, Cheyne shall have the right
to
designate two members to our board of directors, each of whom shall
be an independent director as defined by the rule of the Nasdaq Stock
Market.
|
· |
The
debt restructuring is subject to stockholder approval of the reverse
split
and the debt restructuring and the approval by the holders of our
subordinated notes in the principal amount of $6,144,000, together
with
interest, which was $7,131,000 at March 31, 2008, for notes in the
principal amount of $1,750,000 and 14% of our outstanding common
stock,
after giving effect to the reverse split. These notes bear interest
at 10%
per annum, are amortized based on a 25-year amortization schedule,
and
mature 7½ years after issuance. We have obtained the agreement of more
than 95% of the holders of the subordinated notes to the terms
of the debt restructuring.
|
· |
The
debt restructuring is also subject to agreements of other creditors
accepting reduced amounts for money due to them. These creditors
have
agreed to the reductions.
|
· |
The
agreement also provides that we will offer the holders of our debentures
in the principal amount of $385,000 the right to exchange their debentures
for their proportionate share of notes in the aggregate principal
amount
of $100,000 plus 1% of the Company’s common stock after giving effect to
the reverse split. The agreement permits us to make payments on the
new
notes being issued, but not on the outstanding
debentures.
|
· |
We
have agreed to issue to our key employees 6% of the Company’s common
stock, after giving effect to the reverse
split.
|
· |
For
services relating to the restructuring plan, we are paying Advicorp,
PLC a
fee of $200,000, payable without interest in twenty five equal monthly
installments of $8,000 which are due from January 2009 until January
2011.
In addition, we will issue to Advicorp five-year warrants to purchase
2%
of the common stock,
after giving effect to the issuances in connection with the debt
restructuring (including shares reserved for issuance to management),
at
an exercise price equal to the average closing price of our common
stock
on the five trading days commencing with the first trading day which
follows the 30th day after the effective date of the reverse
split.
Mr. Marco Elser, a director, is chief executive officer of
Advicorp.
|
Item
6. Exhibits
|
10.1
|
Agreement
dated May 8, 2008 between the Company and Cheyne Special Situation
Fund
L.P.
|
|
10.2
|
Form
of agreement between the Company and the holders of the Company’s
subordinated notes.
|
|
31.1
|
Certificate
of Chief Executive Officer and Chief Financial Officer pursuant to
Section
302 of the Sarbanes-Oxley Act of 2002.
|
|
32.1 |
Certificate
of Chief Executive Officer and Chief Financial Officer pursuant to
Section
906 of the Sarbanes-Oxley Act of
2002.
|
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.
|
PORTA
SYSTEMS
CORP. |
|
|
|
|
|
|
Dated:
May 13, 2008
|
By
/s/ Edward B. Kornfeld
Edward
B. Kornfeld
Chief
Executive Officer
and
Chief Financial Officer
|