TII NETWORK TECHNOLOGIES INC - 10-K Annual Report

SECURITIES AND EXCHANGE COMMISSION
Washington. D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 27, 2003

Commission File Number 1-8048

TII NETWORK TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
                                    Delaware                                                               66-0328885
                             (State or other jurisdiction of                                                (I.R.S. Employer Identification No.)
                            incorporation or organization)

1385 Akron Street, Copiague, New York 11726
(Address of principal executive offices) (Zip Code)

(631) 789-5000
(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:
Common Stock. $.01 par value
Series D Junior Participating Preferred Stock Purchase Rights

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

The aggregate market value of the voting stock of the registrant outstanding as of September 19, 2003 held by non-affiliates of the registrant was approximately $11.6 million. While such market value excludes the market value of shares that may be deemed beneficially owned by executive officers and directors, this should not be construed as indicating that all such persons are affiliates.

The number of shares of the Common Stock of the registrant outstanding as of September 19, 2003 was 11,922,284.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement relating to its 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.

Forward-Looking Statements

Certain statements in this Report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this Report, words such as “may,” “should,” “seek,” “believe,” “expect,” anticipate,” “estimate,” “project,” “intend,” “strategy” and similar expressions are intended to identify forward-looking statements regarding events, conditions and financial trends that may affect the Company’s future plans, operations, business strategies, operating results and financial position. Forward-looking statements are subject to a number of known and unknown risks and uncertainties that could cause the Company’s actual results, performance or achievements to differ materially from those described or implied in the forward-looking statements. These factors include, but are not limited to:

general economic and business conditions, especially as it pertains to the telecommunications industry;
the level of inventories maintained by the Company's customers;
potential changes in customer spending and purchasing policies and practices;
potential technological changes, including the Company's ability to timely develop new products and adapt its existing products to technological changes (see "Business - Products" and "Business - Research and Development");
risks inherent in new product introductions, such as start-up delays and uncertainty of customer acceptance (see "Business -General");
the Company's ability to market existing and new products (see "Business - General" and "Business - Marketing and Sales");
the Company's ability to retain and win contracts;
the Company's dependence on third parties for product manufacturing and product components (see "Business - Raw Materials" and "Business - Manufacturing");
the Company's ability to maintain its relationship with or reduce its dependence upon one of its principal contract manufacturers which is an affiliate of a principal customer (see "Business - Manufacturing");
the potential for the disruption of shipments to major customers as a result of, among other things, third party labor disputes, political unrest in or shipping disruptions from countries in which the Company's contract manufacturers produce the Company's products;
weather and similar conditions, particularly the effect of hurricanes on the Company's manufacturing, assembly and warehouse facilities in Puerto Rico or the Pacific Rim (see "Business - Manufacturing" and "Properties");
competition (see "Business - Competition");
the Company's ability to attract and retain technologically qualified personnel (see "Business - Employees");
the Company's ability to fulfill its growth strategies (see "Business - Research and Development");
the Company's ability to maintain the listing of its Common Stock on the Nasdaq SmallCap market (see "Market For Registrant's Common Equity and Related Stockholder Matters");
the availability of financing on satisfactory terms (see "Management's Discussion and Analysis of Financial Condition and Results of Operations").

Part I

ITEM 1. Business

General

TII Network Technologies, Inc. and Subsidiary, formerly named TII Industries, Inc. (“Company” or “TII”), designs, produces and markets lightning and surge protection products, network interface devices (“NIDs”) and station electronic and other products. The Company sells these products principally to United States telephone operating companies (“Telcos”), including the Regional Bell Operating Companies (“RBOCs”) and Independent Operating Companies (together, incumbent local exchange carriers or “ILECs”) and competitive local exchange carriers (“CLECs”). The Company also sells to original equipment manufacturers (“OEMs”) and multi-system operators (“MSOs”) of communications services. The Company believes that its products offer superior, cost-effective performance, features and characteristics, including high reliability, long life cycles, ease of installation and optimum protection against adverse environmental conditions. This has resulted in TII becoming a leading supplier of overvoltage surge protectors to the ILECs for use at their subscriber locations.

Overvoltage surge protection is mandated in the United States by the National Electrical Code (“NEC”) to be installed on subscriber telephone lines to prevent injury to users and damage to their equipment due to surges caused by lightning and other hazardous overvoltages. The NEC is published by the National Fire Protection Agency and typically is adopted by states and local municipalities. While similar requirements exist in most other developed countries, a significant portion of the world’s communications networks remains unprotected from the effects of overvoltage surges. The 1999 edition of the NEC requires overvoltage surge protection to be included on network powered coax lines, a technology that brings telephony and broadband services to homes and businesses. The Company’s patented broadband In-Line® coax protector product line was designed to address this market.

The Company also markets a line of NIDs tailored to various customer specifications. NIDs house the FCC mandated demarcation point between Telco-owned and subscriber-owned property. NIDs typically also enclose overvoltage surge protectors and various station electronic products that, among other things, allow a Telco to remotely test the integrity of its lines, thereby minimizing costly maintenance dispatches.

To address the growing demands and complexities of communications networks in the home, the Company is in the process of bringing to market a multi-service residential gateway product through its traditional Telco distribution channels. This new system is referred to as a SID (Service Interface Device), and is being jointly developed and marketed with a technology partner.

As Telcos expand and upgrade their networks with new technologies to provide users the expanded bandwidth necessary for high-speed transmission of data over traditional Telco lines, TII has developed several station protection and electronic products for use on Telcos’ digital subscriber lines (“DSL”). DSL is superimposed over the existing telephone lines allowing high-speed data to be transmitted over a telephone line.

Recently, three RBOCs (Verizon, SBC and BellSouth) jointly announced a ten to fifteen year multi-billion dollar capital improvement program to deploy fiber optic lines to virtually all homes and businesses within their regions (referred to as Fiber to the Premise, or “FTTP”). FTTP transmission is significantly faster than traditional copper networks currently deployed by most Telcos and MSOs. As Telcos further expand into the highly competitive delivery of data and video services to subscribers, they believe that faster FTTP networks will give them a technological advantage over the MSOs. While the FTTP program is in the early stage of planning and evaluation by the RBOCs, its deployment could have a significant impact on the Company’s traditional protection based products since FTTP networks require less protection than traditional copper networks. Accordingly, the Company is currently developing a fiber optic based NID and is actively pursuing relationships with suppliers of fiber-optic based network products.

Restructuring and Other Charges

Over the last several years, in response to the telecommunications industry-wide slowdown, the Company has restructured and downsized its operations to reduce its cost structure. These actions enabled the Company to operate profitably for the first quarter of fiscal 2003. However, during the second and third quarters of fiscal 2003, the continuation of the telecommunications industry-wide slowdown and a work slowdown at the Company’s principal customer were primarily responsible for a decline in sales from the first quarter levels, resulting in losses for the second and third quarters. In response to this sales decline, the Company took additional steps to lower its cost structure, including a workforce reduction in the second quarter of fiscal 2003. The Company’s efforts to reduce its cost structure, together with increased sales in the fourth quarter of fiscal 2003, contributed to the Company’s return to profitability in the fourth quarter of fiscal 2003.

Products

Lightning and Overvoltage Surge Protection Products. The Company designs, produces and markets overvoltage surge protection products principally for the Telco industry. The Company’s surge protection products are primarily for use on the subscribers’ home or business telephone lines. Surge protectors: (i) protect the subscribers and their equipment; (ii) reduce the subscribers’ loss of service; (iii) reduce the communications providers’ loss of revenue due to subscriber outages; and (iv) reduce the communications providers’ costs to replace or repair damaged equipment. Overvoltage surge protectors differ in power capacity, application, configuration and price to meet varying needs.

In the United States, the NEC mandates overvoltage surge protectors to be installed on all subscribers’ telephone lines that are exposed to lightning and accidental contact with electric light or power conductors.

Gas Tubes: The Company’s gas tubes represent the foundation upon which most of the Company’s overvoltage surge protector products are based. The principal component of the Company’s overvoltage surge protector is a proprietary two or three electrode gas tube. Overvoltage surge protection is provided when the voltage on a communication line elevates to a level preset in the gas tube, at which time the gases in the tube instantly ionize, momentarily disconnecting the phone or other equipment from the circuit while safely conducting the hazardous surge to ground. When the voltage on the line drops to a safe level, the gases in the tube return to their normal state, returning the phone and other connected equipment to service. The Company’s gas tubes are a standard in the industry and have been designed to withstand multiple high-energy overvoltage surges while continuing to operate over a long service life.

Modular Station Protectors: One of the Company’s most advanced overvoltage surge protectors, marketed under the trademark Totel Failsafe® (“TFS”), combines the Company’s three electrode gas tube with a thermally operated failsafe mechanism. The three-electrode gas tube is designed to protect equipment from hazardous overvoltage surges and the failsafe mechanism is designed to insure that, under sustained overvoltage conditions, the protector will become permanently grounded. In certain of its modular protectors the Company combines the TFS protection element with a sealing gel making this protector impervious to severe moisture or environmental contamination while providing advanced overvoltage surge protection. The Company has developed several overvoltage protectors for high-speed broadband applications.

Broadband Coaxial Protectors: The 1999 revision to the NEC requires overvoltage surge protection on all network powered subscriber coax lines, a cable technology that brings telephony and broadband services to homes and businesses. As an integral part of the Company’s broadband product line, the Company has developed and patented a high-performance, 75-ohm Broadband Coax Protector to safeguard coaxial cable lines. While providing overvoltage surge protection, the Company’s In-Line® Broadband Coax Protectors are virtually transparent to the network, permitting high-bandwidth signals to be transmitted without adversely affecting the signal.

Utilizing the Company’s patent on In-Line® Coaxial Cable Surge Protectors, the Company also offers for sale a 50-ohm Base Station Protector product line which is designed to protect wireless service providers’ cell sites from the damaging effects of lightning and other surges.

Solid State and Hybrid Modular Station Protectors: Incorporating solid-state components, the Company’s products include solid-state overvoltage surge protectors. While solid-state overvoltage surge protectors are faster than gas tube overvoltage surge protectors at reacting to surges, a feature that some customers believe important in protecting certain of their sensitive equipment, they have lower energy handling capability and higher capacitance than gas tubes. When an overvoltage surge exceeds the energy handling capacity of the solid-state protector, it fails, causing the telephone or other connected equipment to cease operating. High capacitance on a communication line adversely affects high-bandwidth transmission, distorting the signal. As a result, most Telcos use high-energy handling, low capacitance gas tube protectors at the subscriber location. In the Telco’s switching center, where lower energy handling and higher capacitance is not a major concern, solid-state protectors are used more frequently. As communications equipment becomes more complex, a protector’s reaction speed to a surge may be perceived to be more critical than its energy handling capabilities. In response, the Company has also combined solid-state protectors with the Company’s gas tubes in hybrid overvoltage surge protectors. While generally more expensive and complex than gas tube surge protectors, the hybrid surge protector can provide the speed of a solid-state protector with the energy handling capability of a gas tube. (See “Business - -Competition.”)

AC Powerline Protectors: TII’s powerline surge protectors utilize the Company’s surge protection technology and are principally used by Telcos at their central office (“CO”) locations. These devices protect the connected communication equipment against damage or destruction caused when overvoltage surges enter equipment through the powerline. These products have superior surge handling characteristics compared to the standard strip surge protectors that plug into a homeowner’s AC outlet.

AC Powerline/Dataline Protectors: The Company has developed the TII Lightning and Power Surge Shield™ protection system for personal computers and home entertainment systems. The TII Lightning and Power Surge Shield™ combine the Company’s powerline protection technology with the Company’s proprietary protection for the telephone, DSL, Ethernet and universal serial bus (“USB”) and coax lines. The powerline/dataline protector has unique protection and low capacitance qualities that are ideal for certain applications, especially where protection and low capacitance are necessary, particularly in the emerging market for Home Power Plug networking applications.

Lightning and overvoltage surge protection products, sold separately from NIDs, accounted for approximately 27%, 31% and 56% of the Company’s net sales during the Company’s fiscal years 2003, 2002 and 2001, respectively.

Network Interface Devices. The Company designs, produces and markets various NIDs, which house the FCC mandated demarcation point between Telco-owned and subscriber-owned property. The Company’s NIDs typically also enclose its overvoltage surge protectors and various station electronic products that, among other things, allow Telcos to remotely test the integrity of their lines minimizing costly maintenance dispatches.

To address the demand for voice, high-speed data and interactive video services, Telcos and MSOs are expanding and upgrading their networks to accommodate the higher bandwidth necessary to transmit these services. In response, and with future technology in mind, TII has developed a line of broadband NIDs designed to enclose the technology of choice needed to accommodate higher bandwidth signals, whether traditional twisted pair lines, high-bandwidth coaxial cable or fiber optic lines. The Company’s broadband NID product line is modular in design and thus facilitates expansion to accommodate additional subscriber access lines. For use in various markets, the NID product line currently consists of enclosures that accommodate from one to twenty-five access lines. The Company’s broadband NIDs can also accommodate TII’s DSL electronic products in addition to the Company’s patented coaxial overvoltage surge protector. The Company is currently developing a fiber optic based NID to address the anticipated requirements of the FTTP deployment. NID sales represented approximately 62%, 61% and 39% of the Company’s net sales during fiscal 2003, 2002 and 2001, respectively.

Station Electronic and Other Products. The Company designs, produces and markets station electronic products that are typically installed within a NID. One of the Company’s station electronic products allows a Telco to remotely test the integrity of its lines, minimizing costly maintenance dispatches.

Additionally, as Telcos expand and upgrade their networks with new technologies to provide users with the expanded bandwidth necessary for high-speed transmission of data over traditional Telco lines, TII has developed several DSL station electronic products for this market, including DSL filters and splitters.

Home Networking Systems. To address the growing demands and complexities of communications networks in the home, the Company is in the process of bringing to market a multi-service residential gateway product through its traditional Telco distribution channels. This new system, referred to as a SID (Service Interface Device), is being jointly developed and marketed with a technology partner.

Research and Development

New product opportunities continue to arise in the Company’s traditional Telco markets as well as in the OEM and MSO markets. The Company also continues to evaluate the commercial, industrial and international markets for its current products as well as variations of them. The Company’s research and development (“R&D”) and related marketing efforts are focused on several projects, currently including:

Expanding the NID product line to further penetrate the Telco markets, including the Independent and Canadian markets,
Expanding and enhancing SID, the Company’s multi-service residential gateway system,
Developing fiber optic connectivity products and enclosures, including a broadband NID product line, to address the anticipated future deployment of FTTP, as well as the expanding use of fiber in homes and businesses,
Further developing DSL and coaxial cable overvoltage surge protectors and station electronics for the growing broadband communications markets, including Telcos and MSOs,
Expanding powerline protection technology into targeted markets; and
Developing sealed IDC (Insulation Displacement Connection Technology) cross-connect terminal enclosures.

The Company’s R&D strategy includes developing products internally, with technology partners and with contract manufacturers. The Company’s R&D engineers work closely with its contract manufacturers during the design and development phase of all products, especially its gas tubes and enclosures. The Company is jointly developing and marketing SID with a technology partner.

The Company’s R&D department is skilled and experienced in various technical disciplines, including physics, electrical and mechanical design, with specialization in such fields as plastics, electronics, metallurgy and chemistry. The Company’s contract manufacturing partners are similarly skilled in these R&D fields, with engineering and manufacturing expertise to bring a product of the highest quality and at a competitive price to market on time. The Company’s SID technology partner is skilled in the design of systems products for advanced communications networks.

The Company utilizes advanced computer aided design equipment networked with collaborative partners and directly linked to stereo lithographic modeling capability to accelerate time-to-market.

The Company’s R&D expense was $1.3 million, $1.8 million and $2.9 million during fiscal years 2003, 2002 and 2001, respectively. The decreases in both fiscal years 2003 and 2002 were due to the development costs incurred in fiscal 2001 for the Digital product line, which was discontinued in fiscal 2002, and the Company’s ability to reduce these expenses through the use of collaborative engineering efforts with its contract manufacturers. (See “Business – Manufacturing”)

Marketing and Sales

Prior to selling its products to a customer, the Company must typically undergo a potentially lengthy product qualification process involving approval agencies designated by law, codes and/or customers. Thereafter, the Company continually submits successive generations of products, as well as new products, to its customers for qualification. The Company believes that being a leading supplier of overvoltage surge protectors for over 30 years, its current position as a leading supplier to the Telcos and its strategy for developing products by working closely with its customers provide a strong position from which it can market its current and anticipated new products.

The Company sells to its customers primarily through its direct sales force, a network of distributors and sales representatives. TII also sells to competitive NID suppliers, who incorporate the Company’s overvoltage surge protectors into their products for resale to Telcos.

The following customers accounted for 10% or more of the Company’s consolidated net sales during one or more of the years presented below. The loss of, or the disruption of shipments to, one of these customers could have a material adverse effect on the Company’s results of operations and financial condition.

	Year Ended
	June 27, 2003			June 28, 2002			June 29, 2001
Verizon Corporation (1)		58	%		57	%		33	%
Tyco Electronics Corporation (2)		7	%		11	%		26	%
Telco Sales, Inc.		10	%		6	%		7	%

(1)

The Company is operating under a supply agreement with Verizon that expires in April 2006 and provides for an extension by Verizon for up to one year from that date.

(2)

Tyco Electronics Corporation (a successor to Raychem Corporation) is an OEM that purchases overvoltage protection products from the Company for inclusion within their products, including NIDs.

Purchases of the Company’s products are generally based on individual customer purchase orders for delivery from inventory or within up to thirty days under general supply contracts. The Company, therefore, has no material firm backlog of orders.

The Company’s international sales were approximately $768,000 in fiscal 2003 (3% of sales), $1.3 million in fiscal 2002 (4% of sales) and $1.9 million in fiscal 2001 (5% of net sales). International sales have been made primarily to countries in the Caribbean, South and Central America, Canada, the Pacific Rim and Europe. The Company requires foreign sales to be paid for in U.S. currency. International sales are affected by such factors as NAFTA requirements, exchange rates, changes in protective tariffs and foreign government import controls. The Company believes international markets continue to offer additional opportunities for its products and continues to seek methods to increase these sales.

Manufacturing

While the Company maintains a quick-response, low-cost assembly and specialty gas tube manufacturing operation at its facility in Puerto Rico, with the re-alignment of the Company’s operations, significantly all the high volume production has been outsourced and are now being produced by contract manufacturers within the Pacific Rim, principally Malaysia and China, utilizing, in most cases, the Company’s equipment and processes. The Company maintains all final quality assurance approval for all products prior to shipment.

The Company’s contract manufacturers’ facilities are listed by UL and are ISO 9000 registered. The Company continually evaluates its current and potential contract manufacturers to assure the highest quality product, best delivery and most competitive pricing.

One of the Company’s contract manufacturers is a subsidiary of Tyco Electronics Corporation that also owns a company that is a competitor and customer of the Company. A second contract manufacturer produces a significant portion of the Company’s proprietary gas tubes. This company also sells its own gas tubes to competitors of the Company. There are strict non-disclosure agreements with each of these contract manufacturers.

Raw Materials

The primary components of the Company’s products are stamped, drawn and formed parts made out of a variety of commonly available metals, ceramics and plastics. The manufacture of the Company’s overvoltage surge protectors and station electronic products use commonly available components, printed circuit boards and standard electrical components, such as resistors, diodes and capacitors. While the Company has no orders with suppliers of the components utilized in the manufacture of its products with delivery scheduled later than a year, the Company believes that the raw materials used will continue to be available in sufficient supply at competitive prices. The Company depends on its contract manufacturers to produce the majority of its products for sale to customers. These manufacturers are responsible for the purchase of raw materials, which must meet the Company’s specifications.

Competition

The Company faces significant competition across all of its product lines. Its principal competitors within the Telco market are Corning Cable Systems LLC, Tyco Electronics Corporation, which is also a customer of the Company (see “Business — Marketing and Sales”) and Bourns Inc.

The Company’s gas tube overvoltage surge protectors not only compete with other companies’ gas tube overvoltage surge protectors, but also with solid-state overvoltage surge protectors. While solid-state surge protectors react faster to surges, gas tube overvoltage surge protectors have generally remained the overvoltage surge protection technology of choice at the subscribers’ location by virtually all Telcos because of the gas tube’s ability to repeatedly withstand significantly higher energy surges than solid-state surge protectors. This enables gas tubes to survive longer in the field than solid-state surge protectors, reducing loss of service and costs in dispatching a maintenance vehicle to replace the failed surge protector. Further, solid state protectors have significantly higher capacitance than gas tube protectors. Higher capacitance adversely affects transmission on a high bandwidth communication line by distorting the signal. Solid state overvoltage surge protectors are used principally in Telcos’ central office switching centers where speed is perceived to be more critical than energy handling capabilities and in regions where there is a low incidence of lightning. The Company believes that, for the foreseeable future, both gas tube and solid state protectors will continue to be used as overvoltage surge protectors within the Telco market. The Company also believes that the deployment of FTTP networks by the Telcos could include significantly different protection requirements, which have not yet been determined. The Company is currently developing a fiber optic based NID, while also closely monitoring the developments of these new requirements.

The Company’s reputation among its customers is one of providing swift responses to their needs with creative and effective solutions using products compliant with, and in most cases superior in performance to, the demanding specifications of customers. This approach, combined with the Company’s history of continually improving technology, improved operations and effective collaborations, allows the Company to bring product solutions to its customers faster, more effectively and more competitively priced.

Principal competitive factors within the Company’s Telco markets include price, technology, product features, service, quality, reliability and bringing new products to market on time. Most of the Company’s competitors have substantially greater financial, sales, manufacturing and product development resources than the Company. The Company believes that its sales, marketing and research and development departments, its high quality products and service, its contract manufacturers’ low cost production capabilities and their engineering resources combined with the Company’s overvoltage surge protection technology, enable it to maintain its competitive position.

Patents and Trademarks

The Company owns or has applied for a number of patents relating to certain of its products or product components and owns a number of registered trademarks that are considered to be of value principally in identifying the Company and its products. TII®, In-Line®, Totel Failsafe® and Angle Driver® are among the registered trademarks of the Company. While the Company considers its patents and trademarks to be important, especially in the early stages of product marketing, it believes that, because of technological advances in its industry, its success depends primarily upon its sales, engineering and manufacturing skills and effective development collaborations which have accelerated time-to-market of improved and new products. To maintain its industry position, the Company relies primarily on technical leadership, trade secrets, its proprietary technology and its contract manufacturers’ low cost production capabilities and their engineering resources.

Government Regulation

The Telco industry is subject to regulation in the United States and in other countries. In the United States, the FCC and various state public service or utility commissions regulate most of the Telcos and other communications access providers who use the Company’s products. While such regulations do not typically apply directly to the Company, the effects of such regulations, which are under continuous review and subject to change, could adversely affect the Company’s customers and, therefore, the Company.

The NEC requires that an overvoltage surge protector listed by Underwriters Laboratories or another qualified electrical testing laboratory be installed on all subscribers telephone lines that are exposed to lightning and accidental contact with electric light or power conductors. Listing by Underwriters Laboratories has been obtained by the Company where required.

Compliance with applicable federal, state and local environmental regulations has not had, and the Company does not believe that compliance in the future will have, a material adverse effect on its earnings, capital expenditures or competitive position.

Certain Tax Attributes

Prior to July 1, 2000, the Company had elected the application of Section 936 of the U.S. Internal Revenue Code of 1986, as amended (“Code”). Under that section, the Company was entitled to a federal tax credit in an amount equal to the lesser of the United States federal tax attributable to its taxable income arising from the active conduct of its business within Puerto Rico or the economic activity based credit limitation (on a non-consolidated basis), provided that in its current and two preceding tax years at least 80% of its gross income and at least 75% of its gross income from the active conduct of a trade or business were from Puerto Rico sources. Principally as a result of the Company’s restructurings, the potential for benefits under Section 936 for the Company was substantially reduced. Accordingly, in order to optimize the Company’s tax structure, during fiscal 2001 the Company ended its election under Section 936 of the Code. (See Note 4 of Notes to Consolidated Financial Statements for information relating to the Company’s net operating loss carryforwards.)

Employees

On September 19, 2003, the Company had approximately 76 full-time employees, of whom 43 were employed at the Company’s Puerto Rico facility. The Company has not experienced any work stoppage as a result of labor difficulties and believes it has satisfactory employee relations. The Company is not a party to any collective bargaining agreements.

ITEM 2. Properties

The Company occupies a single story building and a portion of another building, consisting of an aggregate of approximately 14,000 square feet in Copiague, New York under leases that expire in July 2005. These facilities house the Company’s principal research and development activities, marketing, administrative and executive offices.

The Company also leases a 20,000 square foot facility in Toa Alta, Puerto Rico, which is approximately 20 miles southwest of San Juan, under an agreement that expires in April 2006. This facility contains certain of the Company’s assembly and manufacturing, warehousing, research and development, and quality assurance function.

The Company believes that its facilities and equipment are well maintained and adequate to meet its current requirements.

ITEM 3. Legal Proceedings

The Company is not a party to any material pending legal proceedings.

ITEM 4. Submission Of Matters To A Vote Of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2003.

PART II

ITEM 5. Market For Registrant's Common Equity And Related Stockholder Matters

The Company’s Common Stock trades on the Nasdaq SmallCap Market under the symbol “TIII”. The Company’s stock currently trades below $1.00 and as such, is not in compliance with that market’s minimum bid price requirement. The Company has until October 21, 2003 to re-gain compliance before it faces the potential de-listing of its stock from that market. The following table sets forth, for each quarter during fiscal 2003 and 2002, the high and low sales prices of the Company’s common stock on that market:

Fiscal 2003	High		Low
First Quarter Ended September 27, 2002	$	.50	$	.26
Second Quarter Ended December 27, 2002		.50		.27
Third Quarter Ended March 27, 2003		.54		.13
Fourth Quarter Ended June 27, 2003		.50		.12

Fiscal 2002	High
First Quarter Ended September 28, 2001	$	1	.11	$	.51
Second Quarter Ended December 28, 2001			.90		.40
Third Quarter Ended March 29, 2002			.85		.38
Fourth Quarter Ended June 28, 2002			.54		.35

As of September 19, 2003, the Company had approximately 385 holders of record of its common stock.

To date, the Company has paid no cash dividends. For the foreseeable future, the Company intends to retain all earnings generated from operations for use in the Company’s business. Additionally, the Company’s borrowing arrangement entered into September 2003 prohibits the payment of cash dividends.

Information concerning the Company’s equity compensation plans will be contained in the Company’s Proxy Statement to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 with respect to the Company’s 2003 Annual Meeting of Stockholders and is incorporated by reference herein an in Item 13 of this Report.

ITEM 6. Selected Financial Data

The following Selected Financial Data has been derived from the Company’s consolidated financial statements for the five years ended June 27, 2003 and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements and the related notes thereto, included elsewhere in this Report:

Selected Financial Data
(Dollars in thousands, except per share data)

	June 27, 2003			June 28, 2002(a)			June 29, 2001(a)			June 30, 2000			June 25, 1999
Statements of Operations Data(b)

Net sales	$	24,073		$	29,801		$	39,323		$	49,635		$	49,284
Operating loss	$	(997	)	$	(6,865	)	$	(7,589	)	$	(743	)	$	(9,211	)
Net loss attributable
to common stockholders	$	(1,008	)	$	(6,541	)	$	(7,540	)	$	(1,018	)	$	(6,402	)
Basic and diluted net loss
attributable to common stockholders,	$	(0.09	)	$	(0.56	)	$	(0.65	)	$	(0.11	)	$	(0.79	)
per share
Balance Sheet Data

Working capital	$	8,235		$	8,224		$	13,910		$	19,123		$	16,488
Total assets	$	15,101		$	18,528		$	30,762		$	37,316		$	41,230
Debt	$	39		$	489		$	1,463		$	1,567		$	3,077
Redeemable preferred stock	$	-		$	-		$	1,626		$	1,626		$	2,850
Stockholders' equity	$	13,771		$	14,779		$	21,224		$	28,761		$	24,893

______________________

(a)	See Management’s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of several factors that affected the Company’s results of operations in fiscal 2002 and 2001.

(b)	No cash dividends were declared in any of the reported periods.

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and notes thereto appearing elsewhere in this Report.

Business

TII Network Technologies, Inc. and Subsidiary, formerly named TII Industries, Inc., (collectively the “Company” or “TII”), designs, produces and markets lightning and surge protection products, network interface devices (“NIDs”), station electronic and other products. The Company has been a leading supplier of overvoltage surge protectors to U.S. telephone operating companies (“Telcos”) for over 30 years.

Critical Accounting Policies, Estimates and Judgments

TII’s consolidated financial statements have been prepared in accordance with accounting principles that are generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments. The Company believes that the determination of the carrying value of the Company’s inventories and long-lived assets are the most critical areas where management’s judgments and estimates most affect the Company’s reported results. While the Company believes its estimates are reasonable, misinterpretation of the conditions that effect the valuation of these assets could result in actual results varying from reported results, which are based on the Company’s estimates, assumptions and judgments as of the balance sheet date.

Inventories are required to be stated at net realizable value at the lower of cost or market. In establishing the appropriate inventory allowances, management assesses the ultimate recoverability of the inventory considering such factors as technological advancements in products as required by the Company’s customers, average selling prices for finished goods inventory, changes within the marketplace, quantities of inventory items on hand, historical usage or sales of each inventory item, forecasted usage or sales of inventory and general economic conditions.

The Company reviews long-lived assets, such as fixed assets to be held and used or disposed of, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows undiscounted and without interest is less than the carrying amount of the asset, an impairment loss is recognized in the amount by which the carrying amount of the asset exceeds its fair value.

Results of Operations

Overview

Over the last several years, in response to the telecommunications industry-wide slowdown, the Company has restructured and downsized its operations to reduce its cost structure. These actions enabled the Company to operate profitably for the first quarter of fiscal 2003. However, during the second and third quarters of fiscal 2003, the continuation of the telecommunications industry-wide slowdown and a work slowdown at the Company’s principal customer were primarily responsible for a decline in sales from the first quarter levels resulting in losses for the second and third quarters. In response to this sales decline, the Company took additional steps to lower its cost structure, including a workforce reduction in the second quarter of fiscal 2003. The Company’s efforts to reduce its cost structure, together with increased sales in the fourth quarter of fiscal 2003, resulted in the Company’s return to profitability in the fourth quarter of fiscal 2003.

In the fourth quarter of fiscal 2002, the Company further downsized its Puerto Rico operations with the objective of creating a quick-response, low-cost assembly and specialty gas tube manufacturing operation and further expanded the Company’s outsourcing strategy. These steps, together with the consolidation of certain functional departments and management responsibilities into the Company’s New York headquarters, resulted in additional workforce reductions and the reevaluation of the Company’s property, plant and equipment requirements, whereby the Company retained only those assets consistent with this strategy. Management also reevaluated its home networking strategy and made the decision to discontinue the Digital Closet Product line, which, despite receiving several industry awards, did not achieve expected results. Further, as a result of the continuing telecommunications industry-wide slowdown, the Company also reevaluated its inventories. As a result, the Company recorded charges in the fourth quarter of fiscal 2002 of $4.1 million that consisted of $1.9 million for the write-down of inventories determined to be excess or obsolete, $1.7 million for the impairment of long-lived assets and $0.5 million for severance and other costs.

In the third quarter of fiscal 2001, as part of management’s continuing strategy to improve profit margins by finding more cost-effective alternative ways of producing its products, and also as a result of the successes under a fiscal 1999 re-alignment plan, management committed to a plan to further re-align its operations. A key element of the 2001 plan was the expansion of the Company’s outsourcing strategy with contract manufacturers to produce a substantial portion of the remaining components and subassemblies that the Company was still manufacturing. Included in this plan were workforce and production facility reductions, the write-down of certain inventories and manufacturing machinery, equipment and leasehold improvements related to manufacturing activities conducted in Puerto Rico that were outsourced or were used for products that were eliminated, and other cost saving measures. Accordingly, during the third quarter of fiscal 2001, the Company recorded a net re-alignment of operations charge of approximately $6.2 million, including an inventory write-down of approximately $2.7 million (net of a reversal of a remaining allowance of $96,000 from a fiscal 1999 re-alignment charge), $2.9 million for the write-down of net fixed assets, a charge of $300,000 for employee termination benefits for a workforce reduction of 70 employees and $300,000 for a lease commitment for excess manufacturing space. (See Note 2 of Notes to Consolidated Financial Statements.)

Fiscal Years Ended June 27, 2003, June 28, 2002 And June 29, 2001

Net sales for fiscal 2003 decreased $5.7 million or 19.2% to $24.1 million from $29.8 million in fiscal 2002. Net sales for fiscal 2002 decreased $9.5 million or 24.2% to $29.8 million from $39.3 million in fiscal 2001. The sales decrease in both periods was due to the telecommunications industry-wide slowdown including cutbacks by telecommunications service providers in their construction and maintenance budgets and a reduction in the number of telephone access lines per subscriber being deployed. Beginning in the fourth quarter of fiscal 2003 and continuing into the first quarter of fiscal 2004, sales of the Company’s products have been increasing. The Company believes these increases are primarily due to severe weather conditions occurring in the Northeast and the South compounded by the low inventory levels that the service providers have been carrying.

Gross profit in fiscal 2003 was $5.8 million, or 24.1% of sales, compared to $7.2 million in fiscal 2002, or 24.2% of sales, excluding the $1.9 million inventory write-down for excess and obsolete inventory in fiscal 2002. The lower gross profit level in fiscal 2003 was due to the lower sales level. Excluding the inventory write-down in fiscal 2002, gross profit margins for fiscal 2003 and 2002 were essentially at the same levels, despite the lower sales levels in the fiscal 2003 period, due to the actions taken by the Company to reduce its cost structure and an improved mix of sales of higher margin products. Gross profit in fiscal 2002 was $7.2 million, or 24.2% of sales, excluding the $1.9 million inventory write-down, compared to $9.2 million in fiscal 2001, or 23.4% of sales, excluding the $2.7 million inventory write-down as a result of the operations re-alignment. The improved gross profit margin in fiscal 2002, excluding the inventory write-downs, was principally due to the success of the Company’s cost reduction efforts, including the 2001 operations re-alignment, its outsourcing strategy and an increased level of sales of technologically advanced, higher margin products.

Selling, general and administrative expenses in fiscal 2003 decreased $3.2 million, or 37.3%, to $5.5 million, from $8.7 million in fiscal 2002. The decrease in fiscal 2003 was principally due to the success of the Company’s cost reduction efforts and the effect of lower sales on variable expenses. Selling, general and administrative expenses for fiscal 2002 increased $906,000, or 11.6%, to $8.7 million from $7.8 million in fiscal 2001. The increase in fiscal 2002 was principally due to increased marketing expenses related to the introduction and marketing of the Company’s Digital Closet product line, which was discontinued in the fourth quarter of fiscal 2002, and $500,000 of severance and other charges.

Research and development expenses for fiscal 2003 decreased by $413,000, or 23.5%, to $1.3 million from $1.8 million in fiscal 2002. Research and development expenses for fiscal 2002 decreased by $1.1 million, or 38.9%, to $1.8 million from $2.9 million in fiscal 2001. The decreases in both fiscal years 2003 and 2002 were due to absence of the development costs incurred in fiscal 2001 for the Digital product line, which was discontinued in fiscal 2002, and the Company’s ability to reduce these expenses through the use of collaborative engineering efforts with its contract manufacturers. The Company expects that these expenses will increase in fiscal 2004 due to increased development efforts on a fiber capable NID for FTTP applications as well as other fiber optic products.

The charge of $1.7 million in fiscal 2002 was for the impairment of long-lived assets the Company no longer used. See “Overview”, above, for information concerning this charge and the charge for fiscal 2001 operations re-alignment costs, net of reversals.

Interest expense decreased in fiscal 2003 by $29,000 to $41,000 and in fiscal 2002 by $30,000 to $70,000 due to decreased borrowings under the Company’s credit facilities and a reduction in prevailing interest rates.

Interest income in fiscal 2003 increased by $9,000 to $17,000 from $8,000 in fiscal 2002 due to the higher comparable average cash and cash equivalent balances held by the Company during fiscal 2003. Interest income in fiscal 2002 decreased $139,000 to $8,000 from $147,000 due primarily to lower comparable average cash and marketable securities balances held by the Company during fiscal 2002.

Income Taxes

Due to the Company’s pre-tax losses, there was no tax provision during the three years ended June 27, 2003. Prior to July 1, 2000, the Company had elected the application of Section 936 of the U.S. Internal Revenue Code of 1986, as amended (“Code”). Under that section, the Company was entitled to a federal tax credit in an amount equal to the lesser of the United States federal tax attributable to its taxable income arising from the active conduct of its business within Puerto Rico or the economic activity based credit limitation (on a non-consolidated basis), provided that in its current and two preceding tax years at least 80% of its gross income and at least 75% of its gross income from the active conduct of a trade or business were from Puerto Rico sources. Principally as a result of the Company’s restructurings, the potential for benefits under Section 936 for the Company was substantially reduced. Accordingly, in order to optimize the Company’s tax structure, during fiscal 2001 the Company ended its election under Section 936 of the Code. (See Note 4 of Notes to Consolidated Financial Statements for information relating to the Company’s net operating loss carryforwards.)

Impact of Inflation

The Company does not believe its business is affected by inflation to a greater extent than the general economy. The Company monitors the impact of inflation and attempts to adjust prices where market conditions permit. Inflation has not had a significant effect on the Company’s operations during any of the reported periods.

Liquidity and Capital Resources

Fiscal 2003 Liquidity compared to Fiscal 2002

The Company’s cash and cash equivalents balance decreased during fiscal 2003 by $96,000 to $772,000 at the end of fiscal 2003. The decrease resulted from net cash flows used in financing activities of $474,000 primarily to repay the Company’s term loan, partially offset by net cash flows from operations of $293,000 and from investing activities of $85,000. Working capital was $8.2 million at the end of both periods.

During fiscal 2003 and fiscal 2002, the Company generated $293,000 and $2.9 million, respectively, of net cash from operating activities, compared to net cash used in operating activities in fiscal 2001 of $2.1 million. The cash generated from operating activities in fiscal 2003 was produced from cash provided by changes in operating assets and liabilities of $398,000 exceeding the Company’s net cash loss (net loss plus depreciation and amortization expense less gain on disposal of assets) of $105,000. The cash produced by changes in operating assets and liabilities resulted from a decrease of $997,000 in accounts receivable from the prior year balance to $2.5 million due to improved collections and lower sales and inventory decreases of $1.5 million primarily due to the fulfillment of sales orders with existing inventory, partially offset by a decrease in accounts payable and accrued expenses of $2.0 million due to the lower sales volume, cost reduction efforts implemented during the year and accelerated payments to vendors.

Net cash provided by investing activities was $85,000 in fiscal 2003 compared to $136,000 and $2.0 million of net cash used in fiscal 2002 and fiscal 2001, respectively. The comparative increase in net cash provided by investing activities during fiscal 2003 was principally the result of the sale of two of the Company’s condominiums. The Company currently does not plan to sell either of its two remaining condominiums.

Net cash used in financing activities was $474,000 in fiscal 2003 compared to $2.2 million and $102,000 in fiscal 2002 and fiscal 2001, respectively. The net cash used in financing activities in fiscal 2003 resulted principally from the repayment of $455,000 of borrowings under the Company’s revolving credit facility.

Fiscal 2002 Liquidity compared to Fiscal 2001

The Company’s cash and cash equivalents balance increased to $868,000 at the end of fiscal 2002 from $233,000 at the end of fiscal 2001. The increase resulted from net cash flows from operations of $2.9 million partially offset by cash outflows from investing activities of $136,000 and financing activities of $2.2 million. Working capital decreased to $8.2 million at the end of fiscal 2002 from $13.9 million at the end of fiscal 2001. This decrease was due primarily to a reduction in accounts receivable of $3.7 million and inventories of $6.4 million offset, in part, by an increase in cash of $635,000, a reduction in short-term borrowings of $721,000 and a reduction of $3.1 million in accounts payable and accrued liabilities.

During fiscal 2002, the Company generated $2.9 million of net cash from operating activities, compared to net cash used in operating activities in fiscal 2001 of $2.1 million. The cash generated from operating activities in fiscal 2002 was produced from cash provided by changes in operating assets and liabilities ($4.8 million) exceeding the Company’s net cash loss ($1.9 million). The cash produced by changes in operating assets and liabilities resulted from a decrease of $3.7 million in accounts receivable from the prior year balance to $3.5 million due to improved collections and lower sales and inventory decreases of $4.5 million primarily due to the fulfillment of sales orders with existing inventory and improved inventory management practices, partially offset by a decrease in accounts payable and accrued expenses due to the lower sales volume and cost reduction efforts implemented during the year. The Company used cash to fund a net loss from operations of $1.8 million, before non-cash charges of $1.9 million for inventory losses, $1.7 million for the impairment of long-lived assets, and $1.4 million for depreciation and amortization.

Net cash used in investing activities was $136,000 in fiscal 2002 compared to $2.0 million of net cash used in fiscal 2001. The comparative reduction in net cash used for investing activities during fiscal 2002 was principally the result of the purchases of capital equipment in fiscal 2001 for new gas tube manufacturing lines at the outsourcing facilities.

Net cash used in financing activities was $2.2 million in fiscal 2002 compared to $102,000 in fiscal 2001. The net cash used in financing activities in fiscal 2002 resulted from the repurchase of the Company’s Series C Convertible Redeemable Preferred Stock with a face value of $1.6 million for cash of $1.2 million and the issuance of a warrant, the repayment of borrowings under the Company’s revolving credit facility of $721,000 and payments of long-term debt and capital leases of $253,000.

Capital Resources

In September 2003, the Company replaced its prior credit facility that consisted of a $6.0 million revolving credit facility and a term loan with a new facility from another financial institution. As of June 27, 2003 and at the time the Company entered into the new facility, there were no borrowings outstanding under the prior credit facility. As of June 28, 2002, $455,000 was outstanding under the term loan, which was repaid in fiscal 2003. The new revolving credit facility (Credit Facility) enables the Company to have up to $3.0 million of revolving credit loans outstanding at any one time, limited by a borrowing base equal to 85% of eligible accounts receivable, subject to certain reserves. Outstanding borrowings under the Credit Facility bear interest at a specified bank’s prime rate plus 1% (5.0% at September 17, 2003), but never less than 5% per annum, and the Company is also required to pay an annual facility fee of 3/4 of 1% of the maximum amount of the Credit Facility. At June 27, 2003, the borrowing base would have been $2.2 million. The Credit Facility has an initial one year term and is automatically renewed for successive two year periods but may be terminated by the lender at any time on 60 days notice or the Company on 60 days notice prior to the end of the initial term or any renewal term. The Credit Facility is guaranteed by the Company’s subsidiary and is secured by a lien and security interest against substantially all of the assets of the Company. The Credit Facility requires, among other covenants, that the Company maintain a consolidated tangible net worth of at least $12.0 million and working capital of at least $6.0 million. The Credit Facility also prohibits, without the lender’s consent, the payment of cash dividends, significant changes in management or ownership of the Company, business acquisitions, the incurrence of additional indebtedness, other than lease obligations for the purchase of equipment, and the guarantee of the obligations of others.

Funds anticipated to be generated from operations, together with available cash, cash equivalents and the Company’s Credit Facility, are considered to be adequate to finance the Company’s operational and capital needs for the next twelve months.

Contractual Obligations and Commercial Commitments

The following table sets forth a schedule of payments required under the Company’s contractual obligations and includes the maximum potential payments that may be required under the Company’s other commercial commitments:

	Due by Period
Contractual Obligations:	Total		Less Than 1 Year		1 - 3 years		4 - 5 years		After 5 years
Capital lease obligations	$	31,000	$	18,000	$	13,000	$	-	$	-
Operating leases		292,000		136,000		156,000	-		-


Other long-term obligations		8,000		8,000		-	-		-


Total contractual cash obligations	$	331,000	$	162,000	$	169,000	$ -		$ -

The Company has no commitments for capital expenditures, but expects to purchase new equipment and incur leasehold improvements in the normal course of business.

Off-Balance Sheet Financing

The Company has no off-balance sheet contractual arrangements, as that term is defined in Item 304 (a) (4) of Regulation S-K.

Transactions With Related And Certain Other Parties

The Company had an agreement with David Garwood, a member of the Board of Directors, to provide strategic planning consulting services from April 1, 2002 to its expiration in March 31, 2003 at $10,000 per quarter.

Since 1982, the Company has leased equipment from PRC Leasing, Inc., a corporation owned by Alfred J. Roach, the Chairman of the Board of Directors of the Company. The rent under this annually renewable lease is $50,000. The lease was renewed on June 17, 2003. Rent expense under the lease was $50,000, $139,000 and $139,000 in fiscal 2003, 2002 and 2001, respectively.