UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended September 30, 2007
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.
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 x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer o Non-accelerated Filer x
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
At October 31, 2007, the registrant had outstanding 3,622,283 shares of Common Stock, $0.03 Par Value.
OPTELECOM-NKF, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
OPTELECOM-NKF, INC.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2007 AND DECEMBER 31, 2006
(September 30, 2007 Unaudited)
(Dollars and Share Amounts in Thousands)
| | 2007 | | 2006 | |
ASSETS | | | | | |
CURRENT ASSETS | | | | | |
Cash and cash equivalents | | $ | 3,413 | | $ | 3,571 | |
Accounts and contracts receivable, net of allowance for doubtful accounts of $290 and $625 | | 9,305 | | 9,222 | |
Inventories, net | | 5,912 | | 5,759 | |
Deferred tax asset — current | | 678 | | 905 | |
Prepaid expenses and other current assets | | 741 | | 1,047 | |
Total current assets | | 20,049 | | 20,504 | |
Property and equipment, at cost less accumulated depreciation of $7,298 and $6,377 | | 2,729 | | 2,488 | |
Deferred tax asset — less current portion | | 1,588 | | 1,284 | |
Goodwill | | 14,785 | | 13,678 | |
Intangible assets, net of accumulated amortization of $1,990 and $1,288 | | 8,185 | | 8,124 | |
Other assets | | 200 | | 196 | |
TOTAL ASSETS | | $ | 47,536 | | $ | 46,274 | |
| | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | |
CURRENT LIABILITIES | | | | | |
Accounts payable | | $ | 2,740 | | $ | 3,371 | |
Accrued payroll | | 1,331 | | 2,105 | |
Bank line of credit | | 1,600 | | 800 | |
Current portion of notes payable | | 1,619 | | 1,548 | |
Taxes payable | | 396 | | 577 | |
Accrued warranty reserve | | 389 | | 431 | |
Commissions payable | | 323 | | 220 | |
Current portion of capital lease obligations | | 63 | | 71 | |
Other current liabilities | | 907 | | 1,375 | |
Total current liabilities | | 9,368 | | 10,498 | |
Notes payable | | 14,291 | | 14,650 | |
Deferred tax liability | | 2,134 | | 2,102 | |
Interest payable | | 1,051 | | 788 | |
Capital lease obligations | | — | | 45 | |
Other liabilities | | 254 | | 248 | |
Total liabilities | | 27,098 | | 28,331 | |
| | | | | |
STOCKHOLDERS’ EQUITY | | | | | |
Common stock, $0.03 par value — shares authorized, 15,000; issued and outstanding 3,619 and 3,495 shares as of September 30, 2007, and December 31, 2006, respectively | | 108 | | 105 | |
Additional paid-in capital | | 15,241 | | 14,497 | |
Accumulated other comprehensive income | | 1,910 | | 570 | |
Treasury stock, 163 shares, at cost | | (1,265 | ) | (1,265 | ) |
Retained earnings | | 4,444 | | 4,036 | |
Total stockholders’ equity | | 20,438 | | 17,943 | |
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | | $ | 47,536 | | $ | 46,274 | |
See notes to unaudited consolidated financial statements.
3
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Dollars in Thousands, Except Per Share Amounts)
| | 2007 | | 2006 | |
Revenue | | $ | 11,464 | | $ | 10,146 | |
Cost of goods sold | | 4,441 | | 4,059 | |
Gross profit | | 7,023 | | 6,087 | |
Operating expenses: | | | | | |
Sales and marketing | | 2,524 | | 2,021 | |
Engineering | | 1,230 | | 1,222 | |
General and administrative | | 1,547 | | 1,703 | |
Amortization of intangibles | | 191 | | 178 | |
Total operating expenses | | 5,492 | | 5,124 | |
Income from operations | | 1,531 | | 963 | |
Other expense, net | | (315 | ) | (296 | ) |
Income before income taxes | | 1,216 | | 667 | |
Provision for income taxes | | 334 | | 271 | |
Net Income | | $ | 882 | | $ | 396 | |
Basic earnings per share | | $ | 0.24 | | $ | 0.11 | |
Diluted earnings per share | | $ | 0.24 | | $ | 0.11 | |
Weighted average common shares outstanding — basic | | 3,617,246 | | 3,503,925 | |
Weighted average common shares outstanding — diluted | | 3,621,396 | | 3,530,908 | |
| | | | | |
Net income | | $ | 882 | | $ | 396 | |
Foreign currency translation | | 912 | | 240 | |
Comprehensive income | | $ | 1,794 | | $ | 636 | |
See notes to unaudited consolidated financial statements.
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OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Dollars in Thousands, Except Per Share Amounts)
| | 2007 | | 2006 | |
Revenue | | $ | 29,490 | | $ | 28,648 | |
Cost of goods sold | | 12,006 | | 12,083 | |
Gross profit | | 17,484 | | 16,565 | |
Operating expenses: | | | | | |
Sales and marketing | | 7,234 | | 6,017 | |
Engineering | | 3,770 | | 3,574 | |
General and administrative | | 4,463 | | 4,378 | |
Amortization of intangibles | | 563 | | 450 | |
Total operating expenses | | 16,030 | | 14,419 | |
Income from operations | | 1,454 | | 2,146 | |
Other expense, net | | (918 | ) | (892 | ) |
Income before income taxes | | 536 | | 1,254 | |
Provision for income taxes | | 128 | | 470 | |
Net income | | $ | 408 | | $ | 784 | |
Basic earnings per share | | $ | 0.12 | | $ | 0.23 | |
Diluted earnings per share | | $ | 0.12 | | $ | 0.22 | |
Weighted average common shares outstanding — basic | | 3,496,083 | | 3,422,554 | |
Weighted average common shares outstanding — diluted | | 3,502,166 | | 3,565,621 | |
| | | | | |
Net income | | $ | 408 | | $ | 784 | |
Foreign currency translation | | 1,340 | | 1,476 | |
Comprehensive income | | $ | 1,748 | | $ | 2,260 | |
See notes to unaudited consolidated financial statements.
5
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(Unaudited)
(Dollars in Thousands)
| | 2007 | | 2006 | |
Cash Flows from Operating Activities: | | | | | |
Net income | | $ | 408 | | $ | 784 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | | 1,271 | | 996 | |
Accounts receivable provision | | (352 | ) | 141 | |
Change in allowance for inventory obsolescence | | 110 | | 34 | |
Accrued warranty reserve | | (60 | ) | 96 | |
Stock based compensation | | 703 | | 735 | |
Deferred rent | | 7 | | 18 | |
Deferred tax asset | | (58 | ) | (608 | ) |
Deferred tax liability | | (141 | ) | (114 | ) |
Change in assets and liabilities: | | | | | |
Accounts and contracts receivable | | 758 | | (1,629 | ) |
Inventories | | (8 | ) | (767 | ) |
Prepaid expenses and other current assets | | 373 | | (120 | ) |
Other assets | | 15 | | (189 | ) |
Accounts payable and other accrued expenses | | (1,503 | ) | (101 | ) |
Other current liabilities | | (699 | ) | (315 | ) |
Interest payable | | 262 | | 359 | |
Net cash provided by (used in) operating activities | | 1,086 | | (680 | ) |
Cash Flows from Investing Activities: | | | | | |
Capital expenditures | | (875 | ) | (260 | ) |
Net cash used in investing activities | | (875 | ) | (260 | ) |
Cash Flows from Financing Activities: | | | | | |
Net increase in bank line of credit | | 800 | | 400 | |
Payments on notes payable and capital leases | | (1,126 | ) | (1,892 | ) |
Proceeds from employee stock purchase plan | | 34 | | 30 | |
Proceeds from exercise of stock options | | 11 | | 1,248 | |
Net cash used in financing activities | | (281 | ) | (214 | ) |
Effect of exchange rates on cash and cash equivalents | | (88 | ) | 579 | |
Net decrease in cash and cash equivalents | | (158 | ) | (575 | ) |
Cash and cash equivalents — beginning of period | | 3,571 | | 3,046 | |
Cash and cash equivalents — end of period | | $ | 3,413 | | $ | 2,471 | |
Supplemental Disclosures of Cash Flow Information: | | | | | |
Cash paid during the period of interest | | $ | 485 | | $ | 499 | |
Cash paid during the period for income taxes | | $ | 717 | | $ | 774 | |
| | | | | | | | | | | | | |
See notes to unaudited consolidated financial statements.
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OPTELECOM-NKF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in Thousands except per share amounts)
NOTE A — BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, including the accounts of Optelecom-NKF, Inc. and its wholly owned subsidiaries (collectively referred to as “we”, “us, “our”, “the Company”, “Optelecom” or the “Registrant”), have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to those rules. The Company believes that the disclosures made are adequate to make the information presented not misleading.
In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain prior amounts have been reclassified to conform to the current period presentation. The results for the interim periods presented are not necessarily indicative of the results to be expected for future quarters or the fiscal year as a whole. It is suggested that these unaudited financial statements be read in conjunction with the financial statements and the footnotes included in the Company’s latest annual report to the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2006.
NOTE B — COMPREHENSIVE INCOME
Comprehensive income is comprised of net income from operations and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains and losses that under generally accepted accounting principles are included in other comprehensive income, a component of Shareholders’ Equity within the Consolidated Balance Sheets, rather than Net Earnings on the Statement of Operations. Under existing accounting standards, other comprehensive income for the Company reflects the impact of fluctuations of the Euro to U.S. dollar foreign exchange rate.
NOTE C — INVENTORIES
Production materials are valued at the lower of cost or market applied on a standard cost basis. Work-in-process and finished goods inventory includes direct labor, materials and overhead and are valued at the lower of cost or market, cost being determined using standards that approximate actual costs on a specific identification basis. The Company writes down its inventory for estimated obsolescence or unmarketable inventory based upon assumptions about future demand and market conditions as well as historical inventory turnover. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Inventories consist of the following:
| | September 30,
2007 | | December 31,
2006 | |
Production materials | | $ | 3,451 | | $ | 3,431 | |
Work in process | | 1,211 | | 785 | |
Finished goods | | 1,892 | | 2,050 | |
Allowance for obsolescence | | (642 | ) | (507 | ) |
Total inventories, net | | $ | 5,912 | | $ | 5,759 | |
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NOTE D — NOTES PAYABLE
On March 8, 2005 the Company completed the acquisition of NKF Electronics B.V. The purchase price for the acquisition was approximately 18.3 million Euros ($24.4 million USD), which consisted of a cash payment of 11.0 million Euros ($14.5 million USD) and a 6% subordinated debt issued to the seller for the remainder.
The cash portion of the purchase price was funded by a $14.6 million senior term facility provided by a bank, consisting of a 4.1 million Euro based term loan ($5.4 million USD) and a $9.2 million USD based term loan. The 4.1 million Euro-based term loan has been paid in full by the Company. The USD term loan carries 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 term facility divided by EBITDA. As of September 30, 2007, the interest rate on this facility was 9.07%. The term loan is subject to a 72-month amortization with a balloon payment due after 48 months in April 2009. Principal and interest are payable on a monthly basis.
The subordinated debt is denominated in Euros with a principal amount of 7.3 million Euros and is provided by Draka Holding, N.V. who was the seller. The subordinated debt accrues interest at a rate of 6% per year and is due and payable in full on March 8, 2010. This Euro denominated debt experienced an increase of $585 thousand and $785 thousand during the third quarter of 2007 and first nine months of 2007 due to the impact of exchange rate changes.
The Company has a line of credit facility which allows us to borrow in either U.S. Dollars or Euros with a maximum amount not to exceed $5 million U.S. Dollars. The 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, 2007, the Company had $1.6 million outstanding on its bank line of credit with an effective interest rate of 7.60%. This entire balance is outstanding to the U.S. legal entity. The Company does have additional borrowing capability on our Euro line of credit through our subsidiary based in the Netherlands.
The Company is required by the bank to comply with certain financial covenants including maintaining a minimum fixed charge coverage ratio and a maximum senior debt leverage ratio. The Company was not in compliance with one of these covenants at both September 30, 2007 and December 31, 2006, however the Company received waivers from the bank related to the noncompliance through September 30, 2007. The noncompliance was a shortfall in maintaining the fixed charge covenant.
Obligations to the bank under the acquisition debt and the line of credit are secured by the Company’s assets. This includes our accounts receivable, inventory, equipment, securities, property, cash and non-cash proceeds and products. The subordinated note is secured by a Deed of Pledge in the capital of NKF. The pledged shares constitute 35% of the issued share capital of NKF. This debt is subordinate to the security interest of the bank.
Notes payable consist of the following:
| | September 30,
2007 | | December 31,
2006 | |
Senior term facility with a bank due April 2009 | | $ | 5,339 | | $ | 6,483 | |
Subordinated note due March 2010 | | 10,477 | | 9,692 | |
Other | | 94 | | 23 | |
| | 15,910 | | 16,198 | |
Less: Current portion | | (1,619 | ) | (1,548 | ) |
Total notes payable | | $ | 14,291 | | $ | 14,650 | |
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NOTE E — EARNINGS PER SHARE
Basic earnings per share are computed using the weighted average number of common shares outstanding. Diluted earnings per share are computed using the weighted average number of shares outstanding plus the impact of stock options using the treasury stock computation method, provided the options are not anti-dilutive. The following is a reconciliation of the basic and diluted earnings per share. Options to purchase 432 thousand shares of common stock were outstanding during the first nine months of 2007 but were not included in the computation of diluted earnings per share because their inclusion would be anti-dilutive.
| | Three Months Ended
September 30, | |
| | 2007 | | 2006 | |
Basic earnings per share: | | | | | |
Net income | | $ | 882 | | $ | 396 | |
Weighted average common shares — basic | | 3,617 | | 3,504 | |
Basic earnings per share | | $ | 0.24 | | $ | 0.11 | |
Diluted earnings per share: | | | | | |
Net income | | $ | 882 | | $ | 396 | |
| | | | | |
Weighted average common shares — basic | | 3,617 | | 3,504 | |
Assumed conversion of: | | | | | |
Stock options | | 4 | | 27 | |
Weighted average common shares — diluted | | 3,621 | | 3,531 | |
| | | | | |
Diluted earnings per share | | $ | 0.24 | | $ | 0.11 | |
| | Nine Months Ended September 30, | |
| | 2007 | | 2006 | |
Basic earnings per share: | | | | | |
Net income | | $ | 408 | | $ | 784 | |
Weighted average common shares — basic | | 3,496 | | 3,423 | |
Basic earnings per share | | $ | 0.12 | | $ | 0.23 | |
Diluted earnings per share: | | | | | |
Net income | | $ | 408 | | $ | 784 | |
| | | | | |
Weighted average common shares — basic | | 3,496 | | 3,423 | |
Assumed conversion of: | | | | | |
Stock options | | 6 | | 143 | |
Weighted average common shares — diluted | | 3,502 | | 3,566 | |
| | | | | |
Diluted earnings per share | | $ | 0.12 | | $ | 0.22 | |
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NOTE F — SHARE BASED COMPENSATION
Share-based compensation expense recognized for the three and nine months ended September 30, 2007 was $239 thousand and $703 thousand respectively or $0.07 and $0.20 for both basic and diluted earnings per share. For the three and nine months ended September 30, 2006 share-based compensation expense was $268 thousand and $735 thousand respectively or $0.08 and $0.21 for both basic and diluted earnings per share. As of September 30, 2007, total unamortized compensation expense related to non-vested share-based compensation was $872 thousand and is expected to be recognized over an average weighted period of a year. In each of the periods described above, compensation expense was recorded in the Consolidated Statements of Operations. The Company did not capitalize any stock-based compensation cost during these periods. The Company did not recognize any income tax benefits from stock-based payment plans for the nine months ended September 30, 2007 and 2006.
Stock Option Plans
The Company has two stock-based compensation plans. It is the practice of the Company to satisfy awards and options granted under these plans through the issuance of new shares. The 2002 Incentive Stock Option Plan provides for up to 777 thousand shares available for grant. These options or shares may be granted to officers (including officers who are directors) and other key employees of the Company. There were 66 thousand options available for future grant at September 30, 2007. The exercise price of each option is the market value of the stock at the grant date. Options issued in 2007 are 100% exercisable two years from the grant date. Options issued prior to 2007 are 25% exercisable at the grant date with an additional 50% exercisable one year from the grant date and fully exercisable two years from the grant date. Options expire five years from the date of grant and, in most cases, upon termination of employment.
The 2001 Nonqualified Director Stock Option Plan provides for up to 178 thousand shares available for grant. Options under this plan are granted to non-employee directors at fair market value on the date of grant and are exercisable upon grant and expire five years thereafter. There were 53 thousand awards available for future grant at September 30, 2007.
A summary of the activity, subsequent to December 31, 2006, of the Company’s aggregate stock option awards under its plans is presented below:
| | Shares
(in
thousands) | | Weighted-
Average
Exercise
Price | | Weighted-
Average
Remaining
Contractual
Term (years) | | Aggregate
Intrinsic
Value
(in
thousands) | |
Outstanding, December 31, 2006 | | 350 | | $ | 10.45 | | 3.01 | | $ | 376 | |
Granted | | 114 | | 9.12 | | | | | |
Exercised | | (1 | ) | 3.05 | | | | | |
Forfeited, cancelled or expired | | (6 | ) | 10.48 | | | | | |
Outstanding, March 31, 2007 | | 457 | | 10.13 | | 3.24 | | 51 | |
Granted | | 0 | | | | | | | |
Exercised | | (1 | ) | 5.00 | | | | | |
Forfeited, cancelled or expired | | (9 | ) | 9.96 | | | | | |
Outstanding, June 30, 2007 | | 447 | | 10.14 | | 3.05 | | 35 | |
Granted | | 0 | | | | | | | |
Exercised | | (1 | ) | 4.66 | | | | | |
Forfeited, cancelled or expired | | 0 | | | | | | | |
Outstanding, September 30, 2007 | | 446 | | 10.16 | | 2.81 | | 24 | |
Vested and expected to vest, September 30, 2007 | | 433 | | 10.17 | | 2.76 | | 24 | |
Exercisable, September 30, 2007 | | 323 | | $ | 10.31 | | 2.24 | | $ | 24 | |
10
The following table summarizes information about all stock options outstanding at September 30, 2007.
| | Options Outstanding | | Options Exercisable | |
Range of Exercise Prices | | Number
Outstanding
(in
thousands) | | Weighted
Average
Remaining
Life in Years | | Weighted
Average
Exercise
Price | | Number
Exercisable
(in
thousands) | | Weighted
Average
Exercise
Price | |
$ 4.66 to $9.15 | | 209 | | 3.33 | | $ | 8.77 | | 103 | | $ | 8.46 | |
$ 9.16 to $9.81 | | 112 | | 1.79 | | 9.32 | | 113 | | 9.32 | |
$ 9.82 to $14.24 | | 113 | | 2.79 | | 12.50 | | 96 | | 12.32 | |
$ 14.25 to $27.77 | | 12 | | 3.42 | | 20.44 | | 11 | | 20.48 | |
Total | | 446 | | 2.81 | | $ | 10.16 | | 323 | | $ | 10.31 | |
NOTE G — INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
During the nine months ended September 30, 2007, less than 3 thousand stock options were exercised for the purchase of shares of common stock. The exercise of these stock options generated an income tax deduction equal to the excess of the fair market value over the exercise price. The Company will not recognize a deferred tax asset with respect to the excess stock compensation deductions until those deductions actually reduce our income tax liability. The Company has not recorded a deferred tax asset related to the net operating losses resulting from the exercise of these stock options in the accompanying financial statements. When the Company utilizes these net operating losses to reduce income tax payable, the tax benefit will be recorded as an increase to additional paid in capital.
In July 2006, the Financial Accounting Standards Board issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes --- an interpretation of SFAS No. 109”. FIN 48 clarifies SFAS 109 and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for our fiscal year beginning January 1, 2007, and the Company
11
adopted FIN 48 at that time. The adoption of FIN 48 did not have a material impact on our consolidated financial statements.
NOTE H — BUSINESS UNIT INFORMATION
During the first quarter of 2007, the Company implemented a corporate restructuring. As part of the restructuring, management concluded that the Company operates as one primary business segment, the Communication Products Division (CPD) which develops, manufactures and sells optical fiber-based data communications equipment to both commercial and government customers. The Company derives more than 95% of its revenue from CPD.
Information regarding the Company’s domestic and foreign revenue and long lived assets is as follows:
| | Three Months Ending
September 30, 2007 | | Three Months Ending
September 30, 2006 | |
| |
Revenue
| | Long Lived
Assets | |
Revenue
| | Long Lived
Assets | |
Europe | | $ | 5,294 | | $ | 24,277 | | $ | 5,107 | | $ | 22,471 | |
U.S. | | 4,373 | | 3,179 | | 3,838 | | 2,841 | |
Asia | | 744 | | 31 | | 281 | | | |
Middle East | | 551 | | | | 788 | | | |
Other | | 502 | | | | 132 | | | |
Total | | $ | 11,464 | | $ | 27,487 | | $ | 10,146 | | $ | 25,312 | |
| | Nine Months Ending
September 30, 2007 | | Nine Months Ending
September 30, 2006 | |
| |
Revenue
| | Long Lived
Assets | |
Revenue
| | Long Lived
Assets | |
Europe | | $ | 14,105 | | $ | 24,277 | | $ | 13,955 | | $ | 22,471 | |
U.S. | | 10,781 | | 3,179 | | 10,236 | | 2,841 | |
Asia | | 1,462 | | 31 | | 1,215 | | | |
Middle East | | 2,174 | | | | 1,913 | | | |
Other | | 968 | | | | 1,329 | | | |
Total | | $ | 29,490 | | $ | 27,487 | | $ | 28,648 | | $ | 25,312 | |
NOTE I — RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2006, the Federal Accounting Standards Board ("FASB") issued SFAS No. 157, Fair Value Measurement ("SFAS 157"). SFAS 157 defines "fair value", establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact the adoption of SFAS 157 will have on its consolidated financial position and results of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, ("SFAS 159"). SFAS 159 provides companies with an option to report selected financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact the adoption of SFAS 159 will have on its consolidated financial position and results of operations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read along with the unaudited condensed consolidated financial statements included in this Form 10-Q, as well as the Company’s 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission. The 10-K provides a more thorough discussion of the Company’s products and services, industry outlook, and business trends.
CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS
The Company’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (US GAAP). The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenue and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information. Actual results could differ materially from those estimates. There
12
have been no material changes in the company’s critical accounting policies during the nine months ended September 30, 2007.
OVERVIEW
The Company currently maintains its corporate offices in Germantown, Maryland, with manufacturing facilities and sales offices both in the U.S. and the Netherlands along with additional sales offices in England, Spain, France and Singapore.
The Company is focused on developing, manufacturing and selling optical fiber-based data communication equipment and IP (Internet Protocol)/Ethernet-based products to both commercial and government clients worldwide. We also develop and manufacture innovative optical devices under contract, primarily to government and defense industry customers.
Fiber optic communications equipment was historically the main element of the Company’s product offerings. Technology development is constantly and rapidly improving the capability to transmit at increasing data rates over ever greater distances with fiber-based communication systems. In our markets of security/surveillance and Intelligent Transportation Systems, a rapid transition to video communication systems based on IP/Ethernet network technology is occurring. We are positioning the Company to participate in this market transition with a strong and growing product suite that will address the full range of IP/Ethernet applications.
We design, develop, manufacture and market communications systems employing both fiber optic and IP-Ethernet based technology for traffic monitoring, and commercial security/surveillance video systems. Over the past two years, we have aggressively pursued the expansion of a distribution network both in the United States and abroad; realization of manufacturing and process improvements; development of products with advanced capabilities; and the consolidation of our computer networks including our financial, sales and manufacturing software platforms.
In March 2007 we announced changes to our corporate structure that will globally integrate the management functions previously established as individually and separately-managed units at our U.S. and European operating facilities. The plan integrates under one management team the Company’s global sales and marketing, product development, service, support and fulfillment functions. In addition to the operational benefits, the restructuring reduced costs by approximately $500 thousand in 2007. We anticipate an additional $250 thousand of additional savings for the fourth quarter of 2007.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2006
REVENUE
Consolidated revenue for the quarter ended September 30, 2007 of $11.5 million was $1.3 million or 13% higher than the third quarter of 2006. The increase includes improvement in domestic revenue of $623 thousand, or 16%, and improvement in international revenue of $695 thousand, or 11%. The increase in international revenue includes approximately $400 thousand from the positive impact of foreign exchange rates as the Euro increased vs. the Dollar. Excluding foreign exchange adjustments, international revenue increased 5%.
Approximately 18% of our sales were in IP/Ethernet products in the current quarter and the Company believes the market shift to video communication systems based on IP/Ethernet network technology is underway and will continue. Demand for fiber optic based products still represents a majority of our sales; however fiber optic based sales are projected to decline in domestic and international markets. The newer technology allows users to easily disseminate, store and process video images.
COSTS OF GOODS SOLD
Consolidated costs of goods sold were $4.4 million or 39% of revenue for the quarter ended September 30, 2007, compared to $4.1 million or 40% of revenue for the third quarter of 2006. The decrease to 39% from 40% is primarily because of increased efficiency including from a reduction in force in U.S. manufacturing personnel in March 2007. These cost reductions were somewhat offset by approximately $160 thousand of additional costs from the impact of foreign exchange rates as the Euro increased versus the Dollar.
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GROSS PROFIT
Consolidated gross profit was $7.0 million or 61% of revenue for the quarter ended September 30, 2007, compared to $6.1 million or 60% of revenue for the third quarter of 2006. The 1% gross margin improvement results from the 13% increase in revenue combined with only a 9% increase in costs of goods sold.
OPERATING EXPENSES
Consolidated operating expenses were $5.5 million for the quarter ended September 30, 2007 compared to $5.1 million in 2006, an increase of $368 thousand or 7% in the current quarter. Approximately $150 thousand of this increase was from the impact of foreign exchange rates as the Euro increased versus the Dollar.
The increase excluding foreign exchange rates was 4% which primarily resulted from sales and marketing costs increasing as we added sales and sales support staff in 2007. The majority of the sales and marketing cost increases are from our international operations. These increased costs were partially offset by a $156 thousand reduction in general and administrative expenses as the Company implemented cost control measures in 2007.
OTHER EXPENSE
Other expense for the quarters ended September 30, 2007 and 2006 consisted almost entirely of interest expense. Other expense totaled $315 thousand in the current quarter as increased interest expense on our line of credit was partially offset by a decline in interest expense as we continue to pay down our term loan. The line of credit was used exclusively during both periods by our U.S. operation as it experienced negative cash flow.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2006
REVENUE
Consolidated revenue for the nine months ended September 30, 2007 of $29.5 million was $842 thousand or 3% higher than 2006. Results in the first nine months of 2007 fell short of our expectations; however the revenue increase in the current quarter demonstrated positive progress. 2007 revenue includes a positive impact from the impact of foreign exchange rates totaling approximately $2.0 million. Excluding foreign exchange adjustments, current year revenue shows a small decline versus 2006 of 4%.
Sales increased modestly on a year-over-year basis in both the U.S. and international markets. The U.S. based sales improved 2% and $250 thousand. Revenue in our international operations was up $592 thousand during 2007. However, after considering the positive impact from foreign exchange rates, the revenue amount declined 8%.
COSTS OF GOODS SOLD
Consolidated costs of goods sold were $12.0 million in 2007 compared to $12.1 million in 2006. The costs were comparable while the Company had a small increase in revenue during the current period. The costs of goods sold were held in line with prior periods with a reduction in force in U.S. manufacturing personnel and a reduction in costs from reduced profit sharing for international employees. These cost reductions were somewhat offset by additional costs related to foreign exchange rates.
GROSS PROFIT
Consolidated gross profit was $17.5 million or 59% of revenue for the nine months ended September 30, 2007, compared to $16.6 million or 58% of revenue for the same period in 2006. The gross profit percentage increased slightly in the current year as revenue increased modestly combined with cost reductions in 2007 including a reduction in force in U.S. manufacturing. These cost reductions were somewhat offset by additional costs from the impact of foreign exchange rates. We also had costs in 2006 for compliance with lead-free product requirements that were charged against cost of goods sold. There were no similar costs in 2007.
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Included in 2007 costs of goods sold is an inventory write-off of $110 thousand to identify products which may be difficult to sell as we migrate from fiber optic based products to IP/Ethernet products. The Company’s review of the fiber optic products continues as the market for our products shifts and we update or adapt our product plans. As a result, more inventory write-downs may be necessary if additional products are discontinued or become obsolete.
OPERATING EXPENSES
Consolidated operating expenses were $16.0 million for the nine months ended September 30, 2007 compared to $14.4 million in 2006, an increase of 11%. The Company’s overall increase of $1.6 million in operating expense included increased costs from the impact of foreign exchange rates of approximately $800 thousand. The remaining $800 thousand increase is primarily attributable to:
• Sales and marketing costs as we expand globally and enhance our sales capabilities. This included hiring additional sales managers and sales support staff. The majority of this cost increase is from our international operations.
• Restructuring costs in the U.S. operation which totaled $145 thousand in the first quarter of 2007.
OTHER EXPENSE
Other expense for the first nine months of 2007 and 2006 consisted almost entirely of interest expense. Other expense totaled $918 thousand in the current period as increased interest expense from additional use on our line of credit was partially offset by a decline in interest expense as we continue to pay down our term loan. The line of credit was used exclusively by our U.S. operation as it experienced negative cash flow at times during these periods.
INCOME TAXES
As of September 30, 2007 the Company had deferred tax assets related to net operating losses and research and development tax credit carryforwards totaling $1.8 million. This is an increase of approximately $200 thousand from December 31, 2006. These net operating loss and tax credit carryforwards are in the U.S. operation and begin to expire in the year 2019.
In evaluating the Company’s ability to recover its deferred tax assets, we considered all available positive and negative evidence, including past operating results, the reversal of temporary differences, the forecasts of future taxable income and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with estimates being used to manage the business. Based on the weight of the positive and negative evidence and the information available, the Company believes that it is more likely than not that the deferred tax assets will be realized.
FINANCIAL CONDITION
The Company’s stockholders’ equity increased from $17.9 million at December 31, 2006 to $20.4 million at September 30, 2007. The increase in overall stockholders’ equity resulted from:
• Net income in the current year of $408 thousand.
• An increase in additional paid in capital of $744 thousand primarily from the grant of stock to employees and directors.
• A $1.3 million increase in accumulated other comprehensive income primarily from the positive impact of foreign currency translations as the U.S. Dollar weakened against the Euro.
The total assets of the Company were $47.5 million at September 30, 2007 and $46.3 million at December 31, 2006. This modest increase is directly attributable to a $1.1 million increase in goodwill from the impact of foreign exchange rates.
The Company’s total liabilities decreased $1.2 million from $28.3 million at December 31, 2006 to $27.1 million at September 30, 2007. This is predominately from declines in accounts payable and accrued payroll which were partially offset by an $800 thousand increase in the bank line of credit compared to year-end 2006.
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The Company has a line of credit facility which allows us to borrow in either U.S. Dollars or Euros with a maximum amount not to exceed $5 million U.S. Dollars. As of September 30, 2007, the Company had $1.6 million outstanding on its bank line of credit with an effective interest rate of 7.60%. This balance is slightly below the current maximum amount the U.S. legal entity can borrow on its line of credit.
The Company does have additional borrowing capability of $1.9 million U.S. Dollars on our Euro line of credit through our subsidiary based in the Netherlands. However, use of the Euro line of credit to support the U.S. operation could result in tax liability and tax expense if these dividends were considered a deemed dividend.
Obligations to the bank under the acquisition debt and the line of credit are secured by the Company's assets. This includes our accounts receivable, inventory, equipment, securities, property, cash and non-cash proceeds and products. The subordinated note is secured by a Deed of Pledge in the capital of NKF. The pledged shares constitute 35% of the issued share capital of NKF. This debt is subordinate to the security interest of the bank.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $1.1 million for the first nine months of 2007, compared to cash used of $1.3 million in the same period of 2006. 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. The increase in cash provided by operating activities is due to significant decline in accounts receivable as the Company enhanced its collection efforts and improved revenue. This is somewhat offset by a decline in accounts payable and other liabilities.
Cash used in investing activities was $875 thousand for the first nine months of 2007 and $260 thousand for the same period in 2006. The increase is attributable to an increase in capital expenditures as the Company invested in its sales, information technology, and product development efforts to transition from a Fiber Optic to an IP/Ethernet product set and to further integrate its international and domestic operations.
During 2007 $281 thousand of cash was used for financing activities compared to $375 thousand provided by financing activities during 2006. The current year decrease is a result of a $1.8 million decline in the proceeds from exercising stock options. The decline in exercising stock options is due to the Company’s stock price falling significantly in the past year. This decline was somewhat offset by an $800 thousand increase in the outstanding balance on our line of credit.
We plan to finance our future working capital needs with our operating cash flow and continued use of our line-of-credit. In the event these sources become insufficient to meet funding needs, the Company may be required to scale back sales and marketing expenses, product research and development costs, and/or overhead costs. Additionally, the Company would pursue an increase in its line of credit, additional debt or equity financing, and/or make dividend payments from its European operations. Dividends from international operations could result in increased tax liability and tax expense to the Company.
The Company experienced a net loss in the first and second quarters of 2007 with a return to profitability in the third quarter. If losses were to recur, the liquidity of our business would be adversely impacted. This may result in a reduction in our ability to secure additional financing opportunities. If we are able to secure additional financing under these circumstances the cost could be prohibitive. Our net losses in the first two quarters were primarily from our U.S. operation which has experienced decreased operating cash flow in certain recent periods. Our US operation is currently near the maximum amount allowable outstanding on its line of credit.
FORWARD LOOKING INFORMATION
Statements in this Form 10-Q that are in the future tense, and all statements accompanied by terms such as “believe,” “project,” “expect,” “estimate,” “assume,” “intend,” “anticipate,” and variations or similar terms are intended to be “forward-looking statements” as defined by federal securities law. Forward-looking statements are based upon assumptions, expectations, plans and projections that are believed valid when made, but that are subject to the risks and uncertainties identified under Risk Factors in the company’s annual report on Form 10-K for the year ended December 31, 2006 as amended or supplemented by the information in Part II, Item 1A of this report, that may cause actual results to differ materially from those expressed or implied in the forward-looking statements.
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The company intends that all forward-looking statements made will be subject to safe harbor protection of the federal securities laws pursuant to Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements are based upon, among other things, the company’s assumptions with respect to:
• future revenue;
• expected sales levels and cash flows;
• acquisitions or divestitures of businesses;
• debt payments and related interest rates;
• fluctuations in foreign currency amounts and rates;
• performance issues with key suppliers;
• product performance and the successful execution of internal plans;
• successful negotiation of major contracts;
• effective tax rates and timing and amounts of tax payments;
• the results of any audit or appeal process with the Internal Revenue Service; and
• anticipated costs of capital investments.
You should consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of predictions contained in such forward-looking statements. As noted above, these forward-looking statements speak only as of the date when they are made. The Company does not undertake any obligation to update forward-looking statements to reflect events, circumstances, changes in expectations, or the occurrence of unanticipated events after the date of those statements. Moreover, in the future, the Company, through senior management, may make forward-looking statements that involve the risk factors and other matters described in this Form 10-Q as well as other risk factors subsequently identified. This includes those identified in the Company’s filings with the Securities and Exchange Commission on Form 10-K, Form 10-Q and Form 8-K.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
FOREIGN CURRENCY EXCHANGE RATE RISK
We are exposed to foreign currency exchange rate risk on our investment in our European operations. We do not hedge our net investment in foreign operations or other transactions with these operations and we have no derivative financial instruments for the underlying economic exposure. Most of these gains and losses are recorded directly in shareholders’ equity.
For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” of our annual report on Form 10-K for the year ended December 31, 2006. With the exception of the foreign currency exchange rate risk noted above, our exposures to market risk have not changed materially since December 31, 2006.
Item 4. Controls and Procedures.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of September 30, 2007, 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 were effective as of September 30, 2007.
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CHANGES IN INTERNAL CONTROLS
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, 2007 were identified that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, the Company is involved in legal proceedings and litigation arising in the ordinary course of business. The Company does not believe, but can give no assurance, that the outcome of any such matter would have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.
Item 1A. Risk Factors.
The Company identified numerous risk factors in our Annual Report on Form 10-K for the year ended December 31, 2006. The following are additional risk factors we have identified.
We may be required to establish a valuation allowance on certain deferred tax assets if we are unable to obtain sufficient future profitability in our U.S. operations.
The Company has net operating loss and business tax credit carryforwards for U.S. income tax purposes that begin to expire in 2019. In evaluating the Company’s ability to realize the deferred tax assets recorded as a result of these items, we consider all available positive and negative evidence, including past operating results, the reversal of temporary differences, the forecasts of future taxable income and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about future taxable income which has a substantial amount of inherent subjectivity. If we are unable to obtain sufficient future profitability in the U.S. operations and/or implement appropriate tax planning strategies then the Company may be required to provide a valuation allowance related to its deferred tax assets. While recording a valuation allowance would have no cash flow impact it could have a material negative impact on the earnings and net assets of the Company.
If we are unable to generate new sales and attain profitability, our business and our financial condition and results of operations may be adversely impacted.
Our lack of profitability in certain periods may impact our ability to attract customers, employees, investors and creditors. Our ability to sustain profitability in future periods will depend in large part on our ability to maintain current customers and generate new sales, to maintain or improve our rate of manufacturing utilization, and to manage sales, product development, and general and administrative expenses in proportion to our revenue. We cannot be certain that we will generate profits in the future or that a failure to do so would not have a material adverse effect on our business. Our profitability and cash flow constraints are particularly emphasized in our U.S. operations where our recent sales levels underscore the need to succeed with implementation of product advancements, sales improvements and cost controls.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
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Item 5. Other Information.
None.
Item 6. Exhibits.
3.1 | | Certificate of Incorporation, as amended (incorporated by reference from Form 10-K filed March 31, 1998 and Form 8-K filed April 19, 2005) |
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3.2 | | By-Laws (incorporated by reference from Form 10-K filed March 31, 1998) |
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10.1 | | Amendment to Employment Agreement, dated August 9, 2007, between Optelecom-NKF, Inc. and Steven Tamburo (incorporated by reference from Form 8-K filed August 8, 2007) |
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31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act — filed herewith. |
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31.2 | | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act — filed herewith. |
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32 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 — filed herewith. |
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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.
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| | OPTELECOM-NKF, INC. |
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Date: November 14, 2007 | | /s/ Edmund Ludwig |
| | Edmund Ludwig, |
| | Director, President and Chief Executive Officer |
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Date: November 14, 2007 | | /s/ Steven Tamburo |
| | Steven Tamburo, |
| | Chief Financial Officer |
| | |
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