UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
x | | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For Quarterly Period Ended March 31, 2008
OR
o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | | Accelerated filer o |
| | |
Non-accelerated filer o | | Smaller reporting company x |
(Do not check if a smaller reporting company) | | |
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 April 25, 2008, the registrant had outstanding 3,640,133 shares of Common Stock, $0.03 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 MARCH 31, 2008 AND DECEMBER 31, 2007
(March 31, 2008 Unaudited)
(Dollars in Thousands, Except Share Amounts)
| | Mar. 31,
2008 | | Dec. 31,
2007 | |
| | (unaudited) | | | |
ASSETS | | | | | |
CURRENT ASSETS | | | | | |
Cash and cash equivalents | | $ | 8,093 | | $ | 5,043 | |
Accounts and contracts receivable, net of allowance for doubtful accounts of $316 and $249 | | 8,158 | | 9,575 | |
Inventories, net | | 5,096 | | 5,214 | |
Deferred tax asset—current | | 708 | | 732 | |
Prepaid expenses and other current assets | | 1,014 | | 816 | |
Total current assets | | 23,069 | | 21,380 | |
Property and equipment, less accumulated depreciation of $8,105 and $7,634 | | 2,705 | | 2,594 | |
Deferred tax asset—non-current | | 2,764 | | 2,284 | |
Intangible assets, net of accumulated amortization of $2,644 and $2,259 | | 8,620 | | 8,241 | |
Goodwill | | 16,368 | | 15,259 | |
Other assets | | 220 | | 205 | |
TOTAL ASSETS | | $ | 53,746 | | $ | 49,963 | |
| | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | |
CURRENT LIABILITIES | | | | | |
Accounts payable | | $ | 2,621 | | $ | 2,623 | |
Accrued payroll | | 2,564 | | 2,165 | |
Commissions payable | | 172 | | 198 | |
Current portion of capitalized leases | | 26 | | 45 | |
Bank line of credit | | 1,625 | | 1,000 | |
Current portion of notes payable | | 4,576 | | 1,525 | |
Accrued warranty reserve | | 402 | | 418 | |
Taxes payable | | 79 | | 49 | |
Other current liabilities | | 1,051 | | 1,090 | |
Total current liabilities | | 13,116 | | 9,113 | |
Notes payable | | 11,600 | | 14,245 | |
Deferred tax liability | | 2,207 | | 2,037 | |
Interest payable | | 1,155 | | 1,210 | |
Other liabilities | | 255 | | 257 | |
Total liabilities | | 28,333 | | 26,862 | |
STOCKHOLDERS’ EQUITY | | | | | |
Common stock, $.03 par value—shares authorized, 15,000,000; issued and outstanding, 3,636,730 and 3,632,083 shares as of March 31, 2008 and December 31, 2007, respectively | | 109 | | 109 | |
Additional paid-in capital | | 15,778 | | 15,534 | |
Accumulated other comprehensive gain | | 5,326 | | 3,406 | |
Treasury stock, 162,672 shares, at cost | | (1,265 | ) | (1,265 | ) |
Retained earnings | | 5,465 | | 5,317 | |
Total stockholders’ equity | | 25,413 | | 23,101 | |
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | | $ | 53,746 | | $ | 49,963 | |
See notes to unaudited consolidated financial statements
3
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME (LOSS)
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(Dollars in Thousands, Except Share Amounts)
| | 2008 | | 2007 | |
Revenue | | $ | 10,535 | | $ | 8,835 | |
Cost of goods sold | | 4,076 | | 3,922 | |
Gross profit | | 6,459 | | 4,913 | |
Operating expenses: | | | | | |
Sales and marketing | | 2,661 | | 2,057 | |
Engineering | | 1,416 | | 1,376 | |
General and administrative | | 1,662 | | 1,348 | |
Amortization of intangibles | | 208 | | 183 | |
Total operating expenses | | 5,947 | | 4,964 | |
Income (loss) from operations | | 512 | | (51 | ) |
Other expense, net | | 352 | | 324 | |
Income (loss) before income taxes | | 160 | | (375 | ) |
Provision (benefit) for income taxes | | 12 | | (117 | ) |
Net income (loss) | | $ | 148 | | $ | (258 | ) |
Basic earnings (loss) per share | | $ | .04 | | $ | (.07 | ) |
Diluted earnings (loss) per share | | $ | .04 | | $ | (.07 | ) |
Weighted average common shares outstanding — basic | | 3,632,564 | | 3,518,205 | |
Weighted average common shares outstanding — diluted | | 3,632,635 | | 3,518,205 | |
| | | | | |
Net income (loss) | | $ | 148 | | $ | (258 | ) |
Foreign currency translation | | 1,920 | | 173 | |
Comprehensive income (loss) | | $ | 2,068 | | $ | (85 | ) |
See notes to unaudited consolidated financial statements.
4
OPTELECOM-NKF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(Dollars in Thousands)
| | 2008 | | 2007 | |
Cash Flows from Operating Activities: | | | | | |
Net income (loss) | | $ | 148 | | $ | (258 | ) |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | | 465 | | 426 | |
Accounts receivable provision | | 52 | | (280 | ) |
Change in allowance for inventory obsolescence | | (222 | ) | 73 | |
Stock based compensation | | 228 | | 206 | |
Deferred rent | | (1 | ) | 3 | |
Deferred tax asset | | (451 | ) | (354 | ) |
Deferred tax liability | | 20 | | (47 | ) |
Change in assets and liabilities: | | | | | |
Accounts and contracts receivable | | 1,793 | | 2,202 | |
Inventories | | 523 | | (322 | ) |
Prepaid expenses and other current assets | | (504 | ) | 57 | |
Other assets | | — | | 16 | |
Accounts payable and other accrued expenses | | (132 | ) | (902 | ) |
Other current liabilities | | 448 | | (402 | ) |
Net cash provided by operating activities | | 2,367 | | 418 | |
Cash Flows from Investing Activities: | | | | | |
Capital expenditures | | (294 | ) | (429 | ) |
Net cash used in investing activities | | (294 | ) | (429 | ) |
Cash Flows from Financing Activities: | | | | | |
Net increase in bank line of credit | | 624 | | 800 | |
Payments on notes payable and capital leases | | (400 | ) | (421 | ) |
Proceeds from employee stock purchase plan | | 12 | | 19 | |
Proceeds from exercise of stock options | | 2 | | 2 | |
Net cash provided by financing activities | | 238 | | 400 | |
Effect of exchange rates on cash and cash equivalents | | 739 | | 139 | |
Net increase in cash and cash equivalents | | 3,050 | | 528 | |
Cash and cash equivalents — beginning of period | | 5,043 | | 3,571 | |
Cash and cash equivalents — end of period | | $ | 8,093 | | $ | 4,099 | |
Supplemental Disclosures of Cash Flow Information: | | | | | |
Cash paid during the period of interest | | $ | 115 | | $ | 160 | |
Cash paid during the period for income taxes | | $ | 201 | | $ | 164 | |
See notes to unaudited consolidated financial statements.
5
OPTELECOM-NKF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in Thousands, Except 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, 2007.
NOTE B — COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is comprised of net income from operations and other comprehensive income. Other comprehensive income (loss) refers to revenue, expenses, gains and losses that under U.S. GAAP are included in other comprehensive income (loss), 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 foreign currency, primarily the Euro, to the 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:
(Dollars in Thousands) | | March 31,
2008 | | December 31,
2007 | |
Production materials | | $ | 3,170 | | $ | 3,187 | |
Work in process | | 736 | | 801 | |
Finished goods | | 1,746 | | 1,976 | |
Allowance for obsolescence | | (556 | ) | (750 | ) |
Total inventories, net | | $ | 5,096 | | $ | 5,214 | |
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NOTE D — NOTES PAYABLE
Notes payable consist of the following:
| | March 31, | | December 31, | |
(Dollars in Thousands) | | 2008 | | 2007 | |
Senior term facility with a bank due February 2009 | | $ | 4,576 | | $ | 4,958 | |
Subordinated note due March 2010 (1) | | 12,755 | | 12,022 | |
| | 17,331 | | 16,980 | |
Less Current Portion | | (4,576 | ) | (1,525 | ) |
| | $ | 12,755 | | $ | 15,455 | |
(1) Includes $1.2 million of deferred interest payable on the subordinated note at March 31, 2008 and 2007.
On March 8, 2005, the Company completed the acquisition of NKF Electronics B.V. from Draka Holding, N.V. (the “Seller”). The purchase price was $24.4 million which included both a cash payment and a Subordinated Note to the Seller. The cash payment totaled $14.6 million and was funded by a senior term facility provided by a bank. The Company issued a Euro based Subordinated Note to the Seller for the remaining $9.8 million (€7.3 million Euros).
The balance of the senior term loan at March 31, 2008 was $4.6 million. The term loan carries interest at the rate of LIBOR plus a margin that can range from 2.25% to 3.25% depending on the Company’s leverage position. At the recent quarter end the interest rate on this term loan was 6.3%. The term loan is subject to a 72 month amortization which is payable over four years with a balloon payment in the first quarter of 2009.
The principal balance of the Subordinated Note to the Seller was $11.6 million at March 31, 2008. The Subordinated Note is denominated in Euros and the liability has increased $1.8 million since the acquisition date in March 2005 due to the impact of exchange rate changes. $747 thousand of this additional liability is due to exchange rate changes in the first quarter of 2008. Upon payment in March 2010 the €7.3 million Euro principal balance will result in a cash payment at the prevailing exchange rate on that date.
The Subordinated Note accrues interest at a fixed rate of 6% per year and is due and payable in full in March 2010. $1.2 million of deferred interest payable has been accrued from the acquisition date through March 31, 2008 including $165 thousand accrued in the current quarter. The impact of foreign exchange rates on deferred interest from the Subordinated Note will be recognized as other income (expense) upon payment. The other income (expense) will be the difference between accrued interest in our financial statements and the final cash interest payment to the Seller in March 2010.
In addition to acquisition funding the Company has the ability to borrow up to $5.0 million under its bank line of credit, provided there are sufficient accounts receivable and inventory. This facility allows the Company to borrow in either US Dollars or Euros. The line of credit carries interest at the rate of LIBOR plus a margin that can range from 1.75% to 2.75% depending on the Company’s leverage position. As of March 31, 2008, the Company had $1.6 million outstanding on its bank line of credit with an interest rate of 5.7%. At the recent quarter end the Company was at the maximum amount the U.S. legal entity can borrow on its line of credit and 1.5 million Euro ($2.4 million) is available on the line of credit through our subsidiary based in the Netherlands.
7
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 443 thousand shares of common stock were outstanding during the first three months of 2008 but were not included in the computation of diluted earnings per share because their inclusion would be anti-dilutive.
| | Three Months Ended
March 31, | |
(Dollars in Thousands, Except Share Amounts) | | 2008 | | 2007 | |
Basic earnings per share: | | | | | |
Net income (loss) | | $ | 148 | | $ | (258 | ) |
Weighted average common shares — basic | | 3,632,564 | | 3,518,205 | |
Basic earnings (loss) per share | | $ | .04 | | $ | (.07 | ) |
Diluted earnings (loss) per share: | | $ | .04 | | $ | (.07 | ) |
Net income (loss) | | $ | 148 | | $ | (258 | ) |
Weighted average common shares — basic | | 3,632,564 | | 3,518,205 | |
Assumed conversion of: | | | | | |
Stock options | | 71 | | — | |
Weighted average common shares — diluted | | 3,632,635 | | 3,518,205 | |
| | | | | |
Diluted earnings per share | | $ | .04 | | $ | (.07 | ) |
NOTE F — SHARE BASED COMPENSATION
Share-based compensation expense recognized for the three months ended March 31, 2008 was $228 thousand. For the three months ended March 31, 2007 share-based compensation expense was $206 thousand. As of March 31, 2008, total unamortized compensation expense related to non-vested share-based compensation was $570 thousand and is expected to be recognized over an average weighted period of one 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 three months ended March 31, 2008 and 2007.
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 March 31, 2008. 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 43 thousand awards available for future grant at March 31, 2008.
8
A summary of the activity, subsequent to December 31, 2007, 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, 2007 | | 423 | | $ | 10.27 | | 2.61 | | $ | 5 | |
Granted | | 23 | | 6.96 | | | | | |
Exercised | | (1 | ) | 4.66 | | | | | |
Forfeited, cancelled or expired | | (2 | ) | 6.19 | | | | | |
Outstanding, March 31, 2008 | | 443 | | 10.12 | | 2.52 | | 6 | |
Vested and expected to vest, March 31, 2008 | | 430 | | 10.16 | | 2.47 | | 5 | |
Exercisable, March 31, 2008 | | 317 | | $ | 10.60 | | 1.90 | | $ | 0 | |
The following table summarizes information about all stock options outstanding at March 31, 2008.
| | 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 | |
$ 6.96 to $9.05 | | 106 | | 2.56 | | $ | 8.48 | | 81 | | $ | 8.92 | |
$ 9.06 to $9.48 | | 213 | | 2.64 | | 9.20 | | 118 | | 9.29 | |
$ 9.49 to $13.87 | | 92 | | 1.98 | | 11.94 | | 91 | | 11.94 | |
$13.88 to $27.77 | | 32 | | 3.06 | | 16.45 | | 27 | | 16.80 | |
Total | | 443 | | 2.52 | | $ | 10.12 | | 317 | | $ | 10.60 | |
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 three months ended March 31, 2008, less than one 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 adopted FIN 48 at that time. The adoption of FIN 48 did not have a material impact on our consolidated financial statements.
9
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 IP/Ethernet and optical fiber-based data communications equipment.
Information regarding the Company’s domestic and foreign revenue and long lived assets is as follows:
| | Three Months Ending
March 31, 2008 | | Three Months Ending
March 31, 2007 | |
(Dollars in Thousands) | | Revenue | | Long Lived
Assets | | Revenue | | Long Lived
Assets | |
Europe | | $ | 6,192 | | $ | 26,738 | | $ | 4,337 | | $ | 23,094 | |
U.S. | | 2,956 | | 3,939 | | 2,571 | | 3,555 | |
Asia | | 835 | | — | | 886 | | — | |
Middle East | | 326 | | — | | 357 | | — | |
Other | | 226 | | — | | 684 | | — | |
Total | | $ | 10,535 | | $ | 30,677 | | $ | 8,835 | | $ | 26,649 | |
NOTE I — RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2007, the Financial Accounting Standards Board issued Statement 141 (revised 2007), “Business Combinations” (Statement 141R), to change how an entity accounts for the acquisition of a business. When effective, Statement 141R will replace existing Statement 141 in its entirety. Statement 141R carries forward the existing requirements to account for all business combinations using the acquisition method (formerly called the purchase method). In general, Statement 141R will require acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed, and non-controlling interests in the acquiree. Statement 141R will eliminate the current cost—based purchase method under Statement 141.
Statement 141R is effective for fiscal years and interim periods within those fiscal years beginning on or after December 15, 2008. Early adoption is prohibited. The Company intends to adopt Statement 141R effective January 1, 2009 and apply its provisions prospectively. The Company does not expect the adoption of Statement 141R to have a material impact on its financial statements.
Statement 141R amends the goodwill impairment test requirements in Statement 142. For a goodwill impairment test as of a date after the effective date of Statement 141R, the value of the reporting unit and the amount of implied goodwill, calculated in the second step of the test, will be determined in accordance with the measurement and recognition guidance on accounting for business combinations under Statement 141R. This change could effect the determination of what amount, if any, should be recognized as an impairment loss for goodwill recorded before the effective date of Statement 141R. This accounting will be required when Statement 141R becomes effective (January 1, 2009 for the Company) and applies to goodwill related to acquisitions accounted for originally under Statement 141 as well as those accounted for under Statement 141R.
The Company has $16.4 million of goodwill at March 31, 2008 related to a previous business combination. The Company has not determined what effect, if any, Statement 141R will have on the results of its impairment testing subsequent to December 31, 2008.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS No. 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In December 2007, the FASB issued Staff Position FAS 157-b, which deferred the effective date of SFAS 157 for one year, as it relates to nonfinancial assets and liabilities. The Company plans to adopt the deferred portion of SFAS 157 on January 1, 2009. The Company does not currently expect the adoption of the deferred portion of SFAS 157 to have a material impact on its results of operations and financial condition, however the Company will continue to assess the impact as the guidance evolves.
10
In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which allows companies the option to measure certain financial assets or liabilities at fair value and include unrealized gains and losses in net income rather than equity. Subsequent measurements for the financial instruments and liabilities an entity elects to measure at fair value will be recognized in earnings. SFAS 159 also established additional disclosure requirements. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided that the entity also adopts SFAS 157. The Company has elected not to apply the fair value option for any of its eligible financial instruments and other items in the current period.
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 2007 Annual Report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, 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 have been no material changes in the company’s critical accounting policies during the three months ended March 31, 2008.
OVERVIEW
Optelecom-NKF, Inc. is a global supplier of advanced video surveillance solutions, including IP cameras, video servers/codecs, network video recorders, fiber transmission equipment, video management and video analytics software. We deliver complete solutions for traffic monitoring and security of airports, seaports, casinos, prisons, utilities, public transit, city centers, hospitals, and corporate campuses.
Founded in 1972, Optelecom-NKF is committed to providing its customers with expert technical advice and support in addition to products that are developed and tested for professional and mission critical applications. All Optelecom-NKF IP surveillance solutions are marketed under the Siqura® name.
The Optelecom-NKF corporate headquarters is in Germantown, Maryland, with European corporate offices in Gouda, the Netherlands, and sales offices or support covering Latin America, France, Spain, the UK, Germany, Italy, Dubai and Singapore.
The Company continues to focus its resources on developing additional IP products, sales and distribution channels. Service and technical support programs are in place to attract and maintain a large network of integration companies. The Company primarily attracts new customer contacts through participation in trade shows in both the security and traffic markets. Our web site (www.optelecom-nkf.com) has enabled the convenient and rapid dissemination of information required by our distribution channel personnel and other interested parties to gather information necessary to select our products and services.
The Company has expanded its focus to identify prospects that have a requirement for complete IP-video solutions including the Company’s video codecs, Ethernet network equipment, network video recorders and video management software as well as a broad range of pre and post sales services such as design, detailed engineering and training. Internal training programs have been implemented and additional personnel hired to expand the in-depth knowledge of our worldwide sales and support offices.
We strive to continue improving our position as a leading producer and supplier of powerful, intelligent network video solutions by providing reliable and profitable products and services that enable customers around the world to reduce their total cost of ownership and enhance the effectiveness of their applications. Products for these markets are classified into two broad categories: IP Video and Fiber Optic.
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Video over IP solutions are represented by the Siqura® product line. The Siqura product line includes video servers/codecs, IP cameras, Ethernet switches, recording and storage equipment. Also, to bring together all these hardware components, Siqura software solutions, Operator Office™ and the Optelecom-NKF SDK help the user consolidate a complete video network under one, easy-to-use management platform.
The Video over Fiber product line is comprised of the MC Series and the 9000 Series. The MC Series is designed for most common fiber applications. The 9000 Series is designed for the more complex and demanding video over fiber applications. The availability of 18 different wavelengths and the unique concept of using “option modules” are the core elements behind the versatility of the 9000 Series.
In addition to our two primary product categories of IP and Fiber Optics’ the Company operates an Electro Optics (EO) group focused on Interferometric Fiber Optic Gyro coils and manufacturing innovative optical devices under contract, primarily to government and defense industry customers.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2008 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2007
REVENUE
Revenue for the first quarter of 2008 was $10.5 million, an increase of 19% compared to revenue of $8.8 million reported in the first quarter of 2007. Of the first quarter revenue, 69% came from our international operations, which includes the positive impact from foreign currency exchange rates. Information regarding the Company’s U.S. and international based operations is in the table below. For the purposes of this table, revenue classified as U.S. based includes Canada, Mexico and South America.
| | 2008 | | 2007 | |
(Dollars in thousands) | | U.S. | | International | | U.S. | | International | |
Revenue | | $ | 3,275 | | $ | 7,260 | | $ | 2,759 | | $ | 6,076 | |
Less: Costs of Goods Sold | | 1,315 | | 2,761 | | 1,429 | | 2,493 | |
Gross Profit | | 1,960 | | 4,499 | | 1,330 | | 3,583 | |
Less: Operating Expense | | 2,360 | | 3,587 | | 2,212 | | 2,752 | |
| | | | | | | | | |
Income (loss) from Operations | | $ | (400 | ) | $ | 912 | | $ | (882 | ) | $ | 831 | |
Our U.S. based business had a loss from operations of $400 thousand for the first quarter of 2008 compared to a loss of $882 thousand in 2007 as we increased revenue and gross profit margins in 2008. The U.S. based sales increased $516 thousand from a higher number of orders greater than $250 thousand in the first quarter of 2008 compared to similar large orders in 2007. Our U.S. based operations include sales to North America and Latin America.
Our international based operations had income from operations of $912 thousand for the first quarter of 2008 compared to income from operations of $831 thousand in 2007. The Company’s international results benefited from a positive impact of foreign exchange rates as the U.S. dollar continued to weaken against the Euro. The Company had an overall increase of 19% in 2008 revenue compared to 2007. After considering the impact of foreign exchange rates this increase would have been 9%.
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Revenue by product category was:
(Dollars in thousands) | | Three Months
Ending
March 31, 2008 | | Three Months
Ending
March 31, 2007 | |
Fiber Optic | | $ | 7,660 | | $ | 5,941 | |
IP Video | | 2,651 | | 2,526 | |
Electro Optics | | 224 | | 368 | |
| | | | | |
Total Revenue | | $ | 10,535 | | $ | 8,835 | |
2008 sales of Fiber Optic products were $7.7 million representing a 29% increase from 2007 sales. This increase is attributed to several large orders in the first quarter of 2008 and relatively low sales levels in the first quarter 2007. The Company continues to plan for a market shift away from Fiber Optic and toward IP Video products as it has invested heavily in IP Video products. The current quarter increase in IP Video revenue was 5% or $125 thousand in the first quarter of 2008 over 2007. The IP product growth is primarily in our international operations. The Company continued introducing new IP products in 2008 to address the market shift toward IP products.
GROSS PROFIT
Consolidated gross profit was $6.5 million or 61% of revenues for the quarter ended March 31, 2008, compared to $4.9 million or 56% of revenues in 2007. The increase was $1.5 million or 31% and is primarily because of the following:
· An increase of 9% or $831 thousand in revenue excluding the impact of foreign exchange. Additional revenue results in relatively lower costs of goods sold on a per unit basis as the employee compensation and benefits for personnel in direct labor positions and other fixed costs are spread over a larger revenue base.
· A $512 thousand impact from changes in foreign exchange rates as the U.S. Dollar weakened against the Euro.
OPERATING EXPENSE
Consolidated operating expenses were $5.9 million for the quarter ended March 31, 2008 compared to $5.0 million in 2007. The Company’s operating expenses have increased in certain areas as we develop and deliver new IP Video products to the marketplace. The Company had an overall increase of $983 thousand, of which $148 thousand was in our U.S. operations and $835 thousand in our international based business. The increase in operating expense is primarily due to:
· A $367 thousand impact from changes in foreign exchange rates as the U.S. Dollar weakened against the Euro.
· $419 thousand of additional sales and marketing costs, excluding foreign exchange, as we expand globally and enhance our sales capabilities. This majority of this cost increase is from our international operations.
· $244 thousand of additional general and administrative costs, excluding foreign exchange, resulting from higher legal, tax and audit expense along with a higher retirement benefit for the CEO and a profit sharing accrual due to improved operating performance.
The first quarter of 2007 includes expenses related to a corporate restructuring. The restructuring costs totaled $145 thousand with $61 thousand included in engineering, $35 thousand in sales and marketing, $14 thousand in general and administrative, and the remaining $35 thousand in costs of goods sold.
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OTHER EXPENSE
Other expense for the quarters ended March 31, 2008 and 2007 consisted almost entirely of interest expense. Other expense totaled $352 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 after considering debt payments.
INCOME TAXES
As of March 31, 2008 the Company had deferred tax assets related to net operating losses and research and development tax credit carryforwards totaling $1.9 million. This is an increase of approximately $150 thousand from December 31, 2007. 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 $23.1 million at December 31, 2007 to $25.4 million at March 31, 2008. The increase in overall stockholders’ equity resulted from:
· Net income in the current quarter of $148 thousand.
· An increase in additional paid in capital of $244 thousand primarily from the grant of stock to employees and directors.
· A $1.9 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 $53.7 million at March 31, 2008 compared to $50.0 million at December 31, 2007. This increase is directly attributable to increased cash in our European operations and an increase in the balance of goodwill due to foreign currency rate changes. These increases were partially offset by a $1.4 million decline in accounts receivable.
The Company’s total liabilities increased $1.4 million from $26.9 million at December 31, 2007 to $28.3 million at March 31, 2008. This increase is predominately from increased use on our line of credit in U.S. operations and increased accrued payroll related to year-end incentive and profit sharing accruals.
The Company provides reserves for accounts receivable, inventory obsolescence and warranty against product defects. For the first quarter of 2008, the Company had $52 thousand of additional expense related to the accounts receivable reserve, no expense related to the inventory obsolescence reserve and $27 thousand additional expense related to the warranty reserve.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $2.4 million for three months of 2008 compared to cash provided of $418 thousand in the same period for 2007. 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 increased sales and higher profit margins in 2008.
Cash used in investing activities was $294 thousand for the first quarter of 2008 and $429 thousand for the same period in 2007. The decline in capital expenditures is $135 thousand and is attributed to a larger required investment during the initial stages of the Company’s transition from a Fiber Optic to an IP Video product set. The Company’s efforts to integrate and improve its international and domestic operations are planned to continue throughout 2008.
$238 thousand of cash was provided by financing activities during the first quarter 2008 compared to $400 thousand provided by financing activities during 2007. The current year decline is from higher draw downs on our line of credit during the first quarter 2007.
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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 March 31, 2008 the Company had $1.6 million outstanding on its bank line of credit with an effective interest rate of 5.7%. At the recent quarter end the Company was at the maximum amount the U.S. legal entity can borrow on its line of credit and 1.5 million Euro ($2.4 million) is available on the line of credit through our subsidiary based in the Netherlands. Obligations to the bank under our acquisition debt and this line of credit are secured by the Company’s assets. We also have a subordinated note secured by 35% of the issued share capital our subsidiary based in the Netherlands.
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. The Company does have additional borrowing capability of 1.5 million Euro ($2.4 million) 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 or dividends from international operations could result in increased tax liability and tax expense to the Company.
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, 2007 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. 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.
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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.
In connection with the acquisition of NKF in March 2005 the Company entered into acquisition related debt instruments. The debt includes a 7.3 million Euro denominated subordinated note to the seller. 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 March 31, 2008, $1.2 million of deferred interest payable has been accrued during the term of the subordinated note. In addition to the deferred interest, the liability on the subordinated note totals $11.6 million at March 31, 2008. This is an increase of $0.8 million since December 31, 2007 due to the impact of changes in the foreign exchange rate.
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, 2007. With the exception of the foreign currency exchange rate risk noted above, our exposures to market risk have not changed materially since December 31, 2007.
Item 4. Controls and Procedures.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, 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 March 31, 2008.
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 March 31, 2008 were identified that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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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.
There were no material changes in the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
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Item 4. Submission of Matters to a Vote of Security Holders.
The Company’s Annual Meeting of Stockholders was held on April 25, 2008, at which time the stockholders elected Carl C. Rubbo, Jr. and Walter R. Fatzinger, Jr. as directors of the Company to hold office until the 2011 Annual Meeting of Stockholders. The stockholders also voted to approve the 2008 Stock Incentive Plan. The votes were as follows:
| | Votes for | | Votes
Against | | Withheld/Abstain | |
(1) Election of directors: | | | | | | | |
Carl C. Rubbo, Jr. | | 2,910,197 | | n/a | | 351,253 | |
Walter R. Fatzinger, Jr. | | 2,921,109 | | n/a | | 340,341 | |
(2) Approve 2008 Stock Incentive Plan | | 1,259,232 | | 260,802 | | 14,847 | |
In addition, the following individuals’ term of office as a director continue after the 2008 Annual Meeting of Stockholders: David R. Lipinski., Robert F. Urso, Edmund D. Ludwig, James Armstrong and Thomas W. M. Overwijn.
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) |
| | |
3.2 | | By-Laws (incorporated by reference from Form 10-K filed March 31, 1998) |
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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.
| | |
| | OPTELECOM-NKF, INC. |
| | |
| | |
Date: May 12, 2008 | | /s/ Edmund Ludwig |
| | Edmund Ludwig, |
| | Director, President and Chief Executive Officer |
| | |
Date: May 12, 2008 | | /s/ Steven Tamburo |
| | Steven Tamburo, |
| | Chief Financial Officer |
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