UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________________ to ______________
Commission File Number 0-29798
COMPUDYNE CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 23-1408659
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2530 Riva Road, Suite 201, Annapolis, Maryland 21401
(Address of principal executive offices)
Registrant's telephone number, including area code: (410) 224-4415
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [_] NO [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [_] NO [X]
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 [_]
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 [_] Accelerated filer [_] Non-accelerated filer [X]
Indicate by checkmark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
Yes [_] NO [X]
As of April 28, 2006, a total of 8,119,404 shares of Common Stock, $.75 par
value, were outstanding.
COMPUDYNE CORPORATION AND SUBSIDIARIES
INDEX
PAGE NO.
Part I. Financial Information
Item 1. Financial Statements - Unaudited
Consolidated Balance Sheets - March 31, 2006
and December 31, 2005 3
Consolidated Statements of Operations -
Three Months Ended March 31, 2006 and 2005 4
Consolidated Statement of Changes in Shareholders' Equity -
Three Months Ended March 31, 2006 5
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2006 and 2005 6
Notes to Consolidated Financial Statements 7-15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16-27
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 28
Item 4. Controls and Procedures 29
Part II. Other Information 30
Signature 31
ITEM 1. FINANCIAL STATEMENTS
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31, December 31,
2006 2005
--------- -------------
ASSETS
(dollars in thousands)
Current Assets
Cash and cash equivalents $ 9,647 $ 6,938
Marketable securities 6,522 11,429
Cash and marketable securities - pledged 440 --
Accounts receivable, net 32,741 39,625
Contract costs in excess of billings 11,994 13,764
Inventories 6,556 6,195
Prepaid expenses and other 2,318 2,809
--------- ---------
Total Current Assets 70,218 80,760
Cash and marketable securities - pledged 6,004
Property, plant and equipment, net 9,548 9,962
Goodwill 26,846 26,846
Other intangible assets, net 8,157 8,221
Other 807 903
--------- ---------
Total Assets $ 121,580 $ 126,692
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities $ 19,039 $ 23,030
Billings in excess of contract costs incurred 11,315 13,847
Deferred revenue 8,688 8,094
Current portion of notes payable 440 440
--------- ---------
Total Current Liabilities 39,482 45,411
Notes payable 3,125 3,125
Convertible subordinated notes payable, net 39,352 39,305
Deferred tax liabilities 2,060 2,060
Other 328 369
--------- ---------
Total Liabilities 84,347 90,270
--------- ---------
Commitments and Contingencies
Shareholders' Equity
Preferred stock, 2,000,000 shares authorized and unissued -- --
Common stock, par value $.75 per share: 50,000,000 shares
authorized at March 31, 2006 and December 31, 2005;
8,951,181 and 8,950,356 shares issued at March 31,
2006 and December 31, 2005, respectively 6,713 6,712
Additional paid-in-capital 44,646 44,388
Accumulated deficit (8,156) (8,963)
Accumulated other comprehensive (loss) (294) (39)
Treasury stock, at cost; 831,777 shares at March 31, 2006
and December 31, 2005 (5,676) (5,676)
--------- ---------
Total Shareholders' Equity 37,233 36,422
--------- ---------
Total Liabilities and Shareholders' Equity $ 121,580 $ 126,692
========= =========
The accompanying notes are an integral part of these financial statements.
3
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended March 31,
2006 2005
-------- --------
(in thousands, except per share data)
Revenues:
Contract revenues earned $ 20,826 $ 23,466
Other revenues 19,644 12,840
-------- --------
Total revenues 40,470 36,306
Cost of sales 27,961 23,923
-------- --------
Gross profit 12,509 12,383
Selling, general and administrative expenses 9,736 10,027
Research and development 1,767 2,111
-------- --------
Income from operations 1,006 245
-------- --------
Other expense (income)
Interest expense 815 803
Interest income (278) (228)
Other income (154) (11)
-------- --------
Total other expense 383 564
-------- --------
Income (loss) before taxes on income 623 (319)
Income tax benefit (184) --
-------- --------
Net income (loss) $ 807 $ (319)
======== ========
INCOME (LOSS) PER SHARE:
Basic income (loss) per common share $ .10 $ (.04)
======== ========
Weighted average number of common
shares outstanding 8,119 8,163
======== ========
Diluted income (loss) per common share $ .10 $ (.04)
======== ========
Weighted average number of common
shares and equivalents 8,159 8,163
======== ========
The accompanying notes are an integral part of these financial statements.
4
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited)
(in thousands)
ACCUMULATED
ADDITIONAL OTHER
COMMON STOCK PAID-IN ACCUMULATED COMPREHENSIVE TREASURY STOCK
SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) SHARES AMOUNT TOTAL
----------------- --------- -------- ------------ ------------------- --------
Balance at January 1, 2006 8,950 $6,712 $ 44,388 $(8,963) $ (39) 832 $ (5,676) $ 36,422
Stock options exercised 1 1 3 4
Stock-based compensation 255 255
--------------------------------------------------------------------------------------
Subtotal 8,951 6,713 44,646 (39) 832 (5,676) 36,681
(8,963)
Comprehensive income:
Net income 807 807
Other comprehensive
loss, net of tax:
Unrealized loss on available
for sale marketable securities (255) (255)
--------
Comprehensive income 552
Balance at March 31, 2006 8,951 $ 6,713 $ 44,646 $(8,156) $ (294) 832 $ (5,676) $ 37,233
======= ======= ========= ======= ========= ======== ======== ========
The accompanying notes are an integral part of these financial statements.
5
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31,
2006 2005
-------- --------
(in thousands)
Cash flows from operating activities:
Net income (loss) $ 807 $ (319)
Adjustments to reconcile net income (loss) to net cash provided (used) by
operations:
Depreciation and amortization 795 877
Loss (gain) from disposal of property, plant and equipment 1 (3)
Amortization of debt discount 47 47
(Accretion of premium) Amortization of discount on marketable (6) 5
securities
Stock-based compensation expense 255 --
Changes in assets and liabilities:
Accounts receivable 6,884 966
Contract costs in excess of billings 1,770 1,027
Inventories (361) 271
Prepaid expenses and other current assets 465 471
Other assets 96 (188)
Accounts payable and accrued liabilities (3,991) (5,166)
Billings in excess of contract costs incurred (2,532) (1,221)
Deferred revenue 594 695
Other liabilities (41) (85)
------- -------
Net cash flows provided by (used in) operating activities 4,783 (2,623)
------- -------
Cash flows from investing activities:
Purchase of marketable securities (2,983) (3,739)
Redemption of marketable securities 1,624 6,650
Additions to property, plant and equipment (319) (364)
Proceeds from sale of property, plant and equipment 1 3
Net payment for acquisition -- (18)
------- -------
Net cash flows (used in) provided by investing activities (1,677) 2,532
------- -------
Cash flows from financing activities:
Stock options exercised 3 --
Purchase of treasury shares -- (630)
Restricted cash (400) (294)
------- -------
Net cash used in financing activities (397) (924)
------- -------
Net change in cash and cash equivalents 2,709 (1,015)
Cash and cash equivalents at beginning of period 6,938 5,198
------- -------
Cash and cash equivalents at end of period $ 9,647 $ 4,183
======= =======
The accompanying notes are an integral part of these financial statements.
6
COMPUDYNE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation:
The accompanying unaudited consolidated financial statements of CompuDyne
Corporation and its subsidiaries (the "Company") have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission. The
consolidated balance sheet as of December 31, 2005 has been derived from the
Company's December 31, 2005 audited financial statements. Certain information
and note disclosures included in the annual financial statements, prepared in
accordance with accounting principles generally accepted in the United States of
America, have been condensed or omitted pursuant to those rules and regulations,
although the Company believes that the disclosures made in this Form 10-Q are
adequate to make the information presented not misleading.
In the opinion of the Company, the accompanying unaudited consolidated financial
statements reflect all necessary adjustments and reclassifications (all of which
are of a normal, recurring nature, unless otherwise disclosed) that are
necessary for the fair presentation of the periods presented. It is suggested
that these consolidated unaudited financial statements be read in conjunction
with the consolidated financial statements and the notes thereto included in the
Company's annual report filed with the Securities and Exchange Commission on
Form 10-K for the year ended December 31, 2005. Operating results for the three
month periods ended March 31, 2006 and 2005 are not necessarily indicative of
operating results for the entire fiscal year.
COMPREHENSIVE INCOME (LOSS)
The following table shows the components of comprehensive income (loss), net of
income taxes, for the three months ended March 31, 2006 and 2005, in thousands:
For the Three Months
Ended March 31,
2006 2005
----- -----
Net income (loss) $ 807 $(319)
Unrealized loss on available-for-sale securities (255) (113)
----- -----
Comprehensive income (loss) $ 552 $(432)
===== =====
STOCK-BASED COMPENSATION
In December 2004, the FASB issued SFAS No. 123R (revised 2004) "Share-Based
Payment." This statement replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," and supersedes Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees." This statement requires that the
cost resulting from all share-based payment transactions be recognized in the
financial statements. Pro forma disclosure is no longer an alternative. This
statement establishes fair value as the measurement objective in accounting for
share-based payment arrangements and requires all entities to apply a
fair-value-based measurement method in accounting for share-based payment
transactions with employees. This statement uses the terms compensation and
payment in their broadest senses to refer to the consideration paid for goods or
services, regardless of whether the supplier is an employee.
The Company adopted SFAS No. 123R effective January 1, 2006 and is recognizing
the cost of stock-based compensation, consisting of stock options, using the
modified prospective application method whereby the cost of new awards and
awards modified, repurchased or cancelled after January 1, 2006 and the portion
of awards for which the requisite service has not been rendered (unvested
awards) that are outstanding as of January 1, 2006, as the requisite service is
rendered on or after the effective date, January 1, 2006. This standard will
have a material impact on its financial statements.
INCOME TAXES
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
109, "Accounting for Income Taxes." Under SFAS 109, deferred income taxes are
recognized for the future tax consequences of differences between tax bases of
assets and liabilities and financial reporting amounts, based upon enacted tax
laws and statutory tax rates applicable to the periods in which the differences
are expected to affect taxable income. The Company has decided to provide a
valuation allowance against its deferred tax assets, as it has determined that
due to the Company's recent operating losses there is uncertainty as to whether
it is more likely than not that these assets will be realized.
OTHER RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" (SFAS 154) which replaces APB Opinion No. 20, "Accounting Changes"
and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements-An
Amendment of APB Opinion No. 28." SFAS 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections. It establishes
retrospective application, or the latest practicable date, as the required
method for reporting a change in accounting principle and the reporting of a
correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The adoption of SFAS 154 did not have a material impact on our consolidated
financial position, results of operations or cash flows.
7
Reclassifications - Certain prior year amounts have been reclassified to conform
with the current year's presentation.
2. EARNINGS PER SHARE
Earnings per share are presented in accordance with SFAS No. 128, "Earnings Per
Share." This Statement requires dual presentation of basic and diluted earnings
per share on the face of the statement of operations. Basic earnings per share
is computed using the weighted average number of shares outstanding during the
period and excludes any dilutive effects of options, warrants, or convertible
securities. Diluted earnings per share is computed using the weighted average
number of common and common stock equivalent shares outstanding during the
period; common stock equivalent shares are excluded from the computation if
their effect is antidilutive.
Stock options and warrants to purchase 1,325,633 and 1,442,533 shares for the
three month periods ended March 31, 2006 and 2005, respectively, were not
dilutive and, therefore, were not included in the computation of diluted
earnings per common share. Additionally, the 2,897,768 shares issuable upon
conversion of the 6.25% Convertible Subordinated Notes due January 15, 2011 (the
"2011 Notes") are excluded for the three month periods ended March 31, 2006 and
2005 as the effect is antidilutive.
The computations of the Company's basic and diluted earnings per common share
amounts were as follows:
Three Months Ended
March 31,
2006 2005
------------ ---------
(in thousands, except per share data)
Net income (loss) $ 807 $ (319)
======= =======
Weighted average number of common shares outstanding 8,119 8,163
Effect of dilutive stock options and warrants 40 --
------- -------
Diluted weighted average number of common shares outstanding 8,159 8,163
======= =======
Net income (loss) per common share
Basic $ .10 $ (.04)
Diluted $ .10 $ (.04)
In March 2004, the EITF reached a final consensus on Issue 03-6, "Participating
Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per
Share" ("Issue 03-6"), effective June 30, 2004. Issue 03-6 requires the use of
the two-class method to compute earnings per share for companies that have
issued securities other than common stock that contractually entitle the holder
to participate in dividends and earnings of the Company ("participation rights")
when, and if, it declares dividends on its common stock.
The 2011 Notes contain contingent participation rights. The participation rights
are contingent upon the ability, based on the undistributed earnings for the
period, of the Company to declare and distribute dividends per share equal to or
in excess of the per share fair value of the Company's common stock. The
contingency was not met for the three month periods ended March 31, 2006 and
March 31, 2005. Accordingly, no undistributed earnings have been allocated to
the 2011 Notes. At each reporting period, the Company assesses whether the
contingency criteria have been met and consequently if undistributed earnings
should be allocated to participating securities.
3. STOCK-BASED COMPENSATION
Effective January 1, 2006, we adopted SFAS No. 123(R), "Share-Based Payment."
This statement requires us to expense the fair value of grants of various
stock-based compensation programs over the vesting period of the awards. We
elected to adopt the "Modified Prospective Application" transition method which
does not require the restatement of previously issued financial statements.
Compensation expense is measured and recognized beginning in 2006 as follows:
8
AWARDS GRANTED AFTER DECEMBER 31, 2005 - Awards are measured at their fair value
at date of grant. The resulting compensation expense is recognized in the
consolidated statement of operations ratably over the vesting period of the
award.
AWARDS GRANTED PRIOR TO DECEMBER 31, 2005 - Awards were measured at their fair
value at the date of original grant. Compensation expense associated with the
unvested portion of these options at January 1, 2006 is recognized in the
consolidated statement of operations ratably over the remaining vesting period.
For all grants issued after December 31, 2005 the amount of recognized
compensation expense is adjusted based upon an estimated forfeiture rate which
is derived from historical data.
The following table shows total stock-based compensation expense included in the
Consolidated Statement of Operations:
for the Three Months
Ended March 31, 2006
(In Thousands)
--------------------
Cost of sales $ 18
Selling, general and administrative 214
Research and development 23
---------
Effect on net income $ 255
=========
No similar expense was charged against income in the prior periods as we had
elected to apply the provisions of APB No. 25 to those periods as permitted by
SFAS No. 123.
SFAS No. 123(R) also requires that the tax benefit from the exercise of options
be reflected in the statement of cash flows as a cash inflow from financing
activities. Prior to the adoption of SFAS No. 123(R), these tax benefits were
reflected as a cash inflow from operations. Because we elected to adopt the
"Modified Prospective Application" transition method, the prior year statements
of cash flows have not been restated. The tax benefit from the exercise of
options was $0 for each of the three months ended March 31, 2006 and March 31,
2005.
STOCK OPTION PLANS
2005 STOCK INCENTIVE COMPENSATION PLAN FOR EMPLOYEES. Stock options are granted
with an exercise price equal to the market price of the stock at the date of
grant. Substantially all of the options granted are exercisable pursuant to a
five-year vesting schedule. The fair value of these options is estimated using
the Black-Scholes option pricing model which incorporates the assumptions noted
in the table below. Expected volatilities are based on the historical
performance of our stock. We also use historical data to estimate the timing and
amount of option exercises and forfeitures within the valuation model. The
expected term of the options is derived from the output of the option pricing
model and represents the period of time that options are expected to remain
unexercised. The risk-free interest rate for periods within the contractual life
of the option is based on the U.S. Treasury bond rate in effect at the time of
grant.
2005 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS. Stock options are granted
with an exercise price equal to the market price of the stock at the date of
grant. Substantially all of the options granted are exercisable pursuant to a
three-year vesting schedule. The fair value of these options is estimated using
the Black-Scholes option pricing model which incorporates the assumptions noted
in the table below. Expected volatilities are based on the historical
performance of our stock. We also use historical data to estimate the timing and
amount of option exercises and forfeitures within the valuation model. The
expected term of the options is derived from the output of the option pricing
model and represents the period of time that options are expected to remain
unexercised. The risk-free interest rate for periods within the contractual life
of the option is based on the U.S. Treasury bond rate in effect at the time of
grant.
The 1996 Stock Incentive Plan for Employees and the 1996 Stock Option Plan for
Non-Employee Directors, collectively referred to as the "Prior Plans," have
expired in accordance with their terms and no further stock options may be
granted under these plans.
The fair values of grants in the stated period were computed using the following
range of assumptions for our various stock option plans:
9
for the Three
Months Ended
March 31, 2006
--------------
Risk-free interest rates 4.6%
Dividend yield -- %
Expected volatility 78.5%
Expected lives 6.2 years
Annual forfeiture rate 4.4%
The following is a summary of all option activity for the three months ended
March 31, 2006:
Weighted- Aggregate
Average Intrinsic
Number of Exercise Value at
Shares Price March 31, 2006
---------- --------- ------------------
Outstanding at December 31, 2005 1,453,358 $ 8.755
Granted 123,000 $6.760
Exercised 825 $4.310
Forfeited 1,600 $8.519
Expired 50,050 $9.289
---------- ------
Outstanding at March 31, 2006 1,523,883 $8.579 $333,802
========== ====== ========
Exercisable at March 31, 2006 815,933 $9.540 $191,306
========== ====== ========
A summary of our stock options outstanding at March 31, 2006 follows:
Options outstanding Options exercisable
------------------------------------------------ ------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Remaining Exercise Exercise
Range of Exercise Price Shares Life (Yrs) Price Shares Price
- -------------------------- ------------ ------------- ---------------- ------------- ------------
$1.625 - $6.035 167,350 6.46 $ 5.151 62,350 $ 3.909
$6.250 - $6.825 169,536 9.10 $ 6.665 15,936 $ 6.624
$6.855 - $7.500 191,300 7.66 $ 7.230 69,000 $ 7.253
$7.615 - $7.640 160,000 8.61 $ 7.630 32,000 $ 7.631
$7.719 - $8.075 165,000 5.74 $ 8.051 117,800 $ 8.056
$8.105 - $8.960 174,497 6.66 $ 8.581 87,647 $ 8.549
$9.190 - $10.420 186,700 7.03 $ 10.080 121,700 $ 10.040
$10.460 - $12.000 155,500 6.05 $ 11.246 155,500 $ 11.246
$12.070 - $16.330 153,000 5.94 $ 13.102 153,000 $ 13.102
$16.630 - $16.630 1,000 5.49 $ 16.630 1,000 $ 16.630
- ------------------------------------------------------------------------------------------------------------------
$1.625 - $16.630 1,523,883 7.05 $ 8.579 815,933 $ 9.540
============ =============
In the first quarter of 2006, the weighted-average grant-date fair value of an
option granted was $4.85. The total intrinsic value, the difference between the
exercise price and the market price on the date of exercise, of all options
exercised during the period was approximately $1,600. Total unrecognized
compensation expense from stock options was $2.8 million excluding estimated
forfeitures, which is expected to be recognized over a weighted-average period
of 2.45 years as follows, in thousands:
Compensation
Expense Excluding
Year Estimated Forfeitures
---- ---------------------
2006 (remaining) $ 761
2007 830
2008 607
2009 446
2010 155
2011 15
------
Total $2,814
======
10
For the three months ended March 31, 2005, we applied the intrinsic value based
method of accounting for stock options prescribed by APB No. 25. Accordingly, no
compensation expense was recognized for these stock options since all options
granted have an exercise price equal to the market value of the underlying stock
on the grant date. If compensation expense had been recognized based on the
estimate of the fair value of each option granted in accordance with the
provisions of SFAS No. 123 as amended by SFAS No. 148, our net income would have
been reduced to the following pro forma amounts as follows, in thousands:
Three Months Ended
March 31, 2005
-------------------
Net loss as reported $ (319)
Deduct: pro forma stock based employee
compensation expense, net of tax (234)
----
Pro forma net loss $ (553)
============
Earnings per common share:
Basic - as reported $ (0.04)
Basic - pro forma $ (0.07)
Diluted - as reported $ (0.04)
Diluted - pro forma $ (0.07)
Pro forma compensation expense recognized under SFAS No. 123 does not consider
potential forfeitures.
4. INVESTMENTS IN MARKETABLE SECURITIES
The Company's marketable securities are categorized as available-for-sale
securities, as defined by SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." At March 31, 2006 and December 31, 2005 all of the
Company's investments in marketable securities were classified as
available-for-sale, and as a result, were reported at fair value. Unrealized
gains and losses are reported as a component of accumulated other comprehensive
income/(loss) in shareholders' equity. The cost for marketable securities was
determined using the specific identification method and adjusted for accretion
of discounts or amortization of premiums from the date of purchase to maturity.
The accretion and amortization is included in interest income. The fair values
of marketable securities are estimated based on the quoted market price for
these securities.
At March 31, 2006, $6.4 million of cash and marketable securities, at fair
value, were pledged to the Company's bank to serve as collateral for a portion
of its $15.3 million of letters of credit. Of the $6.4 million of cash and
marketable securities, $440 thousand was classified as a current asset, with the
balance of $6.0 million classified as a long-term asset.
Marketable securities are summarized, in thousands, as follows:
March 31, December 31,
2006 2005
------------------------------------------- ------------------------------------------
Gross Unrealized Gross Unrealized
----------------- Fair ------------------- Fair
Cost Gains Losses Value Cost Grains Losses Value
------- ------ ------- --------- ------- ------- -------- --------
Collateralized mortgage
obligations (CMO's) consisting
of securities issued by
Fannie Mae and Freddie Mac $12,860 $ -- $ 294 $12,566 $11,494 $ -- $ 65 $11,429
The cost and estimated fair value of current marketable securities at March 31,
2006, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because the issuers of the securities have the right
to repay obligations without prepayment penalties. It is the Company's policy to
classify available-for-sale securities that are available for use in current
operations as a current asset.
Estimated
(in thousands) Cost Fair Value
-------- --------
Due after one year and beyond $ 12,860 $ 12,566
-------- --------
Total debt securities $ 12,860 $ 12,566
======== ========
11
5. INVENTORIES
Inventories consist of the following, in thousands:
March 31, December 31,
2006 2005
------- --------
Raw materials $ 4,027 $ 3,984
Work in progress 3,687 3,342
Finished goods 262 240
------- -------
Total inventory 7,976 7,566
Reserve for excess and obsolete inventory (1,420) (1,371)
------- -------
Inventories, net $ 6,556 $ 6,195
======= =======
6. GOODWILL
The Company reviews the carrying value of goodwill annually during the fourth
quarter of the year or whenever events or changes in circumstances indicate that
the carrying value may not be recoverable, utilizing a discounted cash flow
model. Changes in estimates of future cash flows caused by items such as
unforeseen events or changes in market conditions could negatively affect the
reporting unit's fair value and result in an impairment charge. The Company
cannot predict the occurrence of events that might adversely affect the reported
value of goodwill of approximately $26.8 million at March 31, 2006.
Goodwill, by segment, consists of the following, in thousands:
Public
Attack Safety &
Protection Justice Total
---------- -------- --------
December 31, 2005 $ 728 $ 26,118 $ 26,846
------- -------- --------
March 31, 2006 $ 728 $ 26,118 $ 26,846
====== ======== ========
7. INTANGIBLE ASSETS
Intangible assets include the trade name, customer relationships and backlog
from the acquisition of CompuDyne Public Safety & Justice, Inc. (formerly
Tiburon, Inc.) in 2002. Other intangibles include trade names, Department of
State Certifications, Underwriters Laboratories, Inc. listings, and patents
related to the acquisition of Norment in 1998 and its other recent acquisitions.
With the exception of the Norment and Tiburon trade names, which have indefinite
lives, the intangible assets are being amortized using the straight-line method.
Intangible assets consist of the following, in thousands:
March 31, December 31, Amortizable
2006 2005 Lives
------------ ------------ ---------
Cost (in years)
Trade names $ 5,733 $ 5,733 15 - Indefinite
Customer relationships 2,500 2,500 14
Other 1,195 1,195 1-20
------------ ------------
9,428 9,428
------------ ------------
Accumulated amortization
Trade names (46) (45)
Customer relationships (699) (655)
Other (526) (507)
------------ ------------
(1,271) (1,207)
------------ ------------
Net cost $ 8,157 $ 8,221
============ ============
Amortization expense for the Company's intangible assets for the three month
period ended March 31, 2006 was $64 thousand. The following schedule lists the
expected amortization expense for each of the next five years ending December
31, in thousands:
12
YEAR
2006 (remaining) $ 197
2007 256
2008 243
2009 243
2010 229
Thereafter 1,357
-------
Total $ 2,525
=======
8. NOTES PAYABLE AND LINE OF CREDIT
March 31, December 31,
2006 2005
--------- ------------
(in thousands)
Industrial revenue bond, interest payable monthly at a variable rate of 3.14% to
3.71% (3.38% at March 31, 2006) principal payable in quarterly installments of
$35,000. The bond is fully collateralized by a $1.3 million letter of credit and
a bond guarantee agreement. $ 1,260 $ 1,260
Industrial revenue bond, interest payable monthly at a variable rate of 3.07% to
3.65% (3.31% at March 31, 2006) principal payable in annual installments of
$300,000 until 2013 when the annual installments become $100,000. The bond is
fully collateralized by a $2.3 million letter of credit and a bond guarantee
agreement. 2,305 2,305
6.25% Convertible Subordinated Notes due January 15, 2011. The notes bear
interest at a rate of 6.25% per annum, payable semi-annually, and are
convertible into shares of common stock at a conversion price of $13.89 per
share. These notes are subordinated to all other liabilities of the Company. 40,250 40,250
--------- ------ ------
Total notes payable 43,815 43,815
Less convertible subordinated notes discount 898 945
--------- --------
Subtotal 42,917 42,870
Less amount due within one year 440 440
--------- --------
$ 42,477 $ 42,430
========= ========
Maturities of notes payable are as follows, in thousands:
Year Ending December 31, Amount
-------------------------- ---------
2006 (remaining) $ 440
2007 440
2008 440
2009 440
2010 440
Thereafter 41,615
---------
$ 43,815
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 2011 Notes. The 2011 Notes bear interest at a rate of
6.25% per annum, payable semi-annually, and are convertible into shares of
common stock at a conversion price of $13.89 per share, subject to adjustments.
The 2011 Notes are subordinated to all other liabilities of the Company. The
March 31, 2006 carrying value is listed below, in thousands.
13
Face value $ 40,250
Underwriters discounts, net 898
---------
$ 39,352
=========
The 2011 Notes can be converted into the Company's common stock at the option of
the holder at any time at a conversion price of $13.89 per share, subject to
adjustments for stock splits, stock dividends, the issuance of certain rights or
warrants to the existing holders of the Company's common stock and common stock
cash dividends in excess of a stated threshold.
The 2011 Notes are redeemable at the option of the Company after January 15,
2009, at a premium of two percent of the face value plus accrued interest unless
a change in control event, as defined in the indenture dated as of January 15,
2004 between the Company and U.S. Bank, relating to the 2011 Notes, occurs. If
such an event does occur, the Company may redeem the 2011 Notes at a premium in
whole but not in part at face. If a change in control event occurs and the
Company does not elect to redeem the 2011 Notes, the holders can require the
Company to repurchase the 2011 Notes at face value plus accrued interest.
The debt issuance costs for the 2011 Notes are recorded as non-current assets
and are amortized on a straight-line basis to interest expense over the term of
the 2011 Notes. In addition, underwriters' discounts totaled $1.3 million and
are amortized on a straight-line basis to interest expense over the term of the
2011 Notes. Interest expense recorded for the total of the deferred debt
issuance costs and underwriters' discounts on the 2011 Notes totaled $63
thousand and $63 thousand for the three month periods ended March 31, 2006 and
2005, respectively.
On December 19, 2005, the Company and its bank entered into a Second Amended and
Restated Revolving Credit and Security Agreement (the "Second Restated Credit
Agreement"). The Second Restated Credit Agreement amended and restated the
Company's Amended and Restated Credit Agreement dated March 31, 2004.
In connection with the execution of the Second Restated Credit Agreement, the
Company provided the bank with collateral that includes all receivables,
equipment, general intangibles, inventory, investment property, real property
and a security interest in subsidiary stock. The Second Restated Credit
Agreement allows the Company to obtain revolving advances in a principal amount
of up to $20,000,000. Revolving advances are limited by a borrowing base formula
based upon the value of the Company's receivables, inventory, fixed assets, real
property and issued and outstanding letters of credit. The maximum aggregate
face amount of letters of credit that may be drawn under the Second Restated
Credit Agreement is limited to $18,000,000. The Second Restated Credit Agreement
matures on December 18, 2008.
Revolving advances under the Second Restated Credit Agreement bear interest, at
the election of the Company, at a variable rate equal to the alternate base
rate, a prime interest based rate, or the Eurodollar rate plus two and one half
percent. For letters of credit, the Company pays an amount equal to the average
daily face amount of each outstanding letter of credit multiplied by two and one
half percent per annum, and a fronting fee of one quarter of one percent per
annum, together with other administrative fees and charges. The Company paid its
bank a closing fee of $50,000 in connection with the execution of the Second
Restated Credit Agreement. The Company is also required to pay the bank an
unused fee equal to three-eighths of one percent per annum of the amount by
which $20,000,000 exceeds the average daily unpaid balance of the revolving
advances and undrawn amount of any outstanding letters of credit. In addition,
the Company is required to pay a collateral monitoring fee equal to $1,000 per
month and a collateral evaluation fee as required.
The Second Restated Credit Agreement contains various affirmative and negative
covenants including financial covenants. The Company is required to maintain an
unrestricted undrawn borrowing base availability of at least $5,000,000.
Commencing with the fiscal quarter ending June 30, 2006, the Company is required
to maintain a fixed charge coverage ratio of at least 1.1 to 1.0.
9. PRODUCT WARRANTIES
Included in accounts payable and accrued liabilities are estimated expenses
related to warranties made at the time products are sold or services are
rendered. These accruals are established using historical information on the
nature, frequency, and average cost of warranty claims. The Company warrants
numerous products, the terms of which vary widely. In general, the Company
warrants its products against defect and specific non-performance. The changes
in the product warranty liability are displayed in the following table, in
thousands:
Beginning balance at January 1, 2006 $ 388
Plus: accruals for product warranties 221
Less: warranty charges/claims (93)
------
Ending balance at March 31, 2006 $ 516
=====
14
10. OPERATING SEGMENT INFORMATION
The following is the operating segment information for the three months ended
March 31, 2006 and 2005, in thousands:
Revenues Pre-tax Income (Loss)
2006 2005 2006 2005
---------------------- ------------------------
Institutional Security Systems $13,355 $15,732 $ 136 $ 1,230
Attack Protection 11,684 6,898 1,205 499
Integrated Electronic Systems 3,587 2,019 184 (8)
Public Safety and Justice 11,844 11,657 7 (482)
CompuDyne Corporate -- -- (909) (1,558)
------- ------- ------- -------
$40,470 $36,306 $ 623 $ (319)
======= ======= ======= =======
11. CONTINGENCIES
LEGAL MATTERS. The Company is party to certain legal actions and inquiries for
environmental and other matters resulting from the normal course of business.
Some of the businesses, especially Institutional Security Systems, involve
working as a subcontractor to a prime contractor. From time to time the Company
makes claims against the prime contractor, or the prime contractor makes claims
against the Company. At any point in time the Company is engaged in a number of
claim disputes with prime contractors, some of which may have a significant
negative outcome. Although the total amount of potential liability with respect
to these matters can not be ascertained given the nature of the related
allegations, the Company presently believes that any resulting liability will
not have a material effect on its financial position, results of future
operations or cash flows.
In addition to claims with prime contractors, the Company may also make claims
against customers and customers may make claims against the Company.
The Company has learned that the National Association of Securities Dealers
("NASD") and other regulatory bodies are seeking sanctions against purchasers of
the Company's common stock in its 2001 PIPE transaction. In addition, the
Company has learned that the placement agent for this transaction is also being
investigated by the SEC, NASD and other regulatory bodies. The Company is
investigating these matters, has filed lawsuits against certain purchasers and
is evaluating its other options for recovery.
The Company has been named in lawsuits involving asbestos related personal
injury and death claims in which CompuDyne Corporation, individually and as an
alleged successor, is a defendant. The Company has been named as a defendant in
cases related to claims for asbestos exposure allegedly due to asbestos
contained in certain of its predecessor's products. The Company has advised its
insurers of each of these cases, and the insurers are providing a defense
pursuant to agreement with the Company, subject to reservation of rights by the
insurers. The insurers have advised that claims in such litigation for punitive
damages, exemplary damages, malicious and willful and wanton behavior and
intentional conduct are not covered. One of the carriers has given notice that
asbestos related claims are excluded from certain of these policies. The
insurers have additional coverage defenses, which are reserved, including that
claims may fall outside of a particular policy period of coverage. Litigation
costs to date have not been significant and the Company has not paid any
settlements from its own funds.
The Company cannot ascertain the total amount of potential liability with
respect to these legal matters, but does not believe that any such potential
liability should have a material effect on its financial position, future
operations or future cash flows.
The Company, as a government contractor, is from time to time subject to U.S.
Government investigations relating to its operations. Government contractors
that are found to have violated the False Claims Act, or are indicted or
convicted for violations of other federal laws, or are considered not to be
responsible contractors, may be suspended or debarred from government
contracting for some period of time. Such convictions could also result in
fines. Suspension or debarment could have a material adverse effect on the
Company. No such violations or conditions of debarment exist at this time.
15
ITEM 2. COMPUDYNE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
OVERVIEW OF COMPUDYNE CORPORATION
CompuDyne Corporation was reincorporated in Nevada in 1996. We were originally
incorporated in 1952. We believe that we are a leading provider of products and
services to the public security markets. We operate in four distinct segments:
Institutional Security Systems ("ISS"); Attack Protection ("AP"); Integrated
Electronic Systems ("IES"); and Public Safety and Justice ("PS&J").
The Institutional Security Systems segment is headquartered in Montgomery,
Alabama and operates under the trade name Norment Security Group ("Norment").
This segment provides physical and electronic security products and services to
the corrections industry (prisons and jails) and to the courthouse, municipal
and commercial markets. ISS typically serves as a subcontractor, responsible for
their portion of the installation work on larger projects. Installations involve
hard-line (steel security doors, frames, locking devices, etc.) and
sophisticated electronic security systems, including software, electronics,
touch-screens, closed circuit TV, perimeter alarm devices and other security
monitoring controls. ISS also developed a product called MaxWall. MaxWall is a
modular steel, concrete filled prefabricated jail cell. It allows for
construction projects to use considerably less space and can save the project
owner significant amounts of money. ISS provides field level design,
installation and maintenance of both physical and electronic security products.
Included in the Institutional Security Systems segment is the TrenTech line
which manufactures and integrates electronic security systems. TrenTech
integrates generally available products and software as well as developing its
own proprietary systems. TrenTech has developed a sophisticated proprietary
video badging system, with approximately 250 systems installed at more than 70
facilities, most of which are military installations.
The Institutional Security Systems segment also manufactures a complete line of
locks and locking devices under the brand name Airteq. Airteq is an industry
leader in pneumatic and electro-mechanical locking devices used in the
corrections industry.
The Attack Protection segment is one of the country's largest manufacturers of
bullet, blast and attack resistant windows and doors designed for high security
applications such as embassies, courthouses, Federal buildings, banks, corporate
headquarters and other facilities that insist on having the highest level of
protection currently available. We believe that we are a premier provider of
Underwriters Laboratory ballistic standard UL-752 Level 8 security windows and
doors, the highest rating level of commercial ballistic security windows and
doors. Our attack resistant windows and doors are integrated and structurally
secure products with specifically designed frames and encasements that are
integral parts of the structure in which they are installed. Existing product
installations number in the thousands and range from the Middle East to the
White House. AP is a significant supplier of bullet and blast resistant windows
and doors to United States embassies throughout the world. AP usually works
under contracts from prime contractors who have direct contracts with the United
States Department of State, the segment's largest client. Attack Protection
products are also sold to drug stores and convenience stores to secure drive
through facilities. Other commercial applications include guard booths,
tollbooths, cash drawers and other similar items. Additionally, this segment
designs and installs both fixed and pop-up bollards and wedge barrier security
systems.
The Attack Protection segment also manufactures a sophisticated fiber optic
sensor system, known as Fiber SenSys, used to detect physical intrusion. This
application is designed to protect large perimeters including such applications
as Federal facilities, military deployments and bases, oil fields, airport
tarmacs, public utilities, nuclear reactors and water systems. In addition, it
has been installed to protect the perimeters of private estates and other
similar properties.
The Integrated Electronic Systems segment consists of CompuDyne-Integrated
Electronics Division, LLC. Its customer base includes the military, governmental
agencies, and state and local governmental units. IES provides turnkey system
integration of public security and safety systems. This segment specializes in a
wide range of customized access control and badging, intrusion detection,
surveillance and assessment, communications, command and control, fire and life
safety, and asset tracking systems. IES provides central station oversight and
control of multiple and separate facilities as well as security and public life
safety systems and equipment. This segment also designs and manufactures
advanced digital signal processing products used in reconnaissance of foreign
telecommunications signals designed for the United States Government and its
foreign allies.
16
The Public Safety and Justice segment consists of CompuDyne-Public Safety &
Justice, Inc. (formerly Tiburon, Inc.), CorrLogic, LLC, Xanalys Corporation
("Xanalys"), and the acquired assets of 90 Degrees, Inc. ("90 Degrees") and
Copperfire Software Solutions, Inc. ("Copperfire"). PS&J's software systems are
used in a wide range of applications within the public safety and criminal
justice sectors of governmental units, including police, fire and emergency
medical services computer-aided dispatch systems, and police, fire, jail,
prosecution, probation, court records and institutional medical software
management systems. We also specialize in the development, implementation and
support of complex, integrated inmate management software systems, including
inmate medical management systems that improve the efficiency and accuracy of
correctional facility operations.
During the second half of 2004, we expanded our offerings in the Public Safety
and Justice segment by acquiring the assets of 90 Degrees and Copperfire. 90
Degrees provides a web-based fire records management system. 90 Degrees'
enterprise-wide records management solutions assist fire and Emergency Medical
Service agencies in managing responses to emergency situations. We anticipate
that 90 Degrees' open web-based technology product offerings will advance our
current fire and rescue product offerings. Copperfire provides customized report
writing and forms generation software designed specifically for public safety
and justice agencies. The software automates an agency's current business
practices, turning hard copy forms into digital images, to create a paperless
report writing system. Xanalys was acquired during the third quarter of 2005.
Xanalys provides a suite of investigative management and analysis solutions that
enable investigators to collect, analyze and share information to solve cases.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements made in this Form 10-Q with regard to the Company's
expectations as to future revenues, expenses, financial position and industry
conditions, the Company's ability to secure new contracts, the ability to secure
payment and performance bonds, its goals for future operations, implementation
of business strategy and other future events constitute "forward-looking
statements" within the meaning of the federal securities laws. When used in this
Form 10-Q, words such as "anticipate," "believe," "estimate," "expect," "intend"
and similar expressions identify forward-looking statements. Although the
Company makes such statements based on current information and assumptions it
believes to be reasonable, there can be no assurance that actual results will
not differ materially from those expressed or implied by such forward-looking
statements. Actual results could differ materially from those contemplated by
the forward-looking statements as a result of certain important factors,
including but not limited to, capital spending patterns of the security market
and the demand for the Company's products, competitive factors and pricing
pressures, changes in legislation, regulatory requirements, government budget
problems, the Company's ability to secure new contracts, the ability to remain
in compliance with its bank covenants, delays in government procurement
processes, inability to obtain bid, payment and performance bonds on various of
the Company's projects, technological change or difficulties, the ability to
refinance debt when it becomes due, product development risks, commercialization
difficulties, adverse results in litigation, the level of product returns, the
amount of remedial work needed to be performed, costs of compliance with
Sarbanes-Oxley requirements and the impact of the failure to comply with such
requirements, risks associated with internal control weaknesses identified in
complying with Section 404 of Sarbanes-Oxley, the Company's ability to realize
anticipated cost savings, the Company's ability to simplify its structure and
modify its strategic objectives, and general economic conditions. Risks inherent
in the Company's business and with respect to future uncertainties are further
described in our other filings with the Securities and Exchange Commission.
MANAGEMENT OUTLOOK
We continue to find ourselves in very challenging times. We have three major
areas of focus:
o The first is increasing the amount of our backlog.
o The second is migrating to a business model with a more
predictable revenue stream.
o The third is to improve our cost structure (including evaluating
our strategy to determine if we would benefit from focusing on
fewer segments), quality, and customer and employee satisfaction.
Our backlog is a key indicator of what our future revenues will look like. Our
backlog peaked at December 31, 2002, at which time it exceeded $204 million.
Backlog was approximately $128.5 million at March 31, 2006, as shown in the
following table:
17
Institutional Integrated Public
Security Attack Electronics Safety and Backlog
(in thousands) Systems Protection Systems Justice Total
- ----------------------------------------------------------------------------------------------------------------
December 31, 2002 $ 99,527 $ 18,478 $ 11,440 $ 74,867 $204,312
December 31, 2003 $ 57,258 $ 10,043 $ 8,326 $ 63,727 $139,354
December 31, 2004 $ 49,324 $ 20,803 $ 8,299 $ 48,434 $126,860
March 31, 2005 $ 42,700 $ 20,139 $ 8,395 $ 44,488 $115,722
June 30, 2005 $ 56,492 $ 19,466 $ 9,105 $ 46,045 $131,108
September 30, 2005 $ 52,557 $ 16,210 $ 8,146 $ 58,270 $135,183
December 31, 2005 $ 58,128 $ 28,802 $ 7,503 $ 53,705 $148,138
March 31, 2006 $ 57,030 $ 20,961 $ 6,590 $ 43,874 $128,455
The decline in backlog during the first quarter of 2006 could lead to a
potential decline in future quarterly revenues.
Historically, approximately 93% of our revenues were generated from sources
where the ultimate client is a federal, state or local government unit. During
the last few years, due to the general economic slowdown, state and local
budgets, which we are dependent on for approximately 69% of our revenue sources,
have come under intense pressure. Most states were running in a deficit
situation, as were many local governments. This caused many of them to delay and
in some cases cancel certain infrastructure projects until such time as their
economic fortunes rebound. In recent months, tax revenues have been improving
resulting in increased activity preparatory to the issuance of bids and
ultimately the awarding of new projects. In addition, we have increased our
sales and marketing efforts with a specific objective of marketing to the
commercial sector which inherently offers faster project implementation
schedules.
Our second area of focus is the reengineering of our business model so that it
contains a greater percentage of recurring revenue. As indicated in the
following table, approximately 13.0% of our revenue during the first three
months of 2006 was generated from recurring revenue sources (primarily
maintenance revenues), and the majority of these revenues occurred in our Public
Safety and Justice segment. We define one-time revenue as revenue derived from
discrete projects, from which we do not expect to generate incremental revenue
upon the completion of the project. We define recurring revenue as sources of
revenue from which we anticipate receiving revenue in the current, as well as
future periods, for example annual renewable maintenance contracts.
Three Months Ended March 31, 2006
-----------------------------------------------------------
One-time Revenue % Recurring Revenue % Total
-----------------------------------------------------------
Institutional Security Systems $12,163 30.0 $ 1,192 2.9 $13,355
Attack Protection 11,684 28.9 -- -- 11,684
Integrated Electronic Systems 3,587 8.9 -- -- 3,587
Public Safety and Justice 7,766 19.2 4,078 10.1 11,844
------- ------- ------- ------- -------
Total $35,200 87.0 $ 5,270 13.0 $40,470
======= ======= ======= ======= =======
Since the majority of our revenues are one-time revenues and are non-recurring,
we must reinvent our book of business on a continual basis. This makes it very
difficult for us to project our future revenue stream and thus makes it very
difficult for us to project our earnings as well as our business outlook. Over
the next five years, we hope to modify our business model to rely less upon
one-time sources of revenue and more on recurring sources of revenue.
Our third focus area is to improve our cost structure, quality, and client and
employee satisfaction. Our Institutional Security Systems and Attack Protection
business segments are undergoing significant organizational and expense
restructuring, including a partial consolidation of regional office efforts and
an increased focus on centralized performance of the most complicated security
projects. This initiative began by ensuring our organization is properly aligned
with our clients' needs. Many changes have been made and initial results
indicate that our cost, our quality, our clients and our employees are
responding favorably to the changes implemented thus far. We have much room for
improvement as we move toward a more client-oriented organization. The
organization re-alignment is critical to strengthening our future as it allows
us to deploy the Six Sigma and Lean Manufacturing methodologies across all our
business segments more efficiently. The Six Sigma methodology focuses on defect
elimination, which will have a direct impact on our cost, quality, and client
satisfaction. Lean Manufacturing also focuses on reduction of costs and
elimination of waste. In addition, in light of the escalating selling, general
and administrative costs associated with the current heightened regulatory
environment, we are evaluating our structure and strategy to determine if a less
decentralized, or other organizational structure would result in lower selling,
general and administrative costs and we are evaluating our strategy to determine
if we would benefit from focusing on fewer segments.
18
We believe that if we address and implement successfully the above three areas
of focus, we will significantly enhance our future growth opportunities and will
provide for more predictable financial results.
On May 2, 2005, we filed a Form 8-K disclosing that the we failed to timely file
an amendment to our Annual Report on Form 10-K for the year ended December 31,
2004 to provide management's report on internal control over financial reporting
as of December 31, 2004 and the related report of our independent registered
public accounting firm on management's assessment of the effectiveness of
internal control over financial reporting (together, the "404 Report") required
by Section 404 of the Sarbanes-Oxley Act of 2002.
On May 4, 2005, we received a notice from the Listing Qualifications Department
of The Nasdaq Stock Market stating that due to our failure to timely file the
404 Report, we were no longer in compliance with the requirements of Marketplace
Rule 4310(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the Securities and Exchange Commission on or before
the date they are required to be filed with the SEC.
On June 27, 2005, the Company filed its Form 10-K/A with the SEC containing the
404 Report. On June 30, 2005, the Nasdaq Listing Qualifications Panel advised
CompuDyne that CompuDyne had remedied its filing delinquency and was in full
compliance with Nasdaq Market Place Rules.
On December 21, 2005 the Securities and Exchange Commission issued Release No.
33-8644 "Revisions to Accelerated Filer Definition and Accelerated Deadlines For
Filing Periodic Reports" (the "Release"). The Release revised the definition of
"accelerated filer" to make it simpler for accelerated filers whose public float
falls below the $50 million threshold on the measurement date of June 30 to exit
accelerated filer status. Under the new rules, an accelerated filer that has
voting and non-voting equity held by non-affiliates of less than $50 million at
the end of its second fiscal quarter is permitted to exit accelerated filer
status at the end of that year and to file its annual report for that year and
subsequent periodic reports on a non-accelerated basis. Accelerated filer status
affects an issuer's deadlines for filing its periodic reports with the SEC and
complying with the requirements of Section 404 of the Sarbanes-Oxley Act of
2002. A non-accelerated filer must begin to comply with the internal control
over financial reporting requirements including the attestation report of a
registered public accounting firm for its first fiscal year ending on or after
July 15, 2007.
The aggregate worldwide market value of CompuDyne Corporation's equity held by
non-affiliates as of June 30, 2005, the last business day of CompuDyne's second
fiscal quarter, was less than $50 million. As a result, as of December 31, 2005,
CompuDyne exited accelerated filer status.
Prior to the issuance of the Release CompuDyne was classified as an "accelerated
filer" and was required to comply with the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002. In light of the Release, CompuDyne, as a
non-accelerated filer as of December 31, 2005, was not required to comply with
Section 404 for the year ended December 31, 2005. The determination of whether
CompuDyne will be an accelerated filer for the year ending December 31, 2006 is
dependent on the Company's worldwide market value held by non-affiliates on June
30, 2006.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2006 and 2005
Revenues. The Company had revenues of $40.5 million and $36.3 million for the
three months ended March 31, 2006 and March 31, 2005, respectively, representing
an increase of $4.2 million or 11.5%. As discussed below, the increase occurred
primarily due to higher revenues in our IES and AP segments, offset in part by a
decrease in revenues from our ISS segment.
Revenues from the Institutional Security Systems segment were $13.4 million for
the three months ended March 31, 2006, a decrease from $15.7 million for the
three months ended March 31, 2005 representing a decrease of $2.4 million or
15.1%. The Institutional Security Systems segment is largely a construction
driven business. Much of its revenue is obtained by working on new and retrofit
construction projects in the corrections industry, as opposed to sources of
recurring revenue. As such, the decrease in revenue experienced by this segment
is largely attributable to our working on fewer projects than we did in the
previous year and the delay in the start of some projects. Backlog was $42.7
million and $57.0 million at March 31, 2005 and March 31, 2006, respectively.
Although backlog increased at March 31, 2006 as compared to March 31, 2005,
several of ISS' recently won awards were delayed and/or not yet available to be
worked on by us. The years 2003 and 2004 were slow bidding periods for the
Company. Although the gross amount of construction spending in the corrections
area remained relatively flat between 2003 and 2004, the types of projects that
the Company solicits, namely large-scale medium to maximum security
installations, declined significantly in 2003 and 2004. This situation was
further compounded by the general state and local governmental budget deficits
which caused these governmental units to rethink and delay many of their pending
corrections projects. Since 2005, ISS has seen significant, heightened bidding
activity, particularly in the market space it serves, namely large-scale medium
to maximum security prisons. During 2005 and through March 31, 2006, ISS'
backlog has increased.
19
Revenues from the Attack Protection segment were $11.7 million for the three
months ended March 31, 2006, an increase from $6.9 million for the same period
of 2005 representing an increase of $4.8 million or 69.4%. In 2002 the Company
purchased an existing 75,000 square foot factory for the Attack Protection
segment on 20 acres of land in close proximity to its existing factory in
Montgomery, Alabama. This capacity increase was largely driven by the Company's
expectation that the demands for its products, principally its bullet and blast
resistant windows and doors would accelerate significantly in the post September
11, 2001 world. Throughout 2002, 2003, and 2004 this anticipated increase in
demand did not materialize leaving the segment with significant excess capacity.
This segment is composed of two chief product offerings, namely Norshield, which
encompasses bullet and blast resistant windows and doors and ancillary products,
and Fiber SenSys, which encompasses fiber optic intrusion detection systems. For
the three months ended March 31, 2006 the Norshield line experienced a 182.0%
increase in revenues as compared to the three months ended March 31, 2005,
whereas the Fiber SenSys line experienced a 73.6% decrease in revenues for the
comparable period. The increase in revenue of $7.0 million in the Norshield line
is a direct result of the execution on an award of a major contract won in the
fourth quarter of 2005. Execution on this contract began immediately upon award.
Fiber SenSys' revenue decline is a result of the rollout of its next generation
product, which until its testing is completed and accepted, expected by the
third quarter of 2006, will continue to negatively impact revenues. During 2003,
the Company furnished bids to supply its products for eight new embassy
projects. At the time, this was the largest number of embassy projects bid in a
single calendar year for this segment. The Company was awarded four of these
embassy projects, for a total CompuDyne contract value of $7.0 million, and lost
the remaining four embassy project bids to competitors. During 2004, we bid on
fifteen new embassy projects. Through March 31, 2006, the Company was awarded
seven of these embassy projects for a total contract value of $9.6 million, and
lost seven embassy project bids to competitors, with one project still awaiting
award. In 2005, twenty-eight embassy projects were planned. We believe that this
increased level of new embassy construction will continue for the next several
years. Through March 31, 2006 the Company had been awarded three of these
projects, for a total of $19.6 million, and lost one project and one bulk bid
embassy project comprising eight embassies to competitors. Sixteen of these
projects are still awaiting award.
Revenues from Integrated Electronic Systems were $3.6 million for the three
months ended March 31, 2006, an increase from $2.0 million for the same period
of 2005 representing an increase of $1.6 million or 77.7%. The first half of
2005 was a difficult time for IES, with a downturn in revenues and gross profit,
ensuing from: a delay in a large-scale installation contract pending the
government's completion of the building to house the system's Command and
Control Center; a reduction in an ongoing governmental integration program,
resulting from the Department of Defense's base relocation and closure (BRAC)
program; delays in several significant awards, because funding had been
redirected to the war efforts in Iraq and Afghanistan; and a delay in the
start-up of a 5-year, $25 million security contract with the Bureau of Engraving
& Printing ("BEP"), due to an award protest by the predecessor contractor. IES
is currently performing work under the BEP contract although the protest remains
unresolved. During the first quarter of 2006 IES saw its revenues return to a
more normal level.
Revenues from the Public Safety and Justice segment were $11.8 million for the
three months ended March 31, 2006, an increase from $11.7 million for the same
period of 2005 representing a slight increase of $0.2 million or 1.6%. PS&J has
been experiencing lower backlogs and has increased its focus on developing its
next generation products. During the fourth quarter of 2005 and continuing
through the first quarter of 2006, PS&J redeployed a portion of its technical
staff, typically deployed in the research and development area, to work on
projects. It should be noted that although we made three acquisitions in this
segment, two in 2004 (90 Degrees and Copperfire) and one in August 2005
(Xanalys), these acquisitions had little impact on Public Safety and Justice's
revenues due to their relatively small size.
Expenses. Cost of sales of $28.0 million for the three months ended March 31,
2006 were up $4.0 million or 16.9% from $23.9 million during the same period of
2005. The smaller percentage increase in sales as compared to the percentage
increase in cost of goods sold resulted in a decreased gross profit percentage
of 30.9% for the three months ended March 31, 2006 as compared to 34.1% for the
three months ended March 31, 2005.
Cost of goods sold in the Institutional Security Systems segment of $11.2
million for the three months ended March 31, 2006 were down $1.0 million or 8.1%
from $12.2 million during the same period of 2005. This decrease was less than
the related sales decrease of this segment of 15.1%, resulting in a 6.4%
decrease in the gross profit percentage to 16.3% from 22.7% for the three months
ended March 31, 2005. The decrease in the gross profit percentage is largely a
result of ISS' fixed costs now being absorbed by a smaller revenue base during
the first quarter of 2006. In addition, during the first quarter of 2005, one of
this segment's customers terminated its contract for convenience, resulting in
the recognition of $1.3 million in gross margin. In 2002 Institutional Security
Systems' senior management determined that the costs to complete certain of its
West Coast projects were going to be significantly higher than was previously
projected. This resulted in significant cost overruns on many of these projects.
As the work on the projects progressed, the Institutional Security Systems
segment identified additional cost overruns which caused the costs to complete
these projects to increase. Although the projects identified in 2002 are
substantially all complete, the problems in the ISS West Coast operations
continued into 2003, 2004, and 2005. The West Coast office continues to be
affected by one final contract which requires ISS to install a proprietary
duress system which has been validated through an independent consultant and the
manufacturer of the equipment, but will not function as required by the contract
specifications. ISS has incurred significant costs trying to make the equipment
function as desired. The customer is working with ISS to develop a level of
acceptance, and both ISS and the customer are cooperating to close out the
project in an amicable manner. We believe that all future costs on these
projects have been adequately accounted for through March 31, 2006. The West
Coast office has been downsized to a sales and support office, consolidating the
estimating, electronics engineering and electronics fabrication functions into
the Montgomery home office. The West Coast office realized positive gross
margins on its projects in 2005 and 2006. Despite these positive gross margins,
the West Coast office experienced high legal and overhead costs closing out many
of the old projects. While this resulted in an overall loss at the West Coast
operation, the office was also able to significantly reduce aged receivables and
filed multiple claims for possible future upside recovery. The office moved its
facilities to a smaller, more cost effective facility, which will further reduce
overhead costs in the future.
20
The West Coast project overruns resulted in pre-tax losses recorded in the
following periods, in thousands:
Second Half of 2002 $ 2,698
Full Year 2003 4,087
Full Year 2004 6,092
First Quarter of 2005 740
Second Quarter of 2005 472
Third Quarter of 2005 399
Fourth Quarter of 2005 417
First Quarter of 2006 30
--------
Total $ 14,935
========
To address this situation, the Company has implemented more centralized controls
and has reorganized the function of the West Coast office.
Cost of goods sold in the Attack Protection segment of $8.4 million for the
three months ended March 31, 2006 increased $3.9 million or 85.3% from $4.5
million during the same period of 2005. This increase was greater than the
relative sales increase, resulting in a 6.2% decrease in the gross profit
percentage to 28.2% from 34.3% during the three months ended March 31, 2005. The
principal reason for the decrease in the gross profit percentage during the
first quarter of 2006 as compared to the first quarter of 2005 was a shift in
product mix. The bullet and blast resistant windows and doors component of this
segment experienced significant growth while the fiber optic component
experienced a revenue decline. The windows and doors component of the segment is
a lower margin business than is the high margin fiber optic business, resulting
in the overall margin decline during the first quarter of 2006 as compared to
the first quarter of 2005. New senior management hired in January 2005 continues
to reduce manufacturing and overhead costs. In addition, one of this segment's
customers terminated its contracts for convenience during the first quarter of
2005 resulting in the recognition of $0.2 million in gross margin due to
contract closeout activities.
Cost of goods sold in the Integrated Electronic Systems segment of $3.1 million
for the three months ended March 31, 2006 increased $1.3 million or 77.4% from
$1.7 million during the same period of 2005. This increase was consistent with
the related sales increase of this segment of 77.7%, resulting in a 0.1%
increase in the gross profit percentage to 14.1% from 14.0% in the three months
ended March 31, 2005. Substantially all of the projects awarded in this segment
are discrete projects.
Cost of goods sold in the Public Safety and Justice segment of $5.3 million for
the three months ended March 31, 2006 was down $0.2 million or 3.4% from $5.5
million during 2005. This decrease was less than the related sales increase of
this segment of 1.6%, resulting in a 2.3% increase in the gross profit
percentage to 55.2% from 52.9% in the period ended March 31, 2005.
Selling, general and administrative expenses were $9.7 million for the three
months ended March 31, 2006, a decrease of $0.3 million or 2.9% from $10.0
million for the same period of 2005. Much of this decrease is related to
additional costs incurred by the Company during 2005 related to compliance with
Section 404 of the Sarbanes-Oxley Act ("SOX"). The Company exited accelerated
filer status as of December 31, 2005 and is currently exempt from Section 404 of
SOX. In addition, AP's selling, general and administrative expenses increased by
$0.5 million or 36.2% during the three months ended March 31, 2006 as compared
to the three months ended March 31, 2005. This increase was largely the result
of increased legal costs associated with ongoing claims resolutions in actions
both as plaintiff and defendant and for increased selling and training costs as
the segment is trying to expand its presence into new marketplaces.
21
In conjunction with the acquisition of the assets of 90 Degrees and Copperfire
and the stock of Xanalys and in compliance with Statement of Financial
Accounting Standards No. 141 (SFAS 141) Business Combinations, the Company
determined the fair value of the following identifiable assets and assigned the
indicated lives for the purposes of amortization and depreciation.
Amount Life
(In Thousands) (In Years)
-------------- ----------
Software $ 2,434 5
Non Compete Agreements 130 3
Tradename 60 15
-------
$ 2,624
=======
The amortization of the above assets resulted in the Company recording
amortization expense related to these assets of $134 thousand and $130 thousand
for the three months ended March 31, 2006 and 2005, respectively, which is
included in operating expenses.
In an effort to further reduce costs, during the third quarter of 2005 the
Company eliminated the position of Chief Operating Officer and had its division
Presidents report directly to the Company's CEO.
Research and development expenses were $1.8 million for the three months ended
March 31, 2006, a decrease of $0.3 million or 16.3% from $2.1 million for the
same period of 2005. Being a technology-driven enterprise, the Company's Public
Safety and Justice segment continually updates and enhances its software
offerings, thus incurring significant research and development costs. During
2005 Public Safety and Justice started investing in its Next Generation
products. During the first quarter of 2006 and 2005 this segment expended $1.5
million and $0.1 million, respectively, for this project.
Interest expense was $0.8 million for the three months ended March 31, 2006 and
March 31, 2005. The following table compares the weighted average of the
Company's three months ended March 31, 2006 and 2005 interest bearing
borrowings, in thousands, which includes bank letters of credit fees for the
industrial revenue bonds, and the related rates charged thereon:
Monthly Weighted Monthly Weighted
Average - 2006 Average - 2005
Amount Rate Amount Rate
---------- ------ ---------- ------
Industrial revenue bonds $ 3,565 5.5% $ 4,005 3.0%
Subordinated borrowings $ 40,250 6.3% $40,250 6.3%
Swap hedge agreement $ -- -- $ 2,029 2.4%
In addition the Company recorded the following non-cash interest expense, in
thousands:
Amortization and write-off of
deferred financing charges $ 82 $ 67
Other income benefited during the first quarter of 2006 by a $161 thousand
positive legal settlement by the Attack Protection segment.
Taxes on Income. The effective tax rate was a benefit of 2.5% for the three
months ended March 31, 2006 and the effective tax rate was zero percent for the
three months ended March 31, 2005. The tax benefit for the three months ended
March 31, 2006 is primarily a result of $200 thousand previously recorded as a
reserve for uncertain tax positions which is no longer needed, partially offset
by state tax expenses. The Company has decided to provide a valuation allowance
against its deferred tax assets, as it has determined that due to the Company's
2004 and 2005 operating losses there is uncertainty as to whether it is more
likely than not the assets will be realized. The Company had net operating loss
carryforwards for financial accounting purposes of $8.9 million at March 31,
2006.
Net Income (Loss). The Company reported net income of $0.8 million for the three
months ended March 31, 2006 and a net loss of $0.3 million for the three months
ended March 31, 2005. Diluted income per share was $0.10 for the three months
ended March 31, 2006 and a loss of $0.04 for the three months ended March 31,
2005. The weighted average number of common shares outstanding and equivalents
used in computing EPS was 8.2 million for both the three month periods ending
March 31, 2006 and 2005.
22
LIQUIDITY AND CAPITAL RESOURCES
The Company funds its operations through cash flows generated from its
operations, bank and public financings, and the sale of its common stock. The
Company's liquidity requirements arise from cash necessary to carry its
inventories and billed and unbilled receivables, for capital expenditures, to
repurchase shares of its common stock under its share repurchase program, for
payments of principal and interest on outstanding indebtedness and for
acquisitions. The ultimate clients of the Company are primarily federal, state
and local governmental units. In the event the funding of these governmental
units is reduced for any reason, including budgetary reductions due to economic
conditions, there is a risk that the demand for the Company's goods and services
would decrease which would reduce the availability of funds to the Company.
As of March 31, 2006, the Company had working capital of $30.7 million compared
with $35.3 million as of December 31, 2005.
Net cash provided by operating activities was $4.8 million during the three
months ended March 31, 2006 versus $2.6 million used in operating activities
during the three months ended March 31, 2005. The largest component of cash
provided by operating activities was a decrease in accounts receivable of $6.9
million, which was partially offset by a decrease in accounts payable and
accrued liabilities of $4.0 million and a decrease in cost in excess of billings
of $2.5 million.
Net cash used in investing activities was $1.7 million for the three months
ended March 31, 2006 compared to net cash provided of $2.5 million in the three
months ended March 31, 2005. In the three months ended March 31, 2006, the net
of marketable securities bought and redeemed was a decrease of cash of $1.4
million. In the three months ended March 31, 2005 the net redemption of
marketable securities was $2.9 million.
Net cash used in financing activities amounted to $0.4 million for the three
months ended March 31, 2006 compared with net cash used in financing activities
of $0.9 million in the three months ended March 31, 2005.
The following table summarizes contractual obligations consisting of total notes
payable and related interest of the Company as of March 31, 2006 and the
payments due by period, in thousands.
Interest on
Notes Payable Notes Payable
-------------- -------------
December 31:
2006 (remaining) $ 440 $ 1,966
2007 440 2,610
2008 440 2,596
2009 440 2,581
2010 440 2,566
Thereafter 41,615 786
------- -------
Totals $43,815 $13,105
======= =======
In addition, the Company enters into purchase obligations to procure equipment
and services, including subcontractor contracts, in the performance of the
day-to-day operations of its business. Substantially all of these obligations
are covered by our existing backlog and the revenues generated by these backlogs
are expected to be sufficient to meet any payment obligations resulting from
these purchase commitments.
On January 22, 2004, the Company completed the offering of the 2011 Notes. The
offering was for $40.25 million principal amount. The 2011 Notes bear interest
at the rate of 6.25% per annum, payable semi-annually, and are convertible into
shares of common stock at a conversion price of $13.89 per share. The proceeds
from the 2011 Notes were used to repay substantially all of the Company's
outstanding bank borrowings.
On December 19, 2005, the Company and its bank entered into a Second Amended and
Restated Revolving Credit and Security Agreement (the "Second Restated Credit
Agreement"). The Second Restated Credit Agreement amended and restated the
Company's Amended and Restated Credit Agreement dated March 31, 2004.
In connection with the execution of the Second Restated Credit Agreement, the
Company provided the bank with collateral that includes all receivables,
equipment, general intangibles, inventory, investment property, real property, a
security interest in subsidiary stock and cash and marketable securities
specifically pledged to the bank. The Second Restated Credit Agreement allows
the Company to obtain revolving advances in a principle amount of up to
$20,000,000. Revolving advances are limited by a borrowing base formula based
upon the value of the Company's receivables, inventory, fixed assets, real
property, cash and marketable securities specifically pledged to the bank, and
issued and outstanding letters of credit. The maximum aggregate face amount of
letters of credit that may be drawn under the Second Restated Credit Agreement
is limited to $18,000,000. The Second Restated Credit Agreement matures on
December 18, 2008.
23
Revolving advances under the Second Restated Credit Agreement bear interest, at
the election of the Company, at a variable rate equal to the alternate base
rate, a prime interest based rate, or the Eurodollar rate plus two and one half
percent. For letters of credit, the Company pays an amount equal to the average
daily face amount of each outstanding letter of credit multiplied by two and one
half percent per annum, and a fronting fee of one quarter of one percent per
annum, together with other administrative fees and charges. The Company paid its
bank a closing fee of $50,000 in connection with the execution of the Second
Restated Credit Agreement. The Company is also required to pay the bank an
unused fee equal to three-eighths of one percent per annum of the amount by
which $20,000,000 exceeds the average daily unpaid balance of the revolving
advances and undrawn amount of any outstanding letters of credit. In addition,
the Company is required to pay a collateral monitoring fee equal to $1,000 per
month and a collateral evaluation fee as required.
The Second Restated Credit Agreement contains various affirmative and negative
covenants including financial covenants. The Company is required to maintain an
unrestricted undrawn borrowing base availability of at least $5,000,000.
Commencing with the fiscal quarter ending June 30, 2006, the Company is required
to maintain a fixed charge coverage ratio of at least 1.1 to 1.0.
The Company's total outstanding borrowings at March 31, 2006 amounted to
approximately $43.8 million, less broker's discounts in the amount of $0.9
million. The 2011 Notes accounted for $39.4 million, net of broker's discounts,
of these borrowings. The remaining amount of $3.6 million resulted from
borrowings at variable rates and consisted of two industrial revenue bonds
outstanding in the amounts of $1.3 million and $2.3 million. The average
interest rate charged to the Company at March 31, 2006 for its industrial
revenue bonds was 3.3%. The variable interest rate for these borrowings
fluctuated between 3.1% and 3.7% during the three months ended March 31, 2006
based on weekly market conditions. These bonds are fully collateralized by bank
letters of credit issued under the Company's bank agreement. The Company's bank
considers letters of credit as outstanding borrowings when considering the
amount of availability the Company has remaining under its line of credit.
Other than the Company's letters of credit, which amounted to $15.3 million at
March 31, 2006, the Company has no other material off balance sheet liabilities.
At March 31, 2006 the Company had $4.7 million of unused availability under the
Second Restated Credit Agreement, subject to the availability of collateral
under its line of credit.
The Company anticipates that cash generated from operations and its currently
available cash will enable the Company to meet its liquidity, working capital
and capital expenditure requirements during the next 12 months. The Company,
however, may require additional financing to pursue acquisitions, and to meet
its long-term liquidity, working capital and capital expenditure requirements.
If such financing is required, there are no assurances that it will be
available, or if available, that it can be obtained on terms favorable to the
Company. From time to time, the Company may be party to one or more non-binding
letters of intent regarding material acquisitions, which, if consummated, may be
paid for with cash or through the issuance of a significant number of shares of
the Company's common stock.
The Company was profitable for the quarter ended March 31, 2006. The Company
did, however, record significant losses in fiscal 2004 and 2005. We recognize
that sustaining profitability is a critical objective which the Company must
attain. The Company continues to have a significant amount of cash and
marketable securities on its balance sheet at March 31, 2006, however, the
Company must sustain its profitability prior to depleting its current cash and
marketable securities.
On May 2, 2005, we filed a Form 8-K disclosing that we failed to timely file an
amendment to our Annual Report on Form 10-K for the year ended December 31, 2004
to provide management's report on internal control over financial reporting as
of December 31, 2004 and the related report of our independent registered public
accounting firm on management's assessment of the effectiveness of internal
control over financial reporting (together, the "404 Report") required by
Section 404 of the Sarbanes-Oxley Act of 2002. On May 3, 2005, the Company's
bank confirmed in writing that there will not be any event of default under the
various credit agreements, by virtue of the Company's failure to file its report
required by Section 404 of Sarbanes-Oxley in a timely manner.
24
On May 4, 2005, we received a notice from the Listing Qualifications Department
of The Nasdaq Stock Market stating that due to our failure to timely file the
404 Report, we were no longer in compliance with the requirements of Marketplace
Rule 4310(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the Securities and Exchange Commission on or before
the date they are required to be filed with the SEC.
On June 27, 2005, the Company filed its Form 10-K/A with the SEC containing the
404 Report. On June 30, 2005, the Nasdaq Listing Qualifications Panel advised
CompuDyne that CompuDyne had remedied its filing delinquency and was in full
compliance with Nasdaq Market Place Rules.
Another consequence of not filing the 404 Report timely as noted above includes
our inability to use a shorter form registration document for one year in the
event we were to engage in an offering of our securities. This could have an
adverse impact on our ability to raise capital and the cost of raising capital.
This consequence will lapse on June 27, 2006.
Additional Considerations
BID BONDS AND PAYMENT AND PERFORMANCE BONDS
Historically, certain of the Company's projects have required bid bonds at time
of proposal submission and payment and/or performance bonds upon contract award.
The majority of these bonds have been needed in the ISS and PS&J segments.
Recently, approximately 75% of ISS' work has come from jobs where payment and
performance bonds are required and for PS&J, 19% of its work has required
payment and performance bonds. The Company's losses in 2004 and 2005 have made
it more challenging for the Company to attain the bonding needed to procure
certain of its projects. As of March 31, 2006, the Company was required to
provide collateral for two of its projects which it did by issuing bank letters
of credit as collateral in the amount of approximately $5.5 million in total. In
April, an additional $1.8 million bank letter of credit was issued to serve as
collateral for a contract's performance bond. In the event the Company is unable
to obtain bonds, or if the terms, namely additional collateral, of the bonds are
not within the financial means of the Company, the amount of work the Company is
able to contract for will be negatively impacted.
COST CONTAINMENT
Due to current economic conditions, the Company's losses in 2004 and 2005, and
in light of a very strong competitive environment, the Company recognizes that
its ability to increase the prices it charges its clients is limited. In
addition, in light of significant selling, general and administrative costs
associated with the current heightened regulatory environment, we are evaluating
our strategy to determine if a revised strategy would result in lower selling,
general and administrative costs. As a result, in order to enhance our
profitability, the Company will continue to seek ways to reduce its costs.
TOTAL BACKLOG
CompuDyne's backlog amounted to $128.5 million at March 31, 2006. This was a
decrease of 13.3% from the Company's December 31, 2005 backlog of $148.1
million. The break down of the Company's backlog by segment is as follows, in
thousands:
March 31, December 31,
2006 2005
------------- --------------
Institutional Security Systems $ 57,030 $ 58,128
Attack Protection 20,961 28,802
Integrated Electronic Systems 6,590 7,503
Public Safety and Justice 43,874 53,705
-------------- --------------
Total $128,455 $148,138
============== ==============
The decline in backlog during the first quarter of 2006 could lead to a
potential decline in future quarterly revenues.
Included in the backlog of the ISS, AP and PS&J segments at March 31, 2006 is
$16.9 million, $0.9 million and $2.3 million, respectively, representing awards
received by the segment for which the clients have not yet entered into signed
contracts. These awards are expected to result in signed contracts over the next
twelve months.
CORPORATE REORGANIZATION
As part of the Company's efforts to better manage its costs, during the first
quarter of 2005 the Company implemented a corporate reorganization whereby it
converted several corporate entities into LLCs (Limited Liability Corporations).
This activity was designed to improve the Company's tax reporting structure and
should help better manage the Company's state income tax obligations. In
conjunction with this reorganization, our Federal Security Systems group,
formerly known as Quanta Systems Corporation, was re-formed as
CompuDyne-Integrated Electronics Division, LLC, and our Public Safety and
Justice group, formerly known as Tiburon, was renamed CompuDyne-Public Safety &
Justice, Inc. In addition, CorrLogic, Inc. was converted to CorrLogic, LLC and
Fiber SenSys, Inc. was converted to Fiber SenSys, LLC. The impact of this
reorganization is not expected to have a material effect on operations. In
addition, in light of escalating selling, general and administrative costs
associated with the current heightened regulatory environment, we are evaluating
our structure to determine if another organizational structure would result in
lower selling, general and administrative costs.
25
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
A complete description of the Company's significant accounting policies appears
in the Company's Annual Report on Form 10-K for the year ended December 31,
2005.
Percentage of Completion Accounting and Revenue Recognition.
Approximately 50% of the Company's revenues are derived from long-term contracts
where revenue is recognized under the percentage of completion method of
accounting. The Company's software related contracts utilize labor hours
incurred to date on a project, divided by the total expected project hours to
determine the completion percentage. The Company's construction contracts
utilize costs incurred to date on a project, divided by the total expected
project costs to determine the completion percentage. Both of these methods
require considerable judgment and, as such, the estimates derived at any point
in time could differ significantly from actual results. These estimates affect
many of the balance sheet and statement of operations accounts including net
sales, cost of goods sold, accounts receivable, contract costs in excess of
billings and billings in excess of contract costs incurred.
Revenues for support and maintenance contracts are deferred and recognized
ratably over the life of the contract. Sales of products unrelated to contract
revenue are recognized as revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; the seller's price to the buyer is fixed or determinable;
and collectibility is reasonably assured.
Provisions for estimated losses on uncompleted contracts are recognized in the
period such losses are determined.
Inventories are stated at the lower of cost or market, using the First-in,
First-out (FIFO) method. Costs included in inventories consist of materials,
labor, and manufacturing overhead, which are related to the purchase and
production of inventories.
Warranty reserves are estimated and recorded at the time products are sold or
services are rendered. They are established using historical information on the
nature, frequency and average cost of warranty claims. The Company warrants
numerous products, the terms of which vary widely. In general, the Company
warrants its products against defect and specific non-performance.
Accounts receivable are expected to be substantially collected within one year
except for a portion of the receivables recorded as retainage. Retainage
expected to be collected in over one year is reflected as a current asset as it
will be collected within the operating cycle under the related contract.
Tax valuation allowances are established when the Company believes it is not
"more likely than not" that the Company will be able to receive tax benefits in
the future. The federal income tax benefit recorded in the first quarter of 2006
is primarily the result of the reduction of a liability maintained for uncertain
tax positions which was no longer required.
Goodwill and Intangible Assets.
The Company reviews the carrying value of goodwill and intangible assets not
subject to amortization annually during the fourth quarter of the year or when
events or changes in circumstances indicate that the carrying value may not be
recoverable, utilizing a discounted cash flow model. Changes in estimates of
future cash flows caused by items such as unforeseen events or changes in market
conditions could negatively affect the Company's reporting units' fair value and
result in an impairment charge. The carrying value of goodwill and intangible
assets not subject to amortization totaled approximately $26.8 million and $5.7
million, respectively, and intangible assets subject to amortization totaled
approximately $2.5 million, net, at March 31, 2006. The Company cannot predict
the occurrence of events that might adversely affect these values.
Stock Compensation Policy.
Effective January 1, 2006, we adopted SFAS No. 123(R), "Share-Based Payment."
This statement requires us to expense the fair value of grants of various
stock-based compensation programs over the vesting period of the awards. We
elected to adopt the "Modified Prospective Application" transition method which
does require the restatement of previously issued financial statements.
Compensation expense is measured and recognized beginning in 2006 as follows:
AWARDS GRANTED AFTER DECEMBER 31, 2005 - Awards are measured at their fair value
at date of grant. The resulting compensation expense is recognized in the
consolidated statement of operations ratably over the vesting period of the
award.
26
AWARDS GRANTED PRIOR TO DECEMBER 31, 2005 - Awards were measured at their fair
value at the date of original grant. Compensation expense associated with the
unvested portion of these options at January 1, 2006 is recognized in the
consolidated statement of operations ratably over the remaining vesting period.
For all grants issued after December 31, 2005 the amount of recognized
compensation expense is adjusted based upon an estimated forfeiture rate which
is derived from historical data.
ECONOMIC CONDITIONS AND THE AFTER EFFECT OF THE SEPTEMBER 11, 2001 TERRORIST
ATTACKS
Much of the work CompuDyne performs is for state and local governmental units.
These entities were severely impacted by recent economic conditions and the
resulting contraction of the tax bases of these governmental units. This has
caused these governmental units to carefully evaluate their budgets and defer
expenses and projects where possible. Much of the work of the Company's Public
Safety and Justice and Institutional Security Systems segments is contracted
with these state and local governmental units. As a result, these segments have
seen delays in new work available to be bid and worked on. In addition, even
work that had been contracted for was sometimes deferred by the customer into
the future. In recent months, it appears the state and local government revenues
have been improving, resulting in increased activity preparatory to the issuance
of requests for new bids and ultimately, the Company expects the awarding of new
projects. It appears to us that we are in the early stages of an economic
recovery as it relates to the segments of the marketplace we serve.
After the occurrence of the tragic events of the September 11, 2001 terrorist
attacks, there was a general perception that our Integrated Electronic Systems
and Attack Protection segments would see a significant increase in order flow.
To the contrary, in the months subsequent to the terrorist attacks these
segments saw a slowing in new work opportunities as the various federal agencies
and other customers that are the usual source of their business slowed their
procurement processes waiting for definitive direction as to how to proceed in
the post September 11 world. Now further complicated by the military action in
Iraq, the Company's clients are reevaluating priorities and budgets and are
funding only their most pressing demands while also making key decisions as to
which projects can be deferred.
As a result of the above factors, during the last few years the Company has
experienced a more challenging marketplace than it experienced in the years
prior to September 11, 2001.
MARKET RISK
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 2011 Notes. The 2011 Notes bear interest at the rate of
6.25% per annum, payable semi-annually, and are convertible into shares of
common stock at a conversion price of $13.89 per share. The Company used a
portion of the proceeds of this note offering to pay down outstanding borrowings
under its variable rate bank notes. Subsequent to the pay-down of its bank notes
the only variable rate borrowing remaining outstanding at March 31, 2006 is
approximately $3.6 million of industrial revenue bonds. Since this borrowing
bears interest at variable rates, in the event interest rates increase
dramatically the increase in interest expense to the Company could be material
to the results of operations of the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error
Corrections" (SFAS 154) which replaces APB Opinion No. 20, "Accounting Changes"
and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements-An
Amendment of APB Opinion No. 28." SFAS 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections. It establishes
retrospective application, or the latest practicable date, as the required
method for reporting a change in accounting principle and the reporting of a
correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The adoption of SFAS 154 is not expected to have a material impact on our
consolidated financial position, results of operations or cash flows.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
CompuDyne has fixed and variable rate notes payable. These on-balance sheet
financial instruments expose the Company to interest rate risk, with the primary
interest rate exposure resulting from changes in the bond market used to
determine the interest rate applicable to the borrowings under the Company's IRB
borrowings.
The following information summarizes our sensitivity to market risks associated
with fluctuations in interest rates as of March 31, 2006. To the extent that the
Company's financial instruments expose the Company to interest rate risk, they
are presented in the table below. The table presents principal cash flows and
related interest rates by year of maturity of the Company's notes payable with
variable rates of interest in effect at March 31, 2006.
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of 6.25% Convertible Subordinated Notes due on January 15,
2011. The 2011 Notes bear interest at a rate of 6.25% per annum, payable
semi-annually, and are convertible into shares of common stock at a conversion
price of $13.89 per share. The Company used a portion of the proceeds of the
2011 Notes to pay down its variable bank notes payable. The pay down of its
variable borrowings reduced the Company's interest rate risk.
Financial Instruments by Expected Maturity Date
Notes Payable Variable Fixed
Year Ending Rate ($) Average Variable Rate ($) Average Fixed
December 31 (In Thousands) Interest Rate (In Thousands) Interest Rate
----------------- --------------- -------------- -------------- -------------
2006 (remaining) $ 440 3.33% $ - -
2007 440 3.33% - -
2008 440 3.33% - -
2009 440 3.33% - -
2010 440 3.33% - -
Thereafter 1,365 3.33% 40,250 6.25%
----------- ------------
Total $ 3,565 3.33% $ 40,250 6.25%
Fair Value $ 3,565 3.33% $ 29,986 15.53%
28
ITEM 4. CONTROLS AND PROCEDURES
CHANGES IN ACCELERATED FILER STATUS
On December 21, 2005 the Securities and Exchange Commission issued Release No.
33-8644 "Revisions to Accelerated Filer Definition and Accelerated Deadlines For
Filing Periodic Reports" (the "Release"). Included in the Release was an
amendment to revise the definition of the term "accelerated filer" to permit an
accelerated filer that has an aggregate worldwide market value of voting and
non-voting common equity held by non-affiliates of less than $50 million as of
the last business day of its second fiscal quarter to exit accelerated filer
status at the end of the fiscal year in which the company's equity falls below
$50 million as of the last business day of its second fiscal quarter and to file
its annual report for that year and subsequent periodic reports on a
non-accelerated basis.
The aggregate worldwide market value of CompuDyne Corporation's equity held by
non-affiliates as of June 30, 2005, the last business day of CompuDyne's second
fiscal quarter, was less than $50 million. As a result, as of December 31, 2005,
CompuDyne exited accelerated filer status.
Prior to the Release, CompuDyne was classified as an "accelerated filer" and was
required to comply with the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002. In light of the Release, CompuDyne will not know if it will or will
not be an accelerated filer for the year ending December 31, 2006 until June 30,
2006.
DISCLOSURE CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), the Company conducted an evaluation under the supervision
and with the participation of the Company's management, including the Chief
Executive Officer and the Chief Financial Officer, of the effectiveness of the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based on that evaluation, the Chief Executive Officer and the
Chief Financial Officer concluded that the disclosure controls and procedures
are effective in ensuring that all information required to be disclosed in
reports that the Company files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms. There was no significant
change in the Company's internal control over financial reporting that occurred
during the Company's most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, the Company's internal control over
financial reporting.
29
PART II - OTHER INFORMATION
Item 6: Exhibits.
Exhibits -
4.1 CompuDyne Corporation to Wachovia Bank of Delaware, National
Association as Trustee Indenture dated January 15, 2004, filed
herewith.
4.2 Specimen Note included as Exhibit A to the Indenture filed as Exhibit
4.1 to this Quarterly Report.
31.1 Certification by Mr. Martin Roenigk, Chief Executive Officer pursuant
to Rule 13a-14(a), filed herewith.
31.2 Certification by Mr. Geoffrey F. Feidelberg, Chief Financial Officer
pursuant to Rule 13a-14(a), filed herewith.
32.1 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, for Mr. Martin Roenigk, Chief Executive
Officer, filed herewith.
32.2 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, for Mr. Geoffrey F. Feidelberg, Chief
Financial Officer, filed herewith.
30
SIGNATURE
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.
COMPUDYNE CORPORATION
Date: May 1, 2006 /S/ Martin Roenigk
------------------
Martin Roenigk
Chief Executive Officer
/S/ Geoffrey F. Feidelberg
--------------------------
Geoffrey F. Feidelberg
Chief Financial Officer
31