The following discussion and analysis should be read in conjunction with the foregoing unaudited Condensed Consolidated Financial Statements and related notes thereto appearing elsewhere in this Report.

Overview

Business

TII Network Technologies, Inc. and subsidiaries (together, "Tii," the "company," "we," "us" or "our") design, manufacture and sell products to service providers in the communications industry for use in their networks. Our products are typically found outdoors in the service provider's distribution network, at the interface where the service provider's network connects to the user's network, and inside the user's home or apartment, and are critical to the successful delivery of voice and broadband communication services.

We sell our products through a network of sales channels, principally to telephone operating companies ("Telcos"), multi-system operators ("MSOs") of communications services, including cable and satellite service providers, and original equipment manufacturers ("OEMs").

Results of Operations

The following table sets forth certain statement of operations information as a
percentage of net sales for the periods indicated (except "Income tax
provision," which is stated as a percentage of "(Loss) income before income
taxes"):



                                               Three months ended March 31,
                                                2009                     2008
                                                                                             Dollar           Percent
                                                       % of                   % of          increase          increase
                                        Amount      Net sales    Amount    Net sales       (decrease)        (decrease)
Net sales                              $  5,749        100.0 %   $ 8,851      100.0 %      $   (3,102 )       (35.0 %)
Cost of sales                             3,622         63.0 %     5,599       63.3 %          (1,977 )       (35.3 %)
Gross profit                              2,127         37.0 %     3,252       36.7 %          (1,125 )       (34.6 %)

Operating expenses:
Selling, general and administrative       1,884         32.8 %     2,407       27.2 %            (523 )       (21.7 %)
Research and development                    439          7.6 %       622        7.0 %            (183 )       (29.4 %)
Total operating expenses                  2,323         40.4 %     3,029       34.2 %            (706 )       (23.3 %)

Operating (loss) income                    (196 )       -3.4 %       223        2.5 %            (419 )      (187.9 %)

Interest income                               3          0.1 %        17        0.2 %             (14 )       (82.4 %)

(Loss) income before income taxes          (193 )       -3.4 %       240        2.7 %            (433 )      (180.4 %)
Income tax provision                         39        -20.2 %        89       37.1 %             (50 )       (56.2 %)
Net (loss) income                      $   (232 )       -4.0 %   $   151        1.7 %      $     (383 )      (253.6 %)

Net sales for the three months ended March 31, 2009 were $5,749,000 compared to $8,851,000 for the comparable prior year period, a decrease of $3,102,000 or 35.0%. The decline was due to the sharp downturn in economic activity which has negatively impacted the markets for our connectivity, network interface device and overvoltage surge protection products. This decrease was partially offset by an increase in sales of our broadband products.

Gross profit for the three months ended March 31, 2009 was $2,127,000 compared to $3,252,000 for the comparable prior year period, a decrease of $1,125,000 or 34.6%, which was primarily due to lower sales volume. Gross profit margin remained virtually consistent at 37.0% and 36.7% for the three months ended March 31, 2009 and 2008, respectively. Though the margins have been flat with lower sales, we are under increasing pressure from customers to reduce prices.

          Salary and related benefits - headcount decreases   $ 189,000
          SOX 404 and ERP implementation consulting fees        131,000
          Travel and entertainment expenses                      57,000
          Professional and consulting fees                       48,000
          Advertising                                            47,000
          Sales commissions as a result of decreased sales       39,000
          Other, net                                             12,000
                                                              $ 523,000

Research and development expenses for the three months ended March 31, 2009 were $439,000 compared to $622,000 for the comparable prior year period, a decrease of $183,000 or 29.4%. The decrease was primarily attributable to a decrease in salary and related benefits of $101,000 as a result of decreases in headcount and a decrease of $53,000 in product development activities during the current year period.

Interest income for the three months ended March 31, 2009 was $3,000 compared to $17,000 for the comparable prior year period, a decrease of $14,000 or 82.4%. The decrease was due to lower interest earned as a result of lower interest rates in the 2009 period than the 2008 period.

During the three months ended March 31, 2009 and 2008, we recorded a provision for income taxes of $39,000 and $89,000, respectively. Our income tax provision for each period consists of amounts necessary to align our year-to-date tax provision with the effective tax rate we expect to achieve for the full year. That rate differs from the U.S. statutory rate primarily as a result of the non-deductibility of certain share-based compensation expense for income tax purposes that has been recognized for financial statement purposes, state taxes and additionally, in the current year period, an increase in the valuation allowance against deferred tax assets for our estimate of state net operating losses that will expire unutilized.

Impact of Inflation

We do not believe our business is affected by inflation to a greater extent than the general economy. Our products contain a significant amount of plastic that is petroleum based. We import most of our products from contract manufacturers, principally in Malaysia and China, and fuel costs are, therefore, a significant component of transportation costs to obtain delivery of products. Accordingly, an increase in petroleum prices can potentially increase the cost of our products. Increased labor costs in the countries in which our contract manufacturers produce products for us and a continuing increase in the cost of precious metals could also increase the cost of our products. We monitor the impact of inflation and attempt to adjust prices where market conditions permit, except that we may not increase prices under our general supply agreement with Verizon Services Corp. Inflation has not had a significant effect on our operations during any of the reported periods.

Liquidity and Capital Resources

As of March 31, 2009, we had $19,569,000 of working capital, which included $9,535,000 of cash and cash equivalents, and our current ratio was 11.2 to 1.

The primary reason for the $1,379,000 of cash provided by operating activities in the first three months of 2009 compared to the $1,088,000 cash used in operating activities in the first three months of 2008 was a $678,000 reduction in inventories in the 2009 period compared to a $3,487,000 temporary build-up of inventories in the 2008 period to fulfill anticipated sales. This $4,165,000 variation was partially offset by a reduction in accounts receivable in the 2009 period of $1,075,000 compared to a reduction in the 2008 period of $2,556,000. This was due to a significantly lower accounts receivable balance at January 1, 2009 of $3,906,000 than at January 1, 2008 of $6,994,000, as a result of a decrease in sales volume of $4,042,000 from the quarter ended December 31, 2007 to the quarter ended December 31, 2008.

In December 2008, we entered into an amended credit agreement with JP Morgan Chase Bank, N.A. (the "amended agreement") which replaced a $5,000,000 credit facility that was expiring. Under the amended agreement, we are entitled to borrow from the bank up to $5,000,000 in the aggregate at any one time outstanding, but limited to a borrowing base, in general, equal to 80% of eligible accounts receivable (as defined), plus the lesser of 30% of eligible inventory (as defined, generally to include, with certain exceptions, inventories at the Company's continental United States warehouse), after certain reserves, or $1,500,000. As of March 31, 2009, our borrowing base was $3,700,000. Loans under the amended agreement mature on December 31, 2010. We had no borrowings outstanding under the amended agreement as of March 31, 2009.

Outstanding loans under the amended agreement bear interest, at our option, either at (a) the bank's prime rate plus 2.75% per annum, provided that the prime rate shall not be less than an adjusted one-month London Interbank Offered Rate ("LIBOR") (as defined in the amended agreement), or (b) under a formula based on LIBOR plus 4.5% per annum. We also pay a commitment fee equal to 0.25% per annum on the average daily unused portion of the credit facility.

Our obligations under the amended agreement are collateralized, pursuant to a Continuing Security Agreement, by all of our accounts receivable and inventory, and are also guaranteed by one of our subsidiaries.

The amended agreement contains various covenants, including financial covenants and covenants that prohibit or limit a variety of actions without the bank's consent. These include, among other things, covenants that prohibit our payment of dividends and limit our ability to repurchase stock, incur or guarantee indebtedness, create liens, purchase all or a substantial part of the assets or stock of another entity, other than certain permitted acquisitions, create or acquire any subsidiary, or substantially change our business. The amended agreement requires us to maintain, as of the end of each fiscal quarter, tangible net worth and subordinated debt of at least $35,300,000, a ratio of net income before interest expense and taxes for the 12-month period ending with such fiscal quarter to interest expense for the same period of at least 2.25 to 1.00, and a ratio of total liabilities, excluding accounts payable in the ordinary course of business, accrued expenses or losses and deferred revenues or gains, to net income before interest expense, income taxes, depreciation and amortization for the 12-month period ending with the fiscal quarter for which compliance is being determined of not greater than 2.5 to 1.0. As of March 31, 2009, we were in compliance with all financial covenants in the amended agreement.

We believe that existing cash, together with internally generated funds and the available line of credit, will be sufficient for our working capital requirements and capital expenditure needs for at least the next twelve months.

Seasonality

Our operations are subject to seasonal variations primarily due to the fact that our principal products, NIDs, are typically installed on the side of homes. During the hurricane season, sales may increase depending upon the severity and location of hurricanes and the number of NIDs that are damaged and need replacement. Conversely, during winter months when severe weather hinders or delays the Telco's installation and maintenance of their outside plant network, NID sales have been adversely affected until replacements can be installed (at which time sales increase).

We have no off-balance sheet contractual arrangements, as that term is defined in Item 303(a)(4) of Regulation S-K.

Critical Accounting Policies, Estimates and Judgments

Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and judgments. A summary of our most critical accounting policies can be found in the Management's Discussion and Analysis of Financial Condition and Results of Operation section of our Annual Report on Form 10-K for year ended December 31, 2008. We regularly evaluate items which may impact our critical accounting estimates and judgments. During the three months ended March 31, 2009, we did not update our critical accounting policies.

Recently Adopted Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS 157 indicates, among other things, that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. SFAS 157 defines fair value based upon an exit price model. In February 2008, the FASB issued FASB Staff Positions (FSP) SFAS No. 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Its Related Interpretive Accounting Pronouncements That Address Leasing Transactions," and FSP SFAS No. 157-2, "Effective Date of FASB Statement No. 157." FSP SFAS 157-1 removes leasing transactions from the scope of SFAS No. 157, while SFAS No. 157-2 deferred the effective date of SFAS 157 to the fiscal year beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. It did not defer recognition and disclosure requirements for financial assets and financial liabilities, or for nonfinancial assets and nonfinancial liabilities that are remeasured at least annually. Effective January 1, 2008, we adopted SFAS 157, with the exception of the application of the statement to non-recurring nonfinancial assets and nonfinancial liabilities, which we adopted effective January 1, 2009. The adoption of SFAS 157 did not impact our financial position or results of operations.

In November 2007, the FASB Emerging Issues Task Force ("EITF") issued EITF 07-5, "Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity's Own Stock." As a result of EITF 07-5, freestanding warrants containing protective features, which provide for adjustments to the exercise or conversion price if the entity subsequently issues shares or other equity-related contracts to a new investor with more favorable pricing, will no longer be eligible to be recorded in equity. EITF 07-5 became effective for us on January 1, 2009. EITF 07-5 has not impacted us to date as we have no outstanding instruments that contain these protective features. We will assess the impact of EITF 07-5 if and when we issue instruments that contain these protective features.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"). SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141(R) also established disclosure requirements to enable the evaluation of the nature and financial effects of the

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements," ("SFAS 160") which will require noncontrolling interests, previously referred to as minority interests, to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. SFAS 160 became effective for us on January 1, 2009. SFAS No. 160 has not impacted us to date as there are no such noncontrolling interests. We will assess the impact of SFAS 160 if and when any noncontrolling interests should arise.

Certain statements in this Quarterly Report on Form 10-Q 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 our 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 our actual results, performance or achievements to differ materially from those described or implied in the forward-looking statements as a result of several factors, including, but not limited to, those factors discussed below and elsewhere in this document. We undertake no obligation to update any forward-looking statement to reflect events after the date of this Report. Among those factors are:

• general economic and business conditions, especially as they pertain to the telecommunications industry;

• potential changes in customers' spending and purchasing policies and practices, which are effected by customers' internal budgetary allotments that may be impacted by the current economic climate, particularly in the United States;

• pressure from customers to reduce pricing without achieving a commensurate reduction in costs;

• the ability to market and sell products to new markets beyond our principal copper-based telephone operating company ("Telco") market which has been declining over the last several years, due principally to the impact of alternate technologies;

• exposure to increases in the cost of our products, including increases in the cost of our petroleum-based plastic products and precious metals;

• the ability to timely develop products and adapt our existing products to address technological changes, including changes in our principal market;

• competition in our traditional Telco market and new markets into which we have been seeking to Ex;

• dependence on, and ability to retain, our "as-ordered" general supply agreements with our largest customer and our ability to win new contracts;

• dependence on third parties for certain product development;

• dependence for products and product components from Pacific Rim contract manufacturers, including on-time delivery that could be interrupted as a result of third party labor disputes, political factors or shipping disruptions, quality control and exposure to changes in costs and changes in the valuation of the Chinese Yuan;

• weather and similar conditions, including the effect of typhoons on our assembly facilities in the Pacific Rim, the effect of hurricanes on our warehouse in the United States which can increase the demand for our products and harsh winter conditions which can temporarily disrupt the installation of certain of our products by Telcos;

• the ability to attract and retain technologically qualified personnel; and

• the availability of financing on satisfactory terms.