UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 30, 2005
Commission File No. 0-8828
OPTELECOM-NKF, INC.
(Exact Name of Registrant as
Specified in its Charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
52-1010850
(IRS employer identification number)
12920 CLOVERLEAF CENTER DRIVE, GERMANTOWN, MARYLAND 20874
(Address of principal executive offices) (Zip code)
Registrant’s telephone number, including area code: (301) 444-2200.
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock $0.03 Par Value.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes o No ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes ý No
At November 11, 2005, the registrant had outstanding 3,296,089 shares of Common Stock, $.03 Par Value.
OPTELECOM-NKF, INC.
FORM 10-Q
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
OPTELECOM-NKF, INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2005 and DECEMBER 31, 2004
(Unaudited)
| | 2005 | | 2004 | |
ASSETS | | | | | |
CURRENT ASSETS | | | | | |
Cash and cash equivalents | | $ | 4,069,979 | | $ | 2,918,959 | |
Accounts and contracts receivable, net | | 6,348,060 | | 3,015,588 | |
Inventories, net | | 4,283,540 | | 2,867,882 | |
Deferred tax asset—current | | 1,122,022 | | 767,841 | |
Prepaid expenses and other current assets | | 765,072 | | 519,494 | |
Total current assets | | 16,588,673 | | 10,089,764 | |
| | | | | |
Property and equipment, net | | 2,740,369 | | 1,870,039 | |
Deferred tax asset—non-current | | 709,349 | | 406,606 | |
Goodwill and other intangible assets | | 20,539,186 | | — | |
TOTAL ASSETS | | $ | 40,577,577 | | $ | 12,366,409 | |
| | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | |
CURRENT LIABILITIES | | | | | |
Accounts payable | | $ | 1,646,654 | | $ | 798,965 | |
Accrued payroll | | 1,031,022 | | 394,185 | |
Commissions payable | | 451,835 | | 297,870 | |
Current portion of notes payable | | 2,479,449 | | 45,000 | |
Accrued warranty reserve | | 313,709 | | 130,084 | |
Other current liabilities | | 924,457 | | 523,078 | |
Total current liabilities | | 6,847,126 | | 2,189,182 | |
| | | | | |
Notes payable – senior | | 10,402,000 | | — | |
Notes payable – subordinated | | 8,287,428 | | 45,000 | |
Deferred tax liability | | 3,541,297 | | 11,526 | |
Deferred rent liability | | 215,078 | | 186,418 | |
Other | | 514,034 | | — | |
Total liabilities | | 29,806,963 | | 2,432,126 | |
| | | | | |
COMMITMENTS AND CONTINGENCIES | | | | | |
| | | | | |
STOCKHOLDERS’ EQUITY | | | | | |
Common stock, $.03 par value—shares authorized, 15,000,000; issued and outstanding, 3,289,885 and 3,179,109 shares as of September 30, 2005 and December 31, 2004, respectively | | 98,696 | | 95,373 | |
Additional paid-in capital | | 12,012,969 | | 11,318,968 | |
Other comprehensive loss | | (1,288,991 | ) | (15,166 | ) |
Treasury stock, 162,672 shares, at cost | | (1,265,047 | ) | (1,265,047 | ) |
Retained earnings (deficit) | | 1,212,987 | | (199,845 | ) |
Total stockholders’ equity | | 10,770,614 | | 9,934,283 | |
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | | $ | 40,577,577 | | $ | 12,366,409 | |
See notes to unaudited consolidated financial statements.
3
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
| | 2005 | | 2004 | |
| | | | | |
Revenues | | $ | 9,358,530 | | $ | 5,529,720 | |
Cost of goods sold | | 3,833,714 | | 2,385,908 | |
Gross profit | | 5,524,816 | | 3,143,812 | |
| | | | | |
Operating expenses: | | | | | |
Engineering | | 935,087 | | 397,717 | |
Selling and marketing | | 1,781,845 | | 897,552 | |
General and administrative | | 1,187,116 | | 1,093,736 | |
Amortization of intangible assets | | 171,553 | | — | |
Total operating expenses | | 4,075,601 | | 2,389,005 | |
| | | | | |
Income from operations | | 1,449,215 | | 754,807 | |
| | | | | |
Other (expense) income: | | | | | |
Interest (expense) income, net | | (374,290 | ) | 4,344 | |
Total other (expense) income | | (374,290 | ) | 4,344 | |
| | | | | |
Income before income taxes | | 1,074,925 | | 759,151 | |
Provision for income taxes | | 300,741 | | 190,571 | |
Net income | | $ | 774,184 | | $ | 568,580 | |
Basic earnings per share | | $ | 0.24 | | $ | 0.18 | |
Diluted earnings per share | | $ | 0.23 | | $ | 0.17 | |
Weighted average common shares outstanding—basic | | 3,265,820 | | 3,171,481 | |
Weighted average common shares outstanding—diluted | | 3,405,244 | | 3,254,563 | |
| | | | | |
Net income | | $ | 774,184 | | $ | 568,580 | |
Foreign currency translation | | 3,325 | | (289 | ) |
Comprehensive income | | $ | 777,509 | | $ | 568,291 | |
See notes to unaudited consolidated financial statements.
4
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
| | 2005 | | 2004 | |
| | | | | |
Revenues | | $ | 23,863,598 | | $ | 13,974,548 | |
Cost of goods sold | | 9,862,878 | | 5,986,439 | |
Gross profit | | 14,000,720 | | 7,988,109 | |
| | | | | |
Operating expenses: | | | | | |
Engineering | | 2,401,265 | | 1,114,879 | |
Selling and marketing | | 4,783,979 | | 2,436,337 | |
General and administrative | | 3,578,673 | | 2,791,842 | |
Amortization of intangible assets | | 452,717 | | 0 | |
Total operating expenses | | 11,216,634 | | 6,343,058 | |
| | | | | |
Income from operations | | 2,784,086 | | 1,645,051 | |
| | | | | |
Other (expense) income: | | | | | |
Interest (expense) income, net | | (791,412 | ) | 12,813 | |
Total other (expense) income | | (791,412 | ) | 12,813 | |
| | | | | |
Income before income taxes | | 1,992,674 | | 1,657,864 | |
Provision for income taxes | | 579,844 | | 482,428 | |
Net income | | $ | 1,412,830 | | $ | 1,175,436 | |
Basic earnings per share | | $ | 0.44 | | $ | 0.37 | |
Diluted earnings per share | | $ | 0.42 | | $ | 0.36 | |
Weighted average common shares outstanding—basic | | 3,234,333 | | 3,153,209 | |
Weighted average common shares outstanding—diluted | | 3,348,113 | | 3,266,897 | |
| | | | | |
Net income | | $ | 1,412,830 | | $ | 1,175,436 | |
Foreign currency translation | | (1,273,825 | ) | (9,348 | ) |
Comprehensive (loss) income | | $ | 139,005 | | $ | 1,166,088 | |
See notes to unaudited consolidated financial statements.
5
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
| | 2005 | | 2004 | |
Cash Flows From Operating Activities | | | | | |
Net income | | $ | 1,412,830 | | $ | 1,175,436 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | | 972,849 | | 315,876 | |
Accounts receivable provision | | 28,775 | | 40,157 | |
Change in allowance for inventory obsolescence reserve | | 8,352 | | (122,420 | ) |
Stock based compensation | | 28,908 | | 16,875 | |
Deferred rent | | 28,660 | | 93,311 | |
Deferred tax asset | | (591,118 | ) | 451,892 | |
Change in assets and liabilities: | | | | | |
Accounts and contracts receivable | | 888,005 | | (637,967 | ) |
Inventories | | 1,283,349 | | (367,685 | ) |
Prepaid expenses and other assets | | (12,969 | ) | 9,414 | |
Accounts payable | | (306,476 | ) | 131,752 | |
Commissions payable | | (119,616 | ) | (75,436 | ) |
Other current liabilities | | 793,230 | | 287,005 | |
Net cash provided by operating activities | | 4,414,779 | | 1,318,210 | |
| | | | | |
Cash Flows From Investing Activities | | | | | |
Capital expenditures | | (462,460 | ) | (575,474 | ) |
Investment in NKF Electronics B.V. | | (14,817,445 | ) | — | |
Net cash used in investing activities | | (15,279,905 | ) | (575,474 | ) |
| | | | | |
Cash Flows From Financing Activities | | | | | |
Borrowings on notes payable | | 14,454,534 | | — | |
Payments on notes payable and capital leases | | (1,618,085 | ) | (45,000 | ) |
Increase in certificate of deposit | | — | | (5,391 | ) |
Proceeds from issuance of common stock | | 269,100 | | 47,961 | |
Proceeds from exercise of stock options | | 399,317 | | 204,988 | |
Net cash provided by financing activities | | 13,504,866 | | 202,558 | |
Effect of exchange rates on cash and cash equivalents | | (1,488,720 | ) | (9,672 | ) |
Net increase in cash and cash equivalents | | 1,151,020 | | 935,622 | |
Cash and cash equivalents—beginning of period | | 2,918,959 | | 1,387,866 | |
Cash and cash equivalents—end of period | | $ | 4,069,979 | | $ | 2,323,488 | |
| | | | | |
Supplemental Disclosures of Cash Flow Information: | | | | | |
Cash paid during the period for interest | | $ | 338,478 | | $ | 2,970 | |
Cash paid during the period for income taxes | | $ | 772,953 | | $ | 53,391 | |
See notes to unaudited consolidated financial statements.
6
OPTELECOM-NKF, INC.
Notes to Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements, including the accounts of Optelecom and its wholly owned subsidiaries (collectively referred to as “the Company”), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the annual financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading.
In the opinion of Management, the accompanying unaudited financial statements reflect all necessary adjustments and reclassifications (all of which are of a normal, recurring nature) that are necessary for fair presentation for the periods presented. It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest annual report to the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2004.
The results for the interim periods are not necessarily indicative of the results to be expected for future quarters or the year.
2. Acquisition of NKF Electronics
On March 8, 2005, Optelecom, Inc. (the “Company”) completed the acquisition of NKF Electronics, B.V. (“NKF”) a private company with limited liability, incorporated in the Netherlands, pursuant to the terms and conditions of the Share Purchase Agreement dated March 8, 2005 (the “Purchase Agreement”) by and among the Company, NKF, Draka Holding, N.V., a limited liability company, incorporated in the Netherlands (“Draka”), and NKF Vastgoed B.V., a private company with limited liability, incorporated in the Netherlands, a direct wholly-owned subsidiary of Draka (“Vastgoed” and together with Draka — the “Sellers”).
Pursuant to the Purchase Agreement, the Company acquired from the Sellers and the Sellers sold, all of the outstanding stock of NKF for the following consideration (the “Acquisition Consideration”): (a) $9,152,870 in cash; (b) $5,454,210 paid in cash to retire NKF’s inter-company debt owed to the Seller; and (c) a Subordinated Promissory Note in the principal amount of $12,007,800 (the “Subordinated Note”). The Subordinated Note accrues interest at a rate of 6% per annum and is due and payable in full on March 8, 2010. The Acquisition Consideration and the Subordinated Note are subject to post-closing adjustment in accordance with the terms and conditions of the Purchase Agreement. The amount of consideration was determined on the basis of arm’s length negotiations between the Company and the Seller.
The Company obtained the services of a third party to value the intangible assets acquired. The purchase price allocation at the current exchange rate resulted in goodwill of approximately $11.17 million and identifiable other intangible assets of approximately $9.36 million. Intangible assets with finite lives are being amortized over a period of 3 to 11 years.
The acquisition was accounted for using the purchase method of accounting, as required by Statement of Financial Accounting Standard No. 141, “Business Combinations.” Under this method of accounting, the Company allocated the purchase price to the fair value of the assets acquired, including identified intangible assets. The preliminary allocation was based on management’s estimates. Management engaged an independent third party valuation firm to assist with the final allocation of the purchase price. The purchase price allocated includes management’s estimate of all post-closing adjustments.
3. Inventory
Inventories consisted of the following:
7
| | September 30, 2005 | | December 31, 2004 | |
Production materials | | $ | 2,565,427 | | $ | 1,604,605 | |
Work in process | | 625,448 | | 192,145 | |
Finished goods | | 1,477,277 | | 1,164,264 | |
Allowance for obsolescence | | (384,612 | ) | (93,132 | ) |
| | $ | 4,283,540 | | $ | 2,867,882 | |
4. Notes Payable
Notes payable consist of the following:
| | September 30, 2005 | | December 31, 2004 | |
Senior term facility with a bank due February 2009 | | $ | 12,836,449 | | $ | — | |
Subordinated note due March 2010 | | 8,264,928 | | — | |
Other | | 67,500 | | 90,000 | |
| | $ | 21,168,877 | | $ | 90,000 | |
As described above, on March 8, 2005 the Company completed the acquisition of NKF Electronics B.V. pursuant to the terms and conditions of the Share Purchase Agreement. The purchase price for the acquisition, subject to final purchase price adjustment, is between 17 and 20 million Euros, which consists of a cash payment of 11 million Euros ($14.5 million USD) and a 6% subordinated note issued by Optelecom, Inc. to Draka Holding N.V. for the remainder.
The cash portion of the purchase price was funded by a $14.5 million senior term facility provided by a Bank, which consists of a 4.1 million Euro based term loan ($5.3 million USD) and a $9.2 million USD based term loan. Both term loans carry interest at the rate of LIBOR plus a margin which can range from 2.25% to 3.25%. The variability in the margin is a function of the Company’s leverage position which is calculated as Total Senior Debt divided by EBITDA. As of September 30, 2005, the interest rate on this facility was 6.42%. The term loans are subject to a seventy two month amortization which is payable over four years via a balloon payment in month 48. Principal and interest are payable on a monthly basis. At September 30, 2005 $12,836,449 was outstanding under this facility.
The Subordinated Note accrues interest at a rate of 6% per annum and is due and payable in full on March 8, 2010.
Subordinated note at date of acquisition | | $ | 12,007,800 | |
Impact of change in exchange rate | | (938,202 | ) |
Estimated adjustment to acquisition consideration | | (2,804,670 | ) |
Subordinated note balance at 9/30/05 | | $ | 8,264,928 | |
As of September 30, 2005 the Company has the ability to borrow up to $5.0 million under a bank line-of-credit provided there are sufficient accounts receivable and inventory. This facility allows the Company to borrow in either USD or Euros with a maximum amount not to exceed $5.0 million USD. The Company’s borrowing base under the facility is equal to between 60% - 85% of the eligible commercial billed accounts receivable and 30% of eligible related inventory.
The revolving line of credit carries interest at the rate of LIBOR plus a margin which can range from 1.75% to 2.75%, depending on the Company’s leverage position. As of September 30, 2005, the Company had no borrowings outstanding on its bank line-of-credit.
Optelecom is required to comply with certain financial ratios including maintaining a minimum fixed charge coverage ratio and a maximum senior debt to EBITDA ratio. The Company was in compliance with all of these covenants at September 30, 2005.
5. Earnings Per Share
Basic earnings per share is computed using the weighted average number of common shares outstanding. Diluted earnings per share is computed using the weighted average number of shares outstanding and the treasury stock computation method for stock options and warrants, provided they are not antidilutive. The following is a reconciliation of the basic and diluted earnings per share.
8
| | Three Months ended September 30, | |
| | 2005 | | 2004 | |
Basic Earnings per Share: | | | | | |
Net Income | | $ | 774,184 | | $ | 568,580 | |
Weighted average common shares – basic | | 3,265,820 | | 3,171,481 | |
Basic income per share | | $ | 0.24 | | $ | 0.18 | |
| | | | | |
Diluted Earnings per Share: | | | | | |
Net Income | | $ | 774,184 | | $ | 568,580 | |
Weighted average common shares – basic | | 3,265,820 | | 3,171,481 | |
Assumed conversion of: | | | | | |
Stock options | | 139,424 | | 83,082 | |
Weighted average common shares – diluted | | 3,405,244 | | 3,254,563 | |
| | | | | |
Diluted income per share | | $ | 0.23 | | $ | 0.17 | |
| | Nine Months ended September 30, | |
| | 2005 | | 2004 | |
Basic Earnings per Share: | | | | | |
Net Income | | $ | 1,412,830 | | $ | 1,175,436 | |
Weighted average common shares – basic | | 3,234,333 | | 3,153,209 | |
Basic income per share | | $ | 0.44 | | $ | 0.37 | |
| | | | | |
Diluted Earnings per Share: | | | | | |
Net Income | | $ | 1,412,830 | | $ | 1,175,436 | |
Weighted average common shares – basic | | 3,234,333 | | 3,153,209 | |
Assumed conversion of: | | | | | |
Stock options | | 113,780 | | 113,688 | |
Weighted average common shares – diluted | | 3,348,113 | | 3,266,897 | |
| | | | | |
Diluted income per share | | $ | 0.42 | | $ | 0.36 | |
6. Stock-based Compensation
The Company has elected to follow Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB 25) and related interpretations, in accounting for its employee stock options and complies with the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (FAS 123). APB 25 provides that the compensation expense relative to the Company’s employee stock options is measured based on the intrinsic value of the stock option. FAS 123 requires companies that continue to follow APB 25 to provide a pro forma disclosure of the impact of applying the fair value method of FAS 123.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (FAS 148). FAS 148 amends FAS 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.
The following table illustrates the effect on net income and net income per common share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation.
9
| | Three Months ended September 30, | |
| | 2005 | | 2004 | |
Net income, as reported | | $ | 774,184 | | $ | 568,580 | |
Deduct: Total stock-based compensation expense determined under fair value based method for all awards | | (269,211 | ) | (214,196 | ) |
Pro-forma net income | | $ | 504,973 | | $ | 354,384 | |
| | | | | |
Net income per share: | | | | | |
Basic, as reported | | $ | 0.24 | | $ | 0.18 | |
Basic, pro-forma | | $ | 0.15 | | $ | 0.11 | |
| | | | | |
Diluted, as reported | | $ | 0.23 | | $ | 0.17 | |
Diluted, pro-forma | | $ | 0.15 | | $ | 0.11 | |
| | Nine Months ended September 30, | |
| | 2005 | | 2004 | |
Net income, as reported | | $ | 1,412,830 | | $ | 1,175,436 | |
Deduct: Total stock-based compensation expense determined under fair value based method for all awards | | (833,529 | ) | (676,254 | ) |
Pro-forma net income | | $ | 579,301 | | $ | 499,182 | |
| | | | | |
Net income per share: | | | | | |
Basic, as reported | | $ | 0.44 | | $ | 0.37 | |
Basic, pro-forma | | $ | 0.18 | | $ | 0.16 | |
| | | | | |
Diluted, as reported | | $ | 0.42 | | $ | 0.36 | |
Diluted, pro-forma | | $ | 0.17 | | $ | 0.15 | |
The effect of applying SFAS No. 123 on a pro forma net income as stated above is not necessarily representative of the effects on reported net income for future years due to, among other things, the vesting period of the stock options and the fair value of additional options to be granted in the future years.
The weighted-average fair value of options granted during 2005 and 2004 was $9.35 and $9.49. The fair value of each option is estimated on the date of grant using the Black Scholes option-pricing model with the following assumptions:
| | 2005 | | 2004 | |
Expected dividend yield | | 0 | % | 0 | % |
Expected stock price volatility | | 70 | % | 105 | % |
Risk-free interest rate | | 4.01 | % | 3.69 | % |
Average expected life | | 4 years | | 4 years | |
7. Business Unit Information
The Company manages its operations in two segments: the Communication Products Segment and the Electro-Optics Segment. The Communication Products Segment, which includes the operations of newly acquired NKF Electronics, develops, manufactures, and sells optical fiber-based data communications equipment to both commercial and government customers. The Electro-Optics Segment is focused on Interferometric Fiber Optic Gyro coils and the manufacture of innovative optical devices under contract, primarily to government and defense industry customers.
10
| | Quarter Ended September 30, 2005 | |
| | Communication
Products
Segment | | Electro-Optics Segment | | Total | |
| | | | | | | |
Revenues | | $ | 9,058,722 | | $ | 299,808 | | $ | 9,358,530 | |
Depreciation and amortization | | 362,771 | | — | | 362,771 | |
Income from operations | | 1,444,102 | | 5,113 | | 1,449,215 | |
Assets | | 40,328,715 | | 248,862 | | 40,577,577 | |
Capital expenditures | | 381,125 | | — | | 381,125 | |
| | | | | | | | | | |
| | Quarter Ended September 30, 2004 | |
| | Communication
Products
Segment | | Electro-Optics Segment | | Total | |
| | | | | | | |
Revenues | | $ | 5,261,446 | | $ | 268,274 | | $ | 5,529,720 | |
Depreciation and amortization | | 108,479 | | — | | 108,479 | |
Income from operations | | 747,829 | | 6,978 | | 754,807 | |
Assets | | 12,049,780 | | 209,662 | | 12,259,442 | |
Capital expenditures | | 121,012 | | — | | 121,012 | |
| | | | | | | | | | |
| | Nine Months Ended September 30, 2005 | |
| | Communication
Products
Segment | | Electro-Optics Segment | | Total | |
| | | | | | | |
Revenues | | $ | 23,111,545 | | $ | 752,053 | | $ | 23,863,598 | |
Depreciation and amortization | | 972,849 | | — | | 972,849 | |
Income (loss) from operations | | 2,755,971 | | 28,115 | | 2,784,086 | |
Assets | | 40,328,715 | | 248,862 | | 40,577,577 | |
Capital expenditures | | 462,460 | | — | | 462,460 | |
| | | | | | | | | | |
| | Nine Months Ended September 30, 2004 | |
| | Communication
Products
Segment | | Electro-Optics Segment | | Total | |
| | | | | | | |
Revenues | | $ | 12,758,973 | | $ | 1,215,575 | | $ | 13,974,548 | |
Depreciation and amortization | | 315,876 | | — | | 315,876 | |
Income from operations | | 1,298,190 | | 346,861 | | 1,645,051 | |
Assets | | 12,049,780 | | 209,662 | | 12,259,442 | |
Capital expenditures | | 575,474 | | — | | 575,474 | |
| | | | | | | | | | |
Optelecom is engaged primarily in the development, manufacture, and sale of integrated multi-media products for communicating video, audio, and other data over both copper wire and optical network systems. Revenues represent shipments and services provided to third parties. Contract costs and operating expenses directly traceable to individual segments were deducted from revenues to arrive at income from operations. Identifiable assets by segment are those assets that are used in the Company’s operations in each segment. Geographically the majority of our revenues come from sales
11
in the United States and Europe. During the nine months ended September 30, 2005 and 2004 revenue by geographic region was as follows:
| | 2005 | | 2004 | |
Americas | | $ | 9,838,034 | | $ | 10,162,061 | |
Europe | | 12,367,134 | | 1,654,511 | |
Asia - Pacific | | 1,184,253 | | 937,075 | |
Other | | 474,177 | | 1,220,901 | |
Total | | $ | 23,863,598 | | $ | 13,974,548 | |
12
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical financial information contained herein, the following discussion and analysis may contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements include declarations regarding the intent, belief or current expectations of the Company and its management. Prospective investors are cautioned that any such forward looking statements are not guarantees of future performance and involve a number of risks and uncertainties; actual results could differ materially from those indicated by such forward looking statements.
The following discussion should be read in conjunction with the Financial Statements and Notes thereto.
ACQUISITION OF NKF ELECTRONICS
On March 8, 2005, the Company completed the acquisition of NKF Electronics pursuant to the terms and conditions of the Share Purchase Agreement. As such, he operating results of the Company include the results of operations of NKF Electronics for the period from March 8, 2005 to September 30, 2005. The purchase of NKF effectively doubled the size of the Company’s operations and revenue, firmly establishing the Company’s position as the leading world-wide independent producer of fiber optic-based communications solutions for video surveillance, traffic monitoring, and business video systems. The integration of the companies will result in expanded and diversified revenue streams, enhanced research and development capabilities, and a more extensive sales and service organization, addressing the world-wide marketplace for the products of both companies.
Founded in 1981, NKF Electronics has accumulated extensive expertise in fiber optic and IP/Ethernet network technologies. This expertise has enabled NKF Electronics to build a broad range of communications products, ranging from fiber optic video modems and multiplexers to complete Video-Over-IP network solutions. All its products are designed and tested for Local, Metropolitan and Wide Area Network (LAN, MAN and WAN) applications, especially those characterized by harsh environmental conditions and by large distances between the individual transmission locations.
Through the acquisition of NKF, we join two strong product lines and two sales units with little geographic overlap, and bring to market industry- leading, advanced communication solutions for mission critical video surveillance, intelligent transportation, and business video systems. We believe that by combining our research and development services and other resources, we can deliver excellent quality products to our customers at great values.
NKF’s primary market position and focus is centered in Europe, while Optelecom is an industry leader in the U.S. marketplace. The Optelecom/NKF combination will create a diversified company that is a global leader in the video surveillance and intelligent transportation markets. The Optelecom-NKF combination creates a company employing over 150 people worldwide with increased financial resources to support global government and commercial end-users.
OVERVIEW
Optelecom-NKF, Inc. offers integrated multi-media products for communicating video, audio, and other data over both copper wire and optical network systems. The Company currently manages its operations under two business segments: the Communication Products Segment (CPS) and the Electro-Optics Segment (EOS). The CPS includes both our U.S. operations and our newly acquired NKF operations. The primary focus of the CPS is the design, manufacture and sale of optical fiber-based data communication equipment to commercial and Government clients as well as the delivery and distribution of video systems over Category5 (CAT5) copper cabling as the transmission medium. The EOS is focused on Interferometric Fiber Optic Gyro coils and the manufacture of innovative optical devices under contract, primarily to government and defense industry customers.
The CPS addresses business opportunities in the worldwide optical communication equipment marketplace, specializing in optical fiber transmission technologies. The majority of its current and future revenues is and will be derived from several niche markets that apply the advantages of fiber optic telecommunications to their transmission requirements. Presently, the vertical markets we serve include communications systems for highway traffic monitoring, advanced air traffic control video monitor displays, security surveillance and control systems, and manufacturing process and control communications. The Company plans to develop products that will take advantage of the bandwidth capacity of fiber,
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primarily in the area of Gigabit Ethernet and Redundant Self-Healing Ring Networks. A common characteristic of these systems is the capability to deliver a large quantity of video feeds over a single fiber. These products are targeted at the security and surveillance and traffic markets.
The NKF operations of CPS focus on business opportunities in the worldwide optical communication equipment marketplace, specializing in optical fiber transmission technologies. In particular, NKF Electronics specializes in a broad range of communications products, ranging from fiber optic video modems and multiplexers to complete Video-Over-IP network solutions. All its products are designed and tested for Local, Metropolitan and Wide Area Network (LAN, MAN and WAN) applications, especially those characterized by harsh environmental conditions and by large distances between the individual transmission locations.
In the EOS, emphasis has been placed on fabrication of precision-wound coils of optical fiber used as the sensing elements of fiber optic gyroscopes. During the past decade, Optelecom has received U.S. Government contracts to investigate advanced manufacturing technology related to gyro coil winding. Optelecom currently pursues this tradition of business development and continues to seek out technology development opportunities with potential for production follow-on. The EOS also produces precision wound coils for applications ranging from optical fiber dispensers used in remote vehicle control systems to precision optical fiber coils for communications systems.
RESULTS OF OPERATIONS
Optelecom-NKF, Inc. designs, develops, manufactures and markets high-bandwidth fiber optic-based communications systems for traffic monitoring, security / surveillance, and business video systems. Over the past two years the Company has aggressively pursued several operational objectives including: 1) the expansion of a distribution network both in the United States and worldwide, 2) realization of manufacturing and process improvements and 3) implementation of a cost and asset management program.
The successful execution of these initiatives along with increased demand in our core markets has enabled the Company to significantly improve its financial condition in 2002, 2003 and 2004, as evidenced by increasing levels of profitability and positive cash flow. The Company continues in 2005 to work at broadening its sales channels, sustaining gross profit margins and controlling costs.
THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2004
Acquisition of NKF Electronics
On March 8, 2005, the Company completed the acquisition of NKF Electronics. As a result, the operating results of the Company include the results of operations of NKF Electronics for the third quarter, 2005.
REVENUES
| | 2005 | | 2004 | |
| | | | | |
Communication Products Segment | | $ | 9,058,722 | | $ | 5,261,446 | |
Electro-Optics Segment | | 299,808 | | 268,274 | |
Total Revenue | | $ | 9,358,530 | | $ | 5,529,720 | |
Consolidated revenues for the three months ended September 30, 2005 of $9,358,530 were $3,828,810 or 69% higher than the third quarter of 2004. Revenue for the Communication Products Segment increased by $3,797,276 or 72%. This
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increase is attributed to the addition of NKF sales for the third quarter of 2005. Electro-Optics revenues increased $31,534 or 12% to $299,808 for the third quarter of 2005 from $268,274 in 2004 primarily as a result of a $50,031 increase in contract services revenues and a $18,497 decrease in coil winding revenues from 2004 to 2005.
GROSS PROFIT
Consolidated gross profit was $5,524,816 or 59% of revenues for the three months ended September 30, 2005 as compared to $3,143,812, or 57% of revenues for the third quarter of 2004. The Communication Products Segments gross profit was $5,442,908 for the third quarter of 2005 compared to $3,092,272 in the third quarter of 2004. Gross profit for the Communications Products Segment as a percent of revenue was 59% for the three months ended September 30, 2005 and 2004. The increase of $2,350,636 or 76% was due primarily to higher sales levels as a result of the purchase of NKF Electronics. The gross profit of the Electro-Optics Division increased from $51,540 in the third quarter of 2004 to $81,394 in the third quarter of 2005 primarily as a result of the higher contract services and coil winding revenues realized in 2005.
OPERATING EXPENSES
Consolidated operating expenses were $4,075,601 for the quarter ended September 30, 2005 compared to $2,389,005 in 2004. This increase of $1,686,596 or 71% is mainly due to the increased costs associated with the acquisition of NKF Electronics.
Engineering expenses increased from $397,717 in the third quarter of 2004 to $935,087 for the third quarter of 2005. The overall increase of $537,370 consisted of primarily of NKF’s engineering personnel and other engineering costs for the quarter as well as increases in the engineering personnel costs for the U.S. operations. Selling and marketing expenses increased from $897,552 in the third quarter of 2004 to $1,781,845 for the third quarter of 2005. The overall increase of $884,293 consisted of NKF’s selling personnel and advertising costs as well as modest increases in personnel and marketing costs for the U.S. operations. General and administrative costs increased from $1,093,736 in the third quarter of 2004 to $1,187,117 for the third quarter of 2005. This 9% increase of $93,381 is primarily attributable to general and administrative salaries of NKF personnel. The Company also incurred $171,553 in amortization of intangible assets related to the acquisition of NKF Electronics during the third quarter of 2005. The Company’s management expects operating expenses to increase as revenues continue to grow and the Company develops and delivers new products to the marketplace.
OTHER INCOME (EXPENSE)
Other income for the quarter ended September 30, 2005 consisted of net interest expense of $374,290. Other income for the prior year quarter consisted of net interest income of $4,344. This increase in interest expense is attributed to the incurrence of debt in relation to the acquisition of NKF Electronics.
NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2004
REVENUES
| | 2005 | | 2004 | |
| | | | | |
Communication Products Segment | | $ | 23,111,545 | | $ | 12,758,973 | |
Electro-Optics Segment | | 752,053 | | 1,215,575 | |
Total Revenue | | $ | 23,863,598 | | $ | 13,974,548 | |
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Consolidated revenues for the nine months ended September 30, 2005 of $23,863,598 were $9,889,050 or 71% higher than the same period of 2004. Revenue for the Communication Products Division increased by $10,352,572 or 81%. This increase is attributed to the addition of NKF since the date of the acquisition on March 8, 2005. Electro-Optics revenues decreased $463,522 or 38% to $752,053 for the nine months ended September 30, 2005 from $1,215,575 in 2004 primarily as a result of a $276,542 decrease in contract services revenues and a $186,980 decrease in coil winding revenues from 2004 to 2005.
GROSS PROFIT
Consolidated gross profit was $14,000,720 or 59% of revenues for the nine months ended September 30, 2005 as compared to $7,988,108, or 57% of revenues for the nine months ended September 30, 2004. The Communication Products Division’s gross profit was $13,816,808 for the nine months ended September 30, 2005 compared to $7,440,827 for the nine months ended September 30, 2004. Gross profit for the Communications Products Segment as a percent of revenue was 60% and 58% for the nine months ended September 30, 2005 and 2004, respectively. The increase of $6,373,101 or 86% was due primarily to higher sales levels as a result of the purchase of NKF Electronics. The gross profit of the Electro-Optics Division decreased from $547,282 for the first nine months of 2004 to $183,912 for the first nine months of 2005 primarily as a result of the lower contract services and coil winding revenues realized in 2005.
OPERATING EXPENSES
Consolidated operating expenses were $11,216,634 for the nine months ended September 30, 2005 compared to $6,343,058 in 2004. This increase of $4,873,576 or 77% is mainly due to the increased costs associated with the acquisition of NKF Electronics on March 8, 2005. Overall the Company incurred approximately $400,000 of non-recurring expenses related to the acquisition during the nine months ended September 30, 2005.
Engineering expenses increased from $1,114,879 in the first nine months of 2004 to $2,401,265 for the first nine months of 2005. The overall increase of $1,286,386 consisted primarily of NKF’s engineering personnel and other engineering costs as well as increases in the engineering personnel costs for the U.S. operations. Selling and marketing expenses increased from $2,436,337 in the first nine months of 2004 to $4,783,979 for the first nine months of 2005. This 96% increase of $2,347,642 consisted of NKF’s selling personnel and advertising costs as well as modest increases in personnel and marketing costs for the U.S. operations. General and administrative costs increased from $2,791,842 in the first nine months of 2004 to $3,578,673 for the first nine months of 2005. This 28% increase of $786,831 is primarily attributable to general and administrative salaries of NKF personnel as well as approximately $200,000 in non-recurring expenses related to the acquisition of NKF Electronics and an additional $200,000 related to the closing of our former UK sales office. The Company also incurred $452,717 in amortization of intangible assets related to the acquisition of NKF Electronics during the nine months ending September 30, 2005. The Company’s management expects operating expenses to increase as revenues continue to grow and the Company develops and delivers new products to the marketplace.
OTHER INCOME (EXPENSE)
Other income for the nine months ended September 30, 2005 consisted of net interest expense of $791,412. Other income (expense) for the prior year period consisted of net interest income of $12,813. This increase is attributed to the incurrence of debt in relation to the acquisition of NKF Electronics.
FINANCIAL CONDITION
The Company’s Stockholders’ equity increased from $9.9 million at December 31, 2004 to $10.8 million at September 30, 2005 due primarily to the net income for the first nine months of 2005 and the exercise of stock options by employees partially offset by the unrealized loss on the revaluation of Euro-denominated assets and liabilities.
Other key components of Optelecom’s financial condition include accounts receivable, inventory, fixed assets and accounts payable. The Company’s current ratio has decreased to 2.42 at September 30, 2005 compared to 4.61 at
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December 31, 2004. This decrease is attributed primarily to the $0.8 million increase in accounts payable and the $2.4 million increase in current portion of notes payable.
Inventory increased from $2.9 million at December 31, 2004 to $4.3 million at September 30, 2005 due to the acquisition of NKF Electronics and to have items on hand to meet the delivery needs of our customers.
During the first nine months of 2005 fixed asset additions were $0.46 million, compared to $0.58 million in 2004. During 2004, as the Company’s profitability continued to improve over prior year levels, capital spending was increased in order to improve and expand on engineering and manufacturing capabilities. Aside from the acquisition of NKF Electronics, the level of capital spending has declined compared to the prior year levels. The Company does not currently have any capital asset purchase commitments.
The Company’s current liabilities increased $4.6 million from $2.2 million at December 31, 2004 to $6.8 million at September 30, 2005 primarily as a result of an increase of $0.8 million in accounts payable and $2.4 million in current portion of notes payable.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $4.4 million for the nine months ended September 30, 2005, compared to $1.3 million in the first nine months of the prior year. Our cash from operations is the result of our net income, adjusted for depreciation, amortization and other non-cash items and changes in our operating assets and liabilities. As noted above, we increased our inventory levels in order to have items on hand to meet the delivery needs of our customers. Should this market continue to increase, we expect to continue to increase inventory levels to meet this need. While the increase in inventory was not the only item that impacted our operating cash flows, it was one significant component.
Cash used in investing activities was $15.3 million for the first nine months of 2005 and $0.6 million for the same period of 2004. The increase is primarily attributable to the purchase of NKF Electronics discussed below. In addition, $0.46 million was expended for new capital equipment in 2005 compared to $0.58 million for the nine months ended September 30, 2005.
During the first nine months of 2005, financing activities provided $13.5 million in cash compared to $0.2 million provided by financing activities during the first nine months of 2004. The current year increase resulted primarily from the borrowings on bank notes and subordinated notes relating to the NKF acquisition.
On March 8, 2005 the Company completed the acquisition of NKF Electronics B.V. pursuant to the terms and conditions of the Share Purchase Agreement. The purchase price for the acquisition, subject to final purchase price adjustment, is between 17 and 20 million Euros, which consists of a cash payment of 11 million Euros ($14.5 million USD) and a 6% subordinated note issued by Optelecom, Inc. to Draka Holding N.V. for the remainder.
The cash portion of the purchase price was funded by a $14.5 million senior term facility provided by M&T Bank, which consists of a 4.1 million Euro based term loan ($5.3 million USD) and a $9.2 million USD based term loan. Both term loans carry interest at the rate of LIBOR plus a margin which can range from 2.25% to 3.25%. The variability in the margin is a function of the Company’s leverage position which is calculated as Total Senior Debt divided by EBITDA. As of September 30, 2005, the interest rate on this facility was 6.95%. The term loans are subject to a seventy two month amortization which is payable over four years via a balloon payment in month 48. Principal and interest are payable on a monthly basis.
The Subordinated Note accrues interest at a rate of 6% per annum and is due and payable in full on March 8, 2010.
As of September 30, 2005 the Company has the ability to borrow up to $5.0 million under a bank line-of-credit provided there are sufficient accounts receivable and inventory. This facility allows the Company to borrow in either USD or Euros with a maximum amount not to exceed $5 million USD. The Company’s borrowing base under the facility is equal to between 60% - 85% of the eligible commercial billed accounts receivable and 30% of eligible related inventory.
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The revolving line of credit carries interest at the rate of LIBOR plus a margin which can range from 1.75% to 2.75%, depending on the Company’s leverage position. As of September 30, 2005, the Company had no borrowings outstanding on its bank line-of-credit.
Optelecom is required to comply with certain financial ratios including maintaining a minimum fixed charge coverage ratio and a maximum senior debt to EBITDA ratio. The Company was in compliance with all of these covenants at September 30, 2005
Optelecom’s future working capital needs will be financed by our operating cash flow and continued use of the line-of-credit. In the event that operating cash flows become insufficient to meet funding needs, the Company may be required to scale back or eliminate product research and development and overhead costs. Additionally, the Company would look to increase its line of credit and/or pursue equity financing. The Company’s strategy will focus on identifying new products that meet the demands of our core markets, expanding our distribution channels and implementing processes which will increase manufacturing efficiencies. Management fully understands the costs required to execute this strategy and will pursue these initiatives in a timely and fiscally prudent manner.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the potential change in an instrument’s value caused by, for example, fluctuations in interest and currency exchange rates. The Company has not purchased any futures contracts nor purchased or held any derivative financial instruments for trading purposes during the nine months ended September 30, 2005 and 2004. The primary market risk exposure is the risk that interest rates on our outstanding borrowings may increase. Optelecom also faces market risk exposure as a result of foreign currency translation adjustments of the Company’s foreign subsidiaries, Optelecom Europe Limited and NKF Electronics. The Company believes this risk is immaterial.
Optelecom currently has no borrowings under its available bank lines-of-credit. Optelecom has not entered into any hedging arrangements with respect to any prior interest obligations under these lines of credit.
Item 4. Controls and Procedures
As of September 30, 2005, under the direction and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company reviewed and evaluated the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are adequate and effective.
In connection with the evaluation by management, including the Chief Executive Officer and Chief Financial Officer, of our internal controls over financial reporting, pursuant to Exchange Act Rule 13a-15(d), no changes during the quarter ended September 30, 2005 were identified that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The Company is currently reviewing the new internal controls documentation and attestation requirements regarding Rule 404 of the Sarbanes Oxley Act of 2002 and is confident that it will fully comply with such requirements.
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PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
On August 2, 2005, a legal action was filed in the Circuit Court for Montgomery County, Maryland, by a registered securities broker against the Company and Richard Alpert, its investor relations consultant. The lawsuit arises out of allegedly libelous statements made in connection with a complaint for violations filed at the direction of the Company against the securities dealer with the National Association of Securities Dealers (“NASD”). The plaintiff is seeking $10,000,000 in consequential and punitive damages.
The Company is vigorously defending the lawsuit. We have filed an answer setting forth numerous valid defenses against the lawsuit including the truth of the statements and the fact that the communications made to the NASD were subject to a qualified privilege and have begun discovery seeking information of the factual basis of the claim as well as any damages suffered. NASD has filed a complaint against the broker as a result of the information provided by the Company seeking appropriate sanctions which could include revocation of the broker’s license. An administrative hearing on this matter was held on October 6-7, 2005. The findings and recommendations of the hearing panel will be forthcoming in 6-8 months.
It is the opinion of the general counsel for the Company that the lawsuit is frivolous and without legal basis in fact or law. Our general counsel has also informed us that he considers the chances of a verdict adverse to the interests of the Company are minimal and that this legal action should not have any material adverse effect on the operations of the Company.
As of the date of this report, except as described above, the Company is not a party to any other litigation or other legal proceedings that, in the opinion of Management, could have a material adverse effect on the Company’s business, financial condition or results of operations.
ITEM 2 - CHANGES IN SECURITIES
None.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Optelecom’s Annual Meeting of Stockholders was held on May 2, 2005 at which time the stockholders elected Carl R. Rubbo Jr. and Walter R. Fatzinger Jr. as directors of Optelecom to hold office until the 2008 annual meeting of stockholders (subject to the election and qualification of their successors or their earlier death, resignation or removal) and approved an increase in the number of shares available under the Optelecom, Inc. 2002 Stock Option Plan from 500,000 shares to 800,000 shares. The votes were as follows:
| | Votes for | | Votes against | | Withheld/Abstain | |
(1) Election of directors: | | | | | | | |
Carl R. Rubbo Jr. | | 2,752,885 | | n/a | | 272,309 | |
Walter R. Fatzinger Jr. | | 2,976,655 | | n/a | | 48,539 | |
| | | | | | | |
(2) Increase the number of shares available under the Optelecom, Inc. 2002 Stock Option Plan from 500,000 shares to 800,000 shares. | | 782,923 | | 294,561 | | 10,675 | |
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ITEM 5 – OTHER INFORMATION
AMENDMENTS TO ARTICLES OF INCORPORATION OR BYLAWS
On April 18, 2005 Optelecom, Inc. (the Company) issued a press release announcing that it had changed its name to Optelecom-NKF, Inc. This name change became effective upon the filing of a Certificate of Amendment of the Company’s Articles of Incorporation with the Delaware Secretary of State on April 13, 2005. Shares of Optelecom-NKF, Inc. will continue to trade under the ticker symbol “OPTC.”
ITEM 6 - EXHIBITS
Exhibits are incorporated by reference to the Company’s June 30, 2005 Form 10-Q.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | OPTELECOM-NKF, INC. |
| | |
| | |
Date: | November 14, 2005 | /s/ Edmund Ludwig | |
| | Edmund Ludwig, |
| | Director, President and Chief Executive Officer |
| | |
| | |
Date: | November 14, 2005 | /s/ James Armstrong | |
| | James Armstrong, |
| | Director, Chief Financial Officer |
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