General
Teltronics, Inc., a Delaware corporation, designs, installs, develops, manufactures and markets electronic hardware and application software products, and engages in electronic manufacturing services primarily in the telecommunication industry.
Management utilizes criteria provided in Statement of Financial Accounting Standards No. 131 to define its operating segments. This standard defines an operating segment as a component of an enterprise (1) which engages in business activities from which it earns sales and incurs expenses, (2) whose operating results are regularly reviewed by the enterprises chief operating decision maker and (3) for which discrete financial information is available.
The Company’s operations are classified into three reportable segments, Teltronics, Inc., Teltronics Limited (“UK”) and Mexico. Operating segment data for 2005, 2004 and 2003 are summarized in Note 16 in the notes to the Consolidated Financial Statements in Part II and are incorporated herein by reference.
Our Financial Condition
The Company has generated operating profits and net income in the last two years. While net sales have been relatively flat over the past three years the Company’s efforts to reduce operating costs since 2001 has had a positive impact on its annual results. The seasonality of the business continues to have a negative impact on the Company’s quarterly results with eight out of the last twelve quarters reflecting net losses.
During 2005 the Company implemented several actions to improve its balance sheet. In July the Company entered into a new Revolving Credit, Term Loan and Security Agreement (“Agreement”) under which the Company obtained a three year $3,000 term loan and was granted an $8,000 revolving credit facility. Under the terms of the Agreement, the Company used approximately $8,100 under the facility to satisfy the Company’s debt under its previous line of credit and a secured promissory note. The Company recognized a gain of $3,897 or $0.48 per share on the satisfaction of the secured promissory note.
In October 2005, the Company entered into a Settlement Agreement (“Settlement Agreement”) with Tri-Link Technologies Inc. (“Tri-Link”) under which all arbitration and legal proceedings were settled. Under the Settlement Agreement, the Company paid $1,000 and issued 750,000 restricted shares of the
Company’s Common Stock and a $750 note to Tri-Link in exchange for the Company’s original promissory note in the amount of $2,250. The Company recognized a gain of $211 on the transaction.
In addition to the foregoing actions, we have been actively seeking additional capital and considering ways to further enhance our capital structure. There is no assurance; however, that we will successfully consummate any such capital raising transaction.
Our Strategy
The decline in the telecommunications and electronics industries over the past few years has resulted in a change in our overall business strategy. Our principal strategy is to provide quality voice and data products and other telecommunication services to the marketplace and to deliver these products and services in the most cost effective manner.
We continue to manufacture our own products as we believe this enables us to be more responsive to our customers, as well as providing an additional source of revenue through our ability to provide electronic manufacturing services. We have invested in facilities that will allow us to expand our manufacturing for our existing product lines and accommodate an increase in our electronic manufacturing services business.
TELTRONICS, INC. SEGMENT Intelligent Systems Management
In the early 1980‘s, telecommunications sales and service providers were looking for ways to differentiate themselves. Competitive pressures significantly eroded margins on sales of equipment, and interconnects began to concentrate more on service to address decreasing sales and margins. This initiative led to the development of enhanced service offerings to their customers, and the Teltronics alarms monitoring, or Intelligent Systems Management (“ISM”) product line was designed to capitalize on this strategy. The ISM products maintained a leadership role in alarms monitoring for voice networks throughout the ‘80‘s and ‘90‘s, but the new century ushered in new technologies and the convergence of voice communications and data communications gained momentum. This convergence is accelerating and the ISM Product line is adapting to the changes.
This convergence is presenting a new wave of challenges to service companies and end users as they struggle to manage an entirely new generation of products. The current focus of Teltronics’ ISM business unit is to adapt our marketing and product strategy to take advantage of these service opportunities and maintain a leadership position in this market. In addition, we are enhancing the product line to expand into the government and industrial markets.
Market. The ISM product line offers a set of tools for any organization that must manage a geographically dispersed population of voice and data systems. The ISM products are ideal for large service organizations, self-maintained enterprises, and various branches of the military. These tools allow the service organization to better utilize their manpower and reduce costs, while providing a higher level of service.
Products. The ISM product line consists of two major components… Remote Agents and a Management Information System (“MIS”). Together these products create an integrated approach to monitoring the health of a diverse population of customer systems. Central to the ISM product strategy is vendor independence, since few customers have a homogenous population of systems to manage. Combining the ISM products with professional services, we offer a total solution for managing voice and data systems that are critical to the success of enterprises in the 21st century.
Remote Agents. A Remote Agent is special-purpose microcomputer device, collocated with voice or data system, that are to be monitored and managed. The Agent is designed to operate in a totally unattended environment, detect events in a wide variety of customer equipment, and report selected events to MIS. Reporting may be via a local area network (LAN), wide area network (WAN), the Internet, or the public telephone network. The Agent is a very intelligent system that is capable of acting alone to collect events and make decisions about what is reported. In addition the Agent may take action,
autonomously or when instructed to do so, to correct problems as they occur. Remote Agents also monitor and report on environmental conditions that impact sensitive telecom and datacom equipment and have the ability to store and forward performance information and other metrics generated by these systems. The Remote Agent provides a secure communications path that allows the service organization to access the critical systems remotely.
For more than a decade, the Site Event Buffer-II ® (“SEB-II”) has been the workhorse Remote Agent in the ISM stable. During that time more than 100,000 units have been installed worldwide. The SEB-II was designed primarily for monitoring voice communications systems that were not network-enabled. This product will be phased out of the product line at the end of the year. The Site Event Buffer Enterprise Agent ® (“SEBea ® ”), introduced in the fourth quarter of 2002, is the third generation of Remote Agent in the ISM product line. The SEBea is designed around a significantly more powerful computing engine and is network enabled to allow management of voice, data, and converged systems. The SEBea supports all features of previous generations of SEB products while offering services such as a Simple Network Protocol (“SNMP”) Proxy Agent, SNMP Segment Manager and greatly expanded environmental monitoring through a range of internal sensors. In addition, the SEBea can monitor up to eight directly attached elements (serial) and a wide range of network elements (Ethernet/IP/SNMP). Recently introduced, NET-PATH ® and NET-PATH m ™, are fifth generation ISM agents. NET-PATH is housed in a streamlined, robust, IU metal chassis similar to a routers and other data communications equipment. NET-PATH m is specifically designed for entry level applications and is priced aggressively to capture new business. Both agents deliver all the same features as the SEBea.
Management Information System. Following the classic network management model, a Remote agent must report to a MIS. IRISnGEN ® is a comprehensive software package used by service organizations as well as the enterprise, to receive and process events from the Remote Agents. Remote Agents, that are monitoring customer equipment, report events to the IRISnGEN software. These events may represent alarm conditions or may simply be status information to indicate that everything is working properly. Using IRISnGEN software, the service organization often identifies and resolves problems before the customer is aware of them. IRISnGEN software is also used to collect data stored in Remote Agents and direct the data to the proper software application for processing. The software also provides the tools required to manage Remote Agents and access network elements for routine maintenance.
A database of network element alarms is maintained in IRISnGEN so that the service organization or enterprise may obtain reports on alarm status at any time. Comprehensive reports that provide statistical analysis of received alarms are also available. Service personnel use the reports to isolate faulty components, identify trends, and track the historical performance of network elements. IRISnGEN is viable for small enterprises with only a few remote sites, yet scales to accommodate large service companies with thousands of remote customers. IRISnGEN has a flexible design that allows the users to tune the system to meet their particular business needs. Geographical alarm display, alarm escalation, alarm correlation, and alarm forwarding are just a few of the capabilities of IRISnGEN. Heavy emphasis is placed on graphics and ad-hoc reporting capabilities. A comprehensive Application Program Interface (API) was introduced to assist customers in integrating IRISnGEN with legacy management systems and databases.
In 2003, a major new software module, Equipment Explorer, was introduced to expand the feature set of the IRISnGEN. Equipment Explorer provides real-time status of bi-polar events and allows point and click control actions to be executed directly to remote monitored equipment for proactive fault resolution. IRISnGEN has traditionally been an events-based system, with new events being displayed as they occur. The status of the event in the viewer is completely controlled by the service engineer who can modify the event status by manually changing it to open or closed. Equipment Explorer handles events in a different manner by employing a new iconic viewer to provide real-time status information for monitored sites or equipment at specific sites. Equipment Explorer can work as a standalone product or in concert with the IRISnGEN Basic Alarms and MapViewer modules to provide the best of both worlds. This module has allowed the ISM product line to move into new military and industrial markets.
Digital Switching Systems
20-20™ Switching Systems. The 20-20 family of switching products was acquired on June 30, 2000, from Harris. The 20-20 is a digital switching system that has been deployed in mission critical applications throughout the world. The 20-20 may be expanded up to 9,600 ports for very large applications and is generally cost effective down to about 300 ports. This switching product may be configured for fully redundant common control when system availability is critical, such as in large call centers or critical government applications. A variant of the 20-20 is used in FAA ground-to-air and ground-to-ground applications where down time must be in the order of less than 5 seconds in a year. Known for its robust computer-telephony interface, the 20-20 has been used by systems integrators throughout the world for large custom applications as well as “local dial tone” in small central office applications.
The 20-20 has been certified and homologated in over 60 countries worldwide. International signaling and transmission protocols have been developed, including international flavors of ISDN and SS7, to permit its use virtually anywhere in the world. Teltronics will continue to focus on developing practical, cost-effective solutions and applications for the 20-20 customers.
A new 512 port IXP shelf will be introduced mid year. The new shelf can be used with exiting or new 20-20 IXP systems. This new shelf will reduce the number of shelves required to reach system maximum capacity by 50%, reducing system costs to better compete in the more competitive traditional PBX applications.
Voice Over Internet Protocol (“VoIP”)
Cypreon™. Cypreon is a VoIP switching system specifically designed to meet the needs of small to medium sized enterprises (both single-site and multi-location). The system combines the high speed access of broadband, the reliability of modern telecommunications, and the power of full-featured network servers to provide high quality voice and data communications to employees whether they work at the office, at home, or around the globe.
The system can sit behind an existing legacy PBX to provide VoIP functionality, or connect directly to the PSTN and IP networks. It supports standard analog and digital trunk connections to the PSTN plus WAN gateway connections to corporate WANs and even the internet for VoIP call transmission. The system supports portal-to-portal VoIP and cost-saving “jump off” capability that enables users to transmit voice calls over the IP network to achieve long distance cost savings then “jump off” and complete the final miles over the PSTN. Simplicity of installation, programming, and administration/use are some of Cypreon’s most appealing benefits. Intuitive, easy to use graphical administration tools take the complexity out of system installation and administration, and Cypreon’s Fingertip Toolset™ enables employees to manage their own workstation settings and launch powerful integrated application suites at the touch of a button.
Linux-based Cypreon supports up to a total of 350 ports, including up to 200 IP phones, WAN Gateways to provide portal-to-portal VoIP, plus PSTN Gateways to support up to 128 Analog trunks and/or phones and up to 96 T1 PRI/120 E1 PRI trunks. The target Cypreon market is users with single or multi-site campus environments with less than 200 phones.
Cypreon is fully compatible with Session Initiation Protocol “SIP”. A new family of SIP phones will be introduced in the second quarter of 2006, to augment our own executive phones.
20-20™ Switching Systems. The Company continues to invest in engineering development to maintain and expand capabilities to include IP Telephony convergence. With the introduction of IP Telephony gateways, the more than 15,000 20-20 end users can upgrade their systems, allowing them to retain the existing 20-20 system investments.
CERATO™, a new family of products, will be introduced in the second quarter of 2006. The new family will include a number of VoIP remote gateways that will support Analog, Digital and VoIP subscribers as well as Analog and Digital Trunks. These gateways will be used to provide cost effective communications between home office and remote offices using the latest VoIP technologies. This new
family of products will also include a family of CERATO communications terminals that support terminations to traditional Digital Subscriber cards as well as VoIP networks. These new communication terminals will be introduced at the end of the second quarter. A new family of high density communication blades will be introduced along with a new high density CERATO communications server. The high density blades will support 128 Direct VoIP terminations, 4 T1/E1 Digital trunks, 32 Analog Subscribers, 32 Digital Subscribers, 32 Analog LS/GS trunks. An embedded SIP server will be included in the CERATO family gateways and communications servers.
Customer Contact Management Systems
OmniWorks® (formerly known as ContactWorks™). This product was also a part of the 20-20 acquisition of June 30, 2000. OmniWorks is a Windows client-server based, sophisticated multi-media customer contact and management system for use by enterprise operations whose mission includes receiving or launching large numbers of telephone calls. The product also has the capability of receiving or launching large quantities of emails, or accommodating real time web-based responses to product/services queries through “chat” sessions. The system detects information about callers, organizes the calls according to predetermined priorities, places the calls in “queues” to be serviced by employees, and may even route the calls based on the “skills” of the call handlers (“skills-based routing”). The database of the current product is Microsoft SQL® and may be fully redundant on separate servers. Originally designed to work with the 20-20 as its “switching fabric”, the Company’s goal is to migrate OmniWorks towards switch-independence, and ultimately it should be able to be deployed behind virtually any switch type in the industry including the Teltronics Cypreon IP product.
OmniWorks may be deployed in small call centers with only a few agents or call handlers, or it may be used in large, complex applications with hundreds of agents. OmniWorks is available to any of the Company’s distribution partners with support from its professional services group; however, the target market is larger users with sophisticated IT requirements and infrastructures.
Emergency Response Systems
Telident Enterprise Systems. Teltronics believes it occupies a unique position in the telecommunications industry by marketing a comprehensive product line that addresses both the public safety and private business sectors of E911 marketplace.
In the public safety systems sector our Telident ANI Controller products offer a complete solution to the emergency services agencies of states, counties and municipalities. These products are designed to ensure timely and accurate response to 911 calls. Over 900 Public Service Answering Points (“PSAP”) throughout the country use these systems to protect lives and property.
In the business sector, the Telident Enterprise Systems product line provides life saving information about 911 calls made by users of PBXs and other telephone systems. Few people realize that emergency response personnel may find it impossible to locate a 911 caller in a multi-building business or on a college campus. This life-threatening problem is the result of a public E911 system that never contemplated modern telecommunications technology such as PBX’s and wireless extensions. The Telident Enterprise Systems products are designed to ensure that emergency personnel receive the information needed to quickly and accurately locate a 911 caller. Our Station Translation System™, and Database Maintenance software are installed in over 1,000 businesses of all sizes.
Electronic Manufacturing Services
Teltronics provides electronic manufacturing services for companies in the telecommunications, industrial control, test and measurement and other computer-related industries. Services include design and test ability reviews, turnkey material procurement and management, automated through-hole or surface mount circuit board assembly, in-circuit and functional test, and final mechanical integration. Teltronics’ manufacturing operations are certified to ISO Q9001 — 2000, BABT 340. The manufacturing facility is also UL registered. Through our quality certifications, Teltronics has established and demonstrated effective procedures and processes that ensure that all products are manufactured, installed and serviced under a quality system, which carries an internationally recognized and certified level of excellence.
Teltronics’ current manufacturing capacity should allow for increased growth of the Company’s existing product lines and accommodate an increase in electronic manufacturing services business.
Trademarks, Patents and Copyrights
We rely on patent, trademark, trade secret and copyright laws both to protect our intellectual property, including our proprietary technology, and to protect us against claims from others. We believe that we have direct intellectual property rights covering substantially all our material technologies. We currently hold a world-wide, non-exclusive, fully paid-up license to make, use and sell the inventions under approximately 30 U.S patents and numerous international patents and patent applications relating to the 20-20 digital switching product line. We consider the patents relating to our digital switching products to be the most important to our business. The patents relating to the 20-20 digital switching systems expire on various dates between 2005 and 2019. We also currently own 5 U.S. patents relating to emergency 9-1-1 call station identification features and a personal translator device for assisting communications. We have approximately 30 registered trademarks in the United States, of which we consider the 20-20 and the SEBea to be our most valuable. We license some technology from third parties that we use in providing manufacturing services to our customers. We believe that such licenses are generally available on commercial terms from a number of licensors. Generally, the agreements governing such technology grant us non-exclusive licenses regarding the subject technology and terminate upon a material breach by us.
The Company also seeks to protect its confidential and proprietary information through the enforcement of confidentiality and non-compete agreements presently executed by key employees.
Component Procurement
The Company assembles all of its products at its manufacturing facility in Sarasota, Florida. All components used in the assembly of the Company’s products are purchased from distributors and manufacturers.
Purchase orders for components are placed from one month to six months in advance, depending on the supply sensitivity of a particular component. Most components are available from several sources, based upon current price quotations. If these suppliers should stop carrying or manufacturing components for the Company, the Company’s operations could be adversely affected until alternative sources are located and increased operating costs could result from product re-engineering required to use such substitute components. Certain electronic components used in the Company’s products are purchased through American distributors from sources outside of the United States. The costs of such components increase as the value of the United States dollar decreases in relation to foreign currencies. In addition, the availability of such components may be affected by factors external to the United States, including war, civil strife, embargo and export or import restrictions. Although there can be no assurance for the future, the Company has not experienced and does not anticipate experiencing any significant difficulty in purchasing components.
Backlog
The Company’s backlog at December 31, 2005 was approximately $14,610, as compared to $14,600 at December 31, 2004. The Company’s backlog is for orders that have scheduled deliveries or maintenance over the next twelve months, and is not an indication that the Company is unable to fulfill these requirements. Given the nature of our relationships with our customers, we allow our customers to reschedule deliveries, and therefore, backlog is not necessarily indicative of our future financial results.
Seasonality
The Company has experienced seasonality due in part to purchasing tendencies of our customers during the fourth and first quarters of each year. Consequently, results for the fourth and first quarters of each year are not as strong as results during the other quarters. The sales of the Company continued to be impacted by the general slowdown of telecommunications expenditures.
Customers
Our core strategy is to establish and maintain long-term relationships with leading telecommunications customers. A small number of customers have historically represented a major portion of our net sales. The table below sets forth the respective portion of net sales for the applicable period attributable to our customers who individually accounted for more than 10% of our net sales in any respective period:
| Years Ended Decmeber 31,
| |||
|---|---|---|---|
| 2005
|
2004
|
2003
| |
| New York City Department of Education | 19% | 14% | 17% |
| IBM | 10% | 12% | 14% |
| Nielsen Media Research | 7% | 10% | 13% |
We expect to continue to depend upon a relatively small number of customers for a significant percentage of our net revenue. The historic percentages in the table above are not necessarily indicative of the percentage of net sales that we may receive from any customer in the future.
Competition
The telecommunications network industry is highly competitive. The Company has one significant competitor with its ISM product group, Ion Networks, Inc. The Company has many competitors in the Digital Switching Systems product group with the dominant players being Lucent and NORTEL. Management of the Company believes the Company’s products are competitive in price, product performance, warranty, technology and service.
Research and Product Development
The Company maintains continuing research and development efforts directed toward enhancement of its existing product lines and development of new products. The Company’s research and development expenditures during the fiscal years ended December 31, 2005, 2004 and 2003 were $3,673, $3,114 and $4,191, respectively.
Regulatory
Federal Communications Commission. The Company must comply with certain regulatory guidelines. Part 68 of the Federal Communications Commission (“FCC”) Rules (“Part 68”) contains the majority of the technical requirements with which telephone systems must comply to qualify for FCC registration for interconnection to the public telephone network. Part 68 registration represents a determination by the FCC that telecommunication equipment interfacing with the public telephone network complies with certain interference parameters and other technical specifications. FCC registration for the Company’s products has been granted and the Company intends to apply for FCC registration for all of its new products.
Certain of the Company’s products are also subject to and comply with regulation under Part 15 of the FCC Rules (“Part 15”) which requires equipment classified as containing a Class A computing device to meet certain radio and television signal interference requirements. Notwithstanding this minimum compliance; however, Part 15 provides that operators of equipment containing Class A computing devices may be required to take whatever steps are necessary to correct radio and television interference caused by operation of such equipment in a residential area.
Environmental. We are subject to a variety of federal, state, local and foreign environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during our manufacturing process. Although we believe that we are currently in substantial compliance with all material environmental regulations, any failure to comply with present and future regulations could subject us to future liabilities or the suspension of production. In addition, such regulations could restrict our ability to expand our facilities or could require us to acquire costly equipment or to incur other significant expense to comply with environmental regulations.
Employees
As of December 31, 2005, the Company employed 256 personnel.
Available Information
Copies of Teltronics’ Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge through Teltronics’ website (www.teltronics.com) as soon as reasonably practicable after we electronically file the material with, or furnish it to, the Securities and Exchange Commission. The information on our website is not, and shall not be deemed to be, a part of this report or incorporated into any other filings we make with the Securities and Exchange Commission.
