Item 1. BUSINESS
Optelecom-NKF, Inc., manufacturer of Siqura® advanced video surveillance solutions, provides a full range of network products based on an open technology platform that simplifies integration and installation. Our Siqura solutions offer a blend of ease of use and processing power, enabling end users to optimize the effectiveness of their surveillance systems while reducing the total cost of ownership. Products and solutions are developed and tested for professional and mission critical applications, such as at highway departments, airports, seaports, casinos, public transport authorities, hospitals, city
centers, shopping centers, military bases, and corporate and government campuses. Founded in 1972, Optelecom-NKF is committed to providing its customers with expert technical advice and support.
The Optelecom-NKF corporate headquarters is in Germantown, Maryland, USA, with European corporate offices in Gouda, the Netherlands, and sales or support offices covering the Americas, France, Spain, the UK, Germany, Italy, Dubai, and Singapore.
HISTORY
Optelecom-NKF is a Delaware corporation whose business activities began in 1972 under the name Optelecom, Inc. The Company's early business commenced with the design and delivery of specialized laser systems and fiber optic communications products for the Department of Defense and other defense related agencies of the Federal government.
During the mid-1990's, we successfully transitioned from having a significant number of military customers to being an industry provider of copper and fiber optic based communications products for both commercial and government customers. We focused on providing integrated multi-media products for communicating video, audio, and other data over both copper wire and optical network systems.
In March 2005, we acquired NKF Electronics B.V. (NKF), a wholly owned subsidiary of Draka Holding N.V. (Draka). NKF was founded in 1981 and had accumulated extensive expertise in fiber optic and IP/Ethernet network technologies. This expertise enabled NKF to build a broad range of communications products, ranging from fiber optic video modems and multiplexers to Video-Over-IP network solutions. In April 2005, the Company's name was changed from Optelecom, Inc. to Optelecom-NKF, Inc. to reflect the importance of this acquisition and new corporate structure.
The Company has received a going concern opinion from its auditors. Its continuation as a going concern is dependent upon obtaining the financing necessary to operate its business and pay its debt. We cannot assure you that we will be able to access any financing in sufficient amounts or at all when needed. Our inability to obtain sufficient working capital funding will have an immediate material adverse effect upon our financial condition and our business.
ORGANIZATION, MARKETS AND PRODUCTS
The Company currently maintains its corporate headquarters in Germantown, Maryland. Our corporate structure globally integrates our management into one functional group. We maintain operating centers in both the United States and the Netherlands under this integrated management structure, which includes research and development (R&D), production, sales and logistics in each location.
We are a global supplier of network video equipment, including video codecs and servers, fiber optic systems, network video recorders, Ethernet switches and video management software. We are a customer and product focused company with a flexible philosophy based on providing companies and governments across the world with top quality solutions for traffic management and security surveillance.
Optelecom-NKF is committed to providing its customers with competitively priced, highly reliable, quality equipment and solutions, along with outstanding technical advice and support. All products are developed and tested for real applications, particularly those that need to operate in challenging environmental conditions and across large distances between individual transmission sites. We are ISO 9001:2008 certified and dedicated to the ongoing improvement of our products and processes, applying a high level of quality monitoring to increase customer satisfaction.
We sell our products worldwide through direct sales, commercial integrators and resellers. Management expects the primary sales channel to continue to be the commercial integrator with an
increasing emphasis on developing key accounts on a direct basis. In addition, several vendors incorporate the Company's products in their product offerings allowing the Company to penetrate markets we do not address directly.
The Company continues to focus its resources on developing additional IP products, sales and distribution channels. Service and technical support programs are in place to attract and maintain a large network of integration companies. The Company primarily attracts new customer contacts through participation in trade shows in both the security and traffic markets and through business development efforts with sales representatives. Our web site (www.optelecom-nkf.com) enables the convenient and rapid dissemination of information by our distribution channel personnel and other interested parties who gather information necessary to select our equipment.
The Company has expanded its focus to identify prospects that have a requirement for complete IP-video solutions including the Company's video codecs, Ethernet network equipment, network video recorders and video management software as well as a broad range of pre and post sales services such as design, detailed engineering and training. Internal training programs have been implemented to expand the in-depth knowledge of our worldwide sales and support offices.
We strive to continue improving our position as a producer and supplier of powerful, intelligent network video solutions by providing reliable products and services that enable customers around the world to reduce their total cost of ownership and enhance the effectiveness of their applications. Products for these markets are classified into the two broad categories of Video over IP and Video over Fiber. Our products are marketed and sold under the Siqura brand name.
The Video over IP solutions product line includes video servers / codecs, IP cameras, Ethernet switches, recording and storage equipment. Also, to bring together these hardware components, Siqura software solutions help the user consolidate a complete video network under one, easy-to-use management platform.
The Video over Fiber product line is comprised of the MC Series and the 9000 Series. The MC Series is designed for most common fiber applications and is recognized for its exceptional price-performance ratio. The 9000 Series is designed for the more complex and demanding Video over Fiber applications. The availability of 18 different wavelengths and the unique concept of using "option modules" are the core elements behind the versatility of the 9000 Series. The 9000 Series is about customization: wavelength availability and system functionality facilitate a wide range of fiber network configuration possibilities.
Video over IP solutions
Codecs/Servers for High-quality Video Compression
The Optelecom-NKF line of Siqura video codec/server portfolio ranges from cost-effective, low bandwidth compact video servers to field-hardened, versatile codec platforms. Our single- and multi-channel codecs/servers are available in MJPEG, MPEG-4, MPEG-2 as well as H.264 video compression formats.
Optelecom-NKF's video codec/servers are designed with a strong focus on standardization. Its embedded Open Streaming Architecture (OSA) offers standardized streaming of video and remote control. All streaming protocols are based on approved standards and tested with different industry vendors. A comprehensive HTTP application programming interface gives access to all controls and allows integration with third party Video Management Systems.
Cameras
Optelecom-NKF Siqura cameras address the requirements of today's CCTV security systems. State-of-the-art camera technology in combination with our MPEG-4 compression algorithm results in crystal clear streaming video. The Siqura portfolio of cameras consists of boxed cameras, fixed dome cameras, mini-dome cameras, and high-speed dome cameras. Available in both analog and IP versions, the Siqura camera line is easily deployed, reliable, and feature rich.
Software Management Solutions
The Optelecom-NKF software suite ranges from single and multi-server Video Management Systems for small and medium video surveillance applications to more sophisticated operator solutions (Operator Storage™, Operator Office™, and MX™ Viewer Lite) to support more system critical video surveillance applications. The suite also includes a comprehensive development kit (MX SDK) for integration with third-party software applications. In addition, versatile management and configuration tools are available for maintenance and service purposes. All components within the software suite interoperate seamlessly with all Siqura components.
Network Video Recording (i-NVR)
The Siqura-NVR provides an intelligent network video storage solution designed to support the most demanding video surveillance applications in which operational availability and reliability are key. Ranging from 8- to 64-channel configurations with full RAID-5 capability, the Siqura-NVR offers an extended set of features for scheduled continuous recording and event-driven operations (i.e., video motion detection) in support of alarm recording, etc. Special care has been given to selecting hardware, such as the hard drives and power supply redundancy, to ensure reliable 24/7 operation.
Video Network Equipment
Part of Optelecom-NKF's portfolio includes field-hardened network equipment consisting of Gigabit Ethernet switches, Fast Ethernet switches, and models with built-in video encoders. The switches are both mechanically and electrically compatible with Optelecom-NKF's MC series 19-inch power supply rack, offering cost-efficient, easy-to-maintain hybrid network solutions.
Video over Fiber Optics
MC Series
The MC series of Optelecom-NKF products is specifically designed for safety, security, and transportation applications. With its compact design and its carefully selected combinations of video, data, and audio channels, the MC series offers a full range of simple to install, cost-effective priced point-to-point fiber optic video surveillance solutions.
9000 Series
The 9000 series of Optelecom-NKF products is specifically tailored to support government and transportation applications. With its modular design and ability to utilize Coarse Wavelength Division Multiplexing (CWDM) drop and insert technology, the 9000 series offers maximum flexibility and scalability by combining any number of video, data, and audio channels. In addition, all 9000 series system modules are supported by a remote network management capability (9900- NMS), which offers users the ability to remotely manage optical wavelengths and overall system performance.
Electro Optics Products
In addition to our two primary product categories of Video over IP and Video over Fiber Optics the Company operates an Electro Optics (EO) group focused on Interferometric Fiber Optic Gyro coils and manufacturing innovative optical devices, primarily to U.S. government defense industry customers. In EO, emphasis has been placed on fabrication of precision-wound coils of optical fiber used as the sensing elements of fiber optic gyroscopes. EO also produces precision wound coils for applications ranging from optical fiber dispensers used in remote vehicle control systems to precision optical fiber coils for communications systems. EO represented 2% of the Company's revenue in 2009.
RESEARCH AND DEVELOPMENT
In recent years the Company has focused on the development of products being applied to the IP Video marketplace. These products may permit us to increase our penetration of the markets we serve and expand into new markets. In previous years the Company increased its research and development staffing and used these additional resources to continue expanding its existing IP product lines. Our research and development expense is classified as a component of Engineering in our financial statements and for the years ended 2009 and 2008 was $4.1 million and $5.5 million respectively.
Although the Company holds a limited number of patents relating to optical sensor technology and optical fiber networks, our business is not materially dependent upon ownership of any one patent or group of patents. We do not license any patents from third parties and we assign no value to patents in our financial statements.
QUALITY MANAGEMENT SYSTEM
The Company maintains a Quality Management System fully compliant with ISO9001:2008 and maintains an ongoing certification to this standard. In keeping with our continuous improvement objectives, we continually implement enhancements to our quality performance metrics which track internal product defects, out-of-box failures, customer concerns, product repairs and new product introduction issues. With the goal of increasing customer satisfaction, management has continued to stress the importance of the Quality Management System and continues to utilize numerous quality tools, including a corrective action process, internal quality control audits and senior management reviews. Additionally, the Quality Management System provides for proper controls, conducts material review meetings, performs Mean Time Between Failure calculations to determine product reliability and works closely with suppliers to reduce incoming material defects. The U.S. and Netherlands-based facilities synchronize quality processes by standardizing many company-wide procedures.
In keeping with our Company's commitment to quality products and services we adhere to the following corporate quality policy: Quality is the responsibility of every Optelecom-NKF employee and focuses on everything we do to maintain our competitive edge. Our commitment to quality includes a customer focus, individual ownership for quality, measurement and feedback systems, maintaining an ISO 9001:2008 compliant quality management system, and continual review of our quality objectives.
MANUFACTURING
Both the US and the Netherlands-based facilities perform routine and specialized manufacturing, assembly, and product testing functions. We use equipment to automatically assemble components onto printed circuit boards at high speed, thereby lowering manufacturing costs and reducing the time-to-market for new product designs. We also maintain a quality assurance function and testing area that performs quality inspections along with optical and electrical testing. Raw materials and supplies used in our business include sheet metal, optical materials, plastic products, and various electronic components, most of which are available from numerous sources. Although the number of companies from which we can obtain optical emitters and detectors for use in our circuit assemblies is limited,
availability is presently not a significant factor in our ability to provide products. However, suppliers have generally reduced inventory levels as a result of the economic downturn which can cause delays in the Company receiving certain components. In 2009, we continued to focus on decreasing the manufacturing defect rate, making throughput cycle-time improvements, and striving toward work-in-progress (WIP) reductions as the result of embracing lean concepts. This progress is all part of continuous, long-term improvement efforts.
COMPETITION
We compete with other companies of roughly equal size that have similar or more resources as well as with much larger companies with greater resources. Our competitors include many privately held companies and some public corporations. The Company historically competes in two primary market segments, traffic monitoring and security surveillance. The competition in these markets often has established mature sales channels that allow for continued market penetration in both domestic and international markets. Management believes that the expansion of the Company's IP product offering through its sales and distribution channels worldwide will be the basis for future development.
SEASONALITY
The Company's products are based on communications equipment technology. As such, seasonality affects our revenues to the extent that normal contracting activities are affected by capital budgets. We are also impacted in areas with colder climates as some outdoor projects are planned to avoid the winter months. This seasonality has often resulted in historically lower levels of revenue in the first half of the year when compared to revenue in the second half of the year.
EMPLOYEES
At December 31, 2009, the Company had 160 full time equivalent employees worldwide, including 48 in manufacturing, 55 in sales and marketing, 33 in research, development and engineering, 3 in Electro Optics, and 21 in general management, quality management, finance and administration. We expect a decrease in headcount over the next 12 months.
CORPORATE
The Company's principal executive offices are located at 12920 Cloverleaf Center Drive, Germantown, MD 20874. The Company's telephone number is (301) 444-2200. Our home page on the Internet is www.optelecom-nkf.com. The Company makes web site content available for informational purposes, which is not incorporated by reference into this Form 10-K.
Item 1A.
Item 1A. RISK FACTORS
Fluctuations in financial performance and recent losses could harm our ability to increase revenue and become profitable.
We have experienced and may continue to experience fluctuations in our quarterly and annual operating results. For the year ended December 31, 2009, our financial performance included lower levels of revenue and gross profit compared to the year ended December 31, 2008. Our revenue declined approximately 20% during the year while gross profit declined from $27.2 million to $20.7 million. Factors that may cause operating results to vary and negatively impact our ability to become profitable include, but are not limited to, the shift by our customers from fiber optic to IP products, the need to transition our U.S. sales model to respond to the market shift to IP products, changing technology, new product transitions, delays in new product introductions, competition, shortages of system components, changes in the mix of products and services sold, economic factors, and timing of planned expenditures in facilities and research and development. The current economic
environment is marked by significant instability and continued economic weakness may be expected for the near future. As a result of the impact of these and other factors, we may not be able to become profitable in the near future and past financial performance should not be considered to be a reliable indicator of the future performance in any particular fiscal period. We are somewhat limited in our ability to reduce expenses quickly in response to any revenue shortfalls. Therefore, our business, financial condition, and operating results could be adversely affected if we do not achieve increased revenues.
We may not be able to continue as a going concern.
Our financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have not made any adjustments to our financial statements as a result of the going concern modification to the report of our independent registered public accounting firm. If we become unable to continue as a going concern, we could have to liquidate our assets, which means that we are likely to receive significantly less for those assets than the values at which such assets are carried on our financial statements Any shortfall in the proceeds from the liquidation of our assets would directly reduce the amounts, if any, that holders of our common stock could receive in liquidation.
There can be no assurance that our plans will be successful, and other unforeseeable actions may become necessary. Any inability to obtain financing or raise capital may require us to reduce the level of our operations. Such actions would have a material adverse effect on us, our business, and operations and result in charges that would be material to our business and results of operations.
Our current capital may not provide the funds necessary for our short and long-term cash requirements and we may not be able to secure additional funding.
Our current capital resources including operating cash flows may not generate the funds needed for our short and long-term cash requirements. Accordingly, we would be required to seek additional funding. In those circumstances, we would look to increase our debt and/or pursue equity financing. There can be no assurance that additional financing will be available in a timely manner or on acceptable terms. If issuing equity securities raises additional funds, further dilution to existing stockholders will result. If adequate funds are not available when needed, we may be required to delay, scale back or eliminate product development, sales and marketing, and overhead costs or potentially be unable to make debt payments or meet other obligations.
The current economic environment has had a negative impact on our business and we may be required to restructure our operations.
During 2009, our business experienced the effects of negative macroeconomic conditions, further aggravated by customer specific challenges and disruptions in the financial and credit markets globally. The affects on our business is spread across our customer segments and geographies with a particular focus in the U.S. Uncertainty around current macroeconomic and industry conditions persists, particularly the effect these conditions and a sustained lack of liquidity in the capital markets will continue to have on the capital spending of our customers. We are uncertain of the impact this may have in future periods on the spending or financial position of our customers. We can not be certain how long these conditions will continue and the magnitude of their effects on our business and results of operations. Consequently, these conditions have negatively affected our business and made our forecasting and planning more difficult. We expect the near term market conditions to be challenging and we continue to seek longer term market opportunities.
During this period of uncertainty, we plan to balance our strategy of continued product development and manage our workforce and operating costs carefully to ensure that they are aligned
with our business and market opportunities. To that end, during 2009 and 2008, we effected staff reductions and we continue to explore additional organizational changes and staff reductions that will allow us to better manage our operations and reduce operating costs. These organizational changes increase the risk that objectives will not be met due to the allocation of valuable limited resources to implement changes. Further, due to the uncertain nature of any of these undertakings, these efforts may not be successful and we may not realize anticipated benefits from these efforts.
We issued $23.1 million of senior and subordinated notes in connection with our acquisition of NKF.
In connection with the acquisition of NKF, we issued $23.1 million of senior and subordinated notes. The issuance of these notes substantially increased our principal payment obligations and we may not have enough cash to repay the notes when due. By incurring indebtedness, the related risks that we face intensify. The degree to which we are leveraged could materially and adversely affect our ability to successfully obtain financing for working capital or other purposes and could make us more vulnerable to industry downturns and competitive pressures. The current economic environment is marked by limited availability of credit in the business sector and we may be required to pursue equity or other financing, if available at all, to refinance the acquisition debt on less than favorable terms. At December 31, 2009, we have an outstanding balance of $14.7 million on this debt. The senior note of $1.9 million was paid in full in March 2010 and the subordinated note is due in full on March 8, 2011.
Our obligations under the promissory note issued to Draka Holding N.V. in connection with the acquisition of NKF are secured by the majority of our assets.
On March 5, 2010, we entered into an amended and restated subordinated promissory note with Draka Holding N.V., pursuant to which Draka agreed to extend the term of the note to March 8, 2011. The current principal amount under the note is €9.1 million Euros ($12.5 million at the prevailing exchange rate on the transaction date). Our obligations under the note are secured by the assets of the Company and a pledge of 65% of the shares of Optelecom-NKF Holding B.V., our holding company in The Netherlands. Fair value of this 65% approximates $14.0 million at December 31, 2009. We do not expect to be able to generate sufficient cash from operations to pay the note when it becomes due. Accordingly, if we are unable to secure financing or equity to refinance the note, Draka could foreclose on its security interest and liquidate the assets securing our obligations under the note.
The loss of one or more of our major customers could adversely affect our business, financial condition and operating results.
For the year ended December 31, 2009, approximately 20% of our revenues were accounted for by sales to five commercial customers. This is similar to the prior year when five customers represented 29% of our revenues. In the event of a reduction, delay or cancellation of orders from one or more significant customers or if one or more significant customers selects products from one of our competitors for inclusion in future projects, our business, financial condition and operating results could be materially and adversely affected. There can be no assurance that current customers will continue to place orders with us, that orders by existing customers will continue at current or historical levels or that we will be able to obtain orders from new customers. The loss of one or more of our current significant customers could materially and adversely affect our business, financial condition and operating results.
We face significant competition for our products and any failure to remain competitive would harm our operating results.
The markets in which we sell our products are highly competitive and characterized by rapidly changing technologies. We face significant competition from a large number of domestic and international competitors, some of which are larger and have larger product development, research and
sales staffs. To remain competitive in both the current and future business climates, we believe we must maintain a substantial commitment to research and development. Our future success will depend in part upon our ability to enhance our current products and to develop and introduce new products that keep pace with technological developments and emerging industry standards that address the increasingly sophisticated needs of our customers. There can be no assurance that we will be successful in developing and marketing such products or producing enhancements that meet these changing demands, or that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or that our new products and product enhancements will adequately meet the demands of the marketplace and achieve market acceptance. Our inability to develop and introduce new products or product enhancements in a timely manner or our failure to achieve market acceptance of new products could have a material adverse effect on our business, financial condition and operating results and our efforts to remain competitive.
Our management structure is globally integrated.
Our corporate structure globally integrates the management functions into one group to address the continually changing technology trends within the industry. The Company was previously established as individually and separately-managed units at our U.S. global headquarters and European operating facilities. Global integration includes product development, manufacturing, sales processes, finance and information technology. The challenges involved in this structure include the following:
•Coordinating manufacturing operations in a rapid and efficient manner;
•Combining product offerings and product lines effectively and quickly;
•Integrating sales efforts so that customers can do business easily with the combined company;
•Bringing together the companies' marketing efforts so that the industry receives useful information about our products and services;
•Coordinating research and development activities to enhance introduction of new products and technologies; and
•Ensuring employee compatibility in diverse global offices and markets.
If we fail to attract and retain key personnel, our business could suffer.
Our future depends, in part, on our ability to attract and retain key personnel. We may not be able to hire and retain personnel at levels consistent with our existing compensation and salary structure. Our future also depends on the continued contributions of our executive management team and other key management, and technical personnel, many of whom could be difficult to replace. The loss of service from these or other executive officers or key personnel or the inability to attract qualified personnel could have a material adverse effect on our business.
Our common stock price is volatile, we have never paid dividends and our stock is subject to future dilution.
Our Common Stock currently trades on the NASDAQ Global Market. The securities markets have from time-to-time experienced significant price and volume fluctuations that were unrelated to our operating performance. In addition, the market prices of the common stock of many publicly traded technology companies have in the past been, and may in the future be, especially volatile. Announcements of technological innovations or new products of the Company or our competitors, developments or disputes concerning proprietary rights, publicity regarding products under development by the Company or our competitors, regulatory developments in both the United States and foreign countries, and economic and other external factors, as well as period-to-period fluctuations in our
operating and product development results, may have a significant impact on the market price of our Common Stock.
We have not paid any cash dividends since our inception and we do not anticipate paying any cash dividends in the foreseeable future. In addition, dilution will occur upon the exercise of outstanding stock options or issuance of additional stock. Further dilution could be significant if we experience additional requirements to fund operations and decide to complete a future equity financing.
We face a number of risks related to the ongoing financial crisis and severe tightening in the global credit markets.
The ongoing global financial crisis affecting the banking system and financial markets has resulted in a severe tightening in the worldwide credit markets, a low level of liquidity in many financial markets and extreme volatility in credit and equity markets. This financial crisis could impact the Company's business in a number of ways, as further discussed above and including:
•Potential Deferment or Cancellation of Purchases and Orders by Customers: Uncertainty about current and future global economic conditions may cause businesses and governments to defer or cancel purchases in response to tighter credit, decreased cash availability and declining consumer confidence. If future demand for our products declines, it will adversely impact our financial results.
•Customers' Inability to Obtain Financing to Make Purchases from the Company and/or Maintain Their Business: Some of our customers require substantial financing in order to fund their operations and make purchases from the Company. The inability of these customers to obtain sufficient credit to finance purchases of our products and/or meet their payment obligations to us could have an adverse impact on our financial results. In addition, if the financial crisis results in insolvencies for our customers, it will adversely impact our financial results.
We face risks related to our international operations and revenue.
Our customers are located throughout the world. In addition, with the acquisition of NKF, we have significant international operations including manufacturing, product development, sales and customer support operations. Our operations outside North America are primarily located in the Netherlands. Our international presence exposes us to certain risks, including the following:
•currency fluctuations;
•our ability to comply with customs, import/export and other trade compliance regulations of the countries in which we do business, together with any unexpected changes in such regulations;
•difficulties in establishing and enforcing our intellectual property rights;
•tariffs and other trade barriers;
•political, legal and economic instability in foreign markets;
•difficulties in staffing and management;
•language and cultural barriers;
•seasonal reductions in business activities in the countries where our international customers are located;
•integration of foreign operations;
•longer payment cycles;
•greater difficulty in accounts receivable collection; and
•potential adverse tax consequences.
Net revenue from International and U.S. based business accounted for 72% and 28%, respectively, of the Company's total revenue in 2009. Within the U.S. based business sales to customers in Canada, South and Central America were 12% in 2009. We expect that revenue from customers outside the United States will continue to account for a significant portion of our total net revenue.
If we fail to manage our exposure to worldwide financial markets successfully, our operating results could suffer.
We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments to manage these risks. A portion of our net revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, our European operations conduct a substantial portion of their activities in other currencies, primarily Euros. A significant change in interest rates or movement in the Euro compared to the U.S. Dollar impacts our operations and financial position.
If we are unable to generate new sales and return to profitability, our business and our financial condition and results of operations will be adversely impacted.
Our lack of profitability in certain periods may impact our ability to attract customers, employees, investors and creditors. Our ability to sustain profitability in future periods will depend in large part on our ability to maintain current customers and generate new sales, to maintain or improve our rate of manufacturing utilization, and to manage sales, product development, and general and administrative expenses in proportion to our revenue. We cannot be certain that we will generate profits in the future and a failure to do so would have a material adverse effect on our business and our ability to operate. Our profitability and cash flow constraints are particularly emphasized in our U.S. operations where our recent sales levels underscore the need to succeed with the implementation of product advancements and sales improvements and maintain cost controls.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
The Company has no unresolved comments from the Securities and Exchange Commission.
Item 2.
Item 2. PROPERTIES
The Company's corporate headquarters and U.S. manufacturing facility is located at 12920 Cloverleaf Center Drive, Germantown, Maryland, where it leases 30,000 square feet of space, substantially all of which is occupied by the Company. The lease expires in August of 2013. We maintain a corporate office and manufacturing facility in Gouda, the Netherlands where we lease approximately 36,000 feet of space, all of which we fully occupy. This lease expires in March of 2015.
The Company also maintains office space in Spain, France, Singapore and Dubai. Management believes that our facilities, which have been specifically designed and fitted to accommodate our requirements, are sufficient to meet our current and anticipated near-term growth needs.
Item 3.
Item 3. LEGAL PROCEEDINGS
None.
PART II
Item 4.
Item 4. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Common Stock, representing its only class of publicly traded securities, is traded on the NASDAQ Global Market under the symbol OPTC. The following are the highest and lowest closing bid prices for the Common Stock as reported by NASDAQ during each quarter for the two years ended December 31, 2009 and 2008, respectively. These quotations may not necessarily reflect actual transactions:
At March 12, 2010, the closing price of our Common Stock was $2.55.
There were 3,676,006 shares of Common Stock outstanding as of March 12, 2010, and 470 record holders as of such date. The Company has never declared or paid any cash dividends on its Common Stock and does not expect to do so in the foreseeable future. The Company intends to use any future earnings to finance its operations or repay its debt obligations.
The following is information on the Company's equity compensation plans as of December 31, 2009.
Item 5.
Item 5. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected historic consolidated financial data for the periods and dates indicated. This information is derived from the Company's audited consolidated financial statements. The information set forth below is qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements, the related notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 6.
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Optelecom-NKF, Inc., manufacturer of Siqura® advanced video surveillance solutions, provides a full range of network products based on an open technology platform that simplifies integration and installation. Our Siqura solutions offer a blend of ease of use and processing power, enabling end-users to optimize the effectiveness of their surveillance systems while reducing the total cost of ownership. All products and solutions are developed and tested for professional and mission-critical applications, such as at highway departments, airports, seaports, casinos, public transport authorities, hospitals, city centers, shopping centers, military bases, and corporate and government campuses.
Founded in 1972, all Optelecom-NKF IP surveillance solutions are marketed under the Siqura® name. Our corporate headquarters is in Germantown, Maryland, USA, with European corporate offices in Gouda, the Netherlands, and sales offices or support covering the Americas, France, Spain, the UK, Germany, Italy, Dubai, China and Singapore.
Optelecom-NKF provides competitively priced, highly reliable, top quality equipment and solutions, along with technical advice and support. All products are developed and tested for real applications, particularly those that need to operate in challenging environmental conditions and across large distances between individual transmission sites. We are ISO 9001:2008 certified and dedicated to the ongoing improvement of our products and processes, applying a high level of quality monitoring to increase customer satisfaction.
We sell our products worldwide through direct sales, commercial integrators and resellers. Management expects the primary sales channel to continue to be commercial integrators with an increasing emphasis on developing key accounts on a direct basis. In addition, several vendors incorporate the Company's products in their product offerings allowing the Company to penetrate markets we do not address directly.
The Company continues to focus its resources on developing additional IP products, sales and distribution channels. Service and technical support programs are in place to attract and maintain a large network of integration companies. The Company primarily attracts new customer contacts through business development efforts and participation in trade shows in both the security and traffic markets. Our web site (www.optelecom-nkf.com) has enabled the convenient and rapid dissemination of information required by our distribution channel personnel and other interested parties to gather information necessary to select our equipment.
The Company has expanded its focus to identify prospects that have a requirement for complete IP-video solutions including the Company's video codecs, Ethernet network equipment, network video recorders and video management software as well as a broad range of pre and post sales services such as design, detailed engineering and training. Internal training programs have been implemented and additional personnel hired to expand the in-depth knowledge of our worldwide sales and support offices.
We strive to continue improving our position as a producer and supplier of powerful, intelligent network video solutions by providing reliable and profitable products and services that enable customers around the world to reduce their total cost of ownership and enhance the effectiveness of their applications. Products for these markets are classified into the two broad categories of Video over IP and Video over Fiber.
Video over IP solutions include video servers / codecs, IP cameras, Ethernet switches, recording and storage equipment. Also, to bring together all these hardware components, Siqura software solutions, Operator Office™ and the Optelecom-NKF SDK, help the user consolidate a complete video network under one, easy-to-use management platform.
The Video over Fiber product line is comprised of the MC Series and the 9000 Series. The MC Series is designed for most common fiber applications and is recognized for its exceptional price-performance ratio. The 9000 Series is designed for the more complex and demanding Video over Fiber applications. The availability of 18 different wavelengths (CWDM technology) and the unique concept of using "option modules" are the core elements behind the versatility of the 9000 Series. The 9000 Series is about customization: wavelength availability and system functionality facilitate a wide range of fiber network configuration possibilities.
In addition to our two primary product categories of IP and Fiber Optics the Company operates an Electro Optics (EO) group focused on Interferometric Fiber Optic Gyro coils and manufacturing innovative optical devices under contract, primarily to U.S. government defense industry customers.
Effect of Recent Market Conditions and Uncertain Macroeconomic Environment on our Business
Through the twelve months ended December 31, 2009, our financial performance included lower levels of revenue and gross profit compared to the year ended December 31, 2008. Our revenue declined 20% during the year while gross profit declined from $27.2 million to $20.7 million resulting in a net loss of $2.4 million. During 2009, our business experienced the effects of negative macroeconomic conditions, further aggravated by customer specific challenges and disruptions in the financial and credit markets globally. The affects on our business are spread across our customer segments and geographies with a particular focus in the U.S.
Uncertainty around current macroeconomic and industry conditions persists, particularly the effect these conditions and a sustained lack of liquidity in the capital markets will continue to have on the capital spending of our customers. We are uncertain of the impact this may have in future periods on the spending or financial position of our customers. We can not be certain how long these conditions will continue and the magnitude of their effects on our business and results of operations. Consequently, these conditions have negatively affected our business and made our forecasting and planning more difficult. We expect the near term market conditions to be challenging and we continue to seek longer term market opportunities.
During this period of uncertainty, we plan to balance our strategy of continued product development and manage our workforce and operating costs carefully to ensure that they are aligned with our business and market opportunities. To that end, during 2009 and 2008, we effected staff reductions which resulted in restructuring charges of approximately $127 thousand and $525 thousand, respectively, in severance costs.
Our continuation as a going concern is dependent upon obtaining the financing necessary to operate the business. If we cannot find sources of additional financing to fund our working capital needs, we will be unable to obtain sufficient capital resources to operate the business. We continue to work toward refinancing our debt obligations which come due in March 2011. However, there is no guarantee that financing will be available for all or part of our outstanding debt. As a result, the Company announced it has authorized its investment banker, Seale & Associates, to expand its role and conduct a broad evaluation of strategic options.
RESULTS OF OPERATIONS
Revenue for 2009 was $36.2 million, a decrease of 20% when compared to 2008. Information regarding the Company's U.S. and international based operations is included in the following table. For the purposes of this table and the following discussion, revenue classified as U.S. based includes Canada, Central and South America.:
Our international operations include the impact from foreign currency translation. On average, the Dollar was stronger in 2009 with an average exchange rate to the Euro of 1.39 compared to 1.47 in 2008. The result of a strengthening Dollar as it relates to our consolidated financial results is that we translated Euro and Pound Sterling sales and related expenses at proportionally lower U.S. Dollar equivalents.
Overall, 2009 revenue from our international operations accounted for 72% of total revenue. Revenue in our European based operations decreased 14% to $26.2 million while international operating expenses decreased 7% during the year. The result is a 65% decrease in international operating profits which totaled $1.3 million in 2009. Excluding the impact of foreign exchange rates the international revenue decrease would have been 8% while the operating expenses would have decreased 2%. Our strongest region is Northern Europe representing almost 36% of the Company's worldwide revenue.
Revenue in our U.S. based operations totaled $10.0 million in 2009 representing a 33% decline from 2008. U.S. operating expenses decreased 13% during the year. The result is an increased U.S. loss from operations in 2009 totaling $3.1 million. The U.S. business continues to be negatively impacted by a number of factors including the macro economic environment, a sales model that is often dependent upon third party representatives and dependence on a shrinking legacy fiber optic product market. The Mid-Atlantic, Northeast and Southeast collectively represent about 68% of the total U.S. business.
Revenue by product category in the recent two year period was:
The Company continues a transition to accommodate an industry-wide shift from video transmission over fiber optics to video over IP/Ethernet based solutions. Fiber Optic products sales in 2009 were down 28% to $21.4 million. This decline accelerated in the current period due to the market shift away from Fiber Optic and toward IP Video products and overall weakness in the economy. In prior years, the Company has invested in IP Video products. However, in 2009 there was a decrease of 5% in IP related revenue over 2008 due to slow U.S. sales and an overall weak macro environment.
Consolidated gross profit was $20.7 million or 57% of revenues for the year ended December 31, 2009, compared to $27.2 million or 60% of revenues in 2008. The gross profit percentage was at the low end of the Company's ongoing target of 57 to 59 percent. The decline in our gross profit margin was primarily from excess capacity in our manufacturing facilities due to lower than expected sales volume. Gross profit was down $6.5 million and 24% in total as a result of the revenue decline. Excluding the impact of foreign exchange rates the consolidated gross profit margin decreased $5.5 million. The current year decrease is directly attributable to the decline in revenues and somewhat offset by efficiency realized in our manufacturing processes.
The gross profit margin in our U.S. business was 54% in 2009 compared to 56% in 2008. This decline was caused by the reduced volume of sales during 2009. The gross profit margin in our international business was 59% in 2009 compared to 62% in 2008 with the reduction also primarily driven by lower sales volume. Lower revenue levels result in relatively higher costs of goods sold as the costs for personnel in direct labor positions and other fixed overhead costs are spread over a smaller revenue base.
Our operating expense decreased during 2009 to $22.5 million from $24.8 million in 2008. The $2.3 million operating expense decline in 2009 includes savings from reduction in personnel related costs totaling $1.2 million and savings from other cost reduction efforts totaling $1.1 million. The current year decrease of $2.3 million includes a reduction of costs in the sales and marketing function totaling $354 thousand, reductions in engineering totaling $1.3 million and reductions in general and administrative costs of $617 thousand. The decrease in operating expenses in 2009 was offset by a $127 thousand charge for severance accruals as we completed a reduction in force in the third quarter which included sales, manufacturing, engineering and administrative personnel. The Company's actions have included changing or replacing certain U.S. sales personnel as we address a reduction in U.S. revenue and a market shift from fiber optic to IP products. In addition, we continue to transition our U.S. sales model and reorganize our sales channels to place greater emphasis on developing and supporting key accounts.
OTHER INCOME (EXPENSE)
Other expense declined in 2009 to $841 thousand compared to a total of $996 thousand in 2008. Substantially all of our other expense is from interest expense and foreign exchange losses. Interest expense on notes payable was $808 thousand in 2009 compared to $858 thousand in 2008 as we paid down our bank term debt during the year. Our foreign exchange loss in 2009 was $38 thousand compared to a loss of $262 thousand in 2008 as a result of larger foreign exchange rate fluctuations in 2008.
In June 2008, the Company implemented a new European holding company structure in the Netherlands. The restructuring included the transfer of our Dutch operating subsidiary (Optelecom-NKF B.V.) from the U.S. parent company to the new European holding company. Consideration for the transfer included an intercompany note receivable to the U.S. parent and a corresponding note payable from the European holding company. The impact from the fluctuations in foreign exchange on the intercompany note payable is included in other income (expense).
Additionally, there is an impact from the fluctuations in foreign exchange on the €7.3 million Euro-based subordinated note and related accrued interest residing on the U.S. parent company's
books issued to Draka Holding, N.V. as part of the consideration during the acquisition of NKF. Prior to the aforementioned restructuring, the foreign exchange impact was included in comprehensive income (loss) as the note was identified as a hedge against the investment in NKF. As a result of that investment being transferred to the European holding company, the impact from the change in foreign exchange on the Subordinated Note and related accrued interest is now included in other income (expense).
INCOME TAXES
The provision for income taxes in 2009 was a $199 thousand benefit compared to $3.2 million expense in 2008. The lower tax expense in 2009 was attributed primarily to the Company recording a full valuation allowance on our U.S. deferred tax assets in 2008. As a result of the full valuation allowance recorded against the U.S. deferred tax assets, we no longer record income tax benefit related to U.S. operating losses and other U.S. deferred tax assets. Based on the weight of the positive and negative evidence and the information available, management continued to conclude that it is not more likely than not that its U.S. deferred tax assets will be realized and therefore continued to record a full valuation allowance on U.S. deferred tax assets as of December 31, 2009. These deferred tax assets are still available for tax purposes to offset potential U.S. taxable income in the future.
INCOME (LOSS) FROM OPERATIONS
Due to the factors described in Results of Operations, our income from operations in 2008 of $2.5 million declined to a loss from operations of $1.8 million in 2009. Considering the lower impact of the valuation allowance on our U.S. deferred tax assets in 2008 our net loss was $1.8 million in 2008 compared to a net loss of $2.4 million in 2009.
IMPACT OF INFLATION
Inflation did not have a significant effect on the operations of the Company during 2009 or 2008, and we do not expect it to have a significant effect during 2010.
FINANCIAL CONDITION
At December 31, 2009, the Company had cash on hand of $4.2 million, including restricted cash of $1.9 million. The cash is held primarily in our international business with the unrestricted portion totaling $2.3 million impacted by changes in foreign exchange rates. The $1.4 million decrease in cash as compared to December 31, 2008, primarily resulted from our operational loss coupled with the continued payment on debt instruments.
Inventory balances decreased during 2009 as the Company managed purchasing to revised sales forecasts. The following shows the composition of inventory for the past two years:
The total assets of the Company were $41.2 million at December 31, 2009, compared to $47.1 million at December 31, 2008, a decline of 13%. The Company had a decline in cash of $1.4 million, a decline in accounts receivable of $2.1 million, and a decline in inventory of $1.4 million. The reduction in cash is the result of lower cash flows from operating activities in 2009 combined with
payment of principal on loans during the period. The decrease in accounts receivable and inventory are attributable to the reduction in sales levels during 2009 compared to the later part of 2008 coupled with a concerted effort by the Company to decrease general levels of inventory and collect on accounts receivable to improve liquidity.
Total liabilities at year-end 2009 were $21.4 million, a $4.6 million decline from year-end 2008. The decline is primarily driven by a reduction in accounts payable, accrued payroll, taxes payable and debt outstanding. The decline in accounts payable is due to a reduction in purchases of production material associated with the decrease in revenue as well as timing of payments. The reduction in accrued payroll is from the reduction in bonus and commission payments in 2009 as a result of lower revenue over 2008. The decline in taxes payable is a result of tax payments made subsequent to year-end 2008 with limited tax owed in 2009 based on operating losses. The decline in debt outstanding is due to principal payments on senior financing during 2009. In March 2010, we paid in full the senior note of $1.9 million. The subordinated note of $12.8 million is due in March 2011 (see risk factors).
Our stockholders' equity decreased from $21.2 million at December 31, 2008, to $19.8 million at December 31, 2009, a decline of 6%. This decrease is from a net loss of $2.4 million in 2009 offset by an increase in additional paid-in capital of $784 thousand as a result of stock compensation expense and an increase in accumulated other comprehensive income of $235 thousand from unrecognized foreign exchange gain as a result of the Euro and U.S. Dollar exchange rate at the balance sheet date.
LIQUIDITY AND CAPITAL RESOURCES
We have outstanding debt totaling $14.7 million at December 31, 2009. $1.9 million is due within three months of December 31, 2009 and is therefore classified as current. The debt includes a senior term loan with a bank for $1.9 million with a balloon payment on February 28, 2010 and a subordinated note and related deferred interest totaling $12.8 million due in March 2011. We also have a line of credit which expires on February 28, 2010 that has no outstanding balance at December 31, 2009.
On December 14, 2009, we entered into an amended financing agreement with our bank. Pursuant to the Amendment, the bank agreed to extend the term of the line of credit available to the Company until February 28, 2010. In consideration for this extension, we agreed to a reduction in our revolving credit facilities to $500 thousand and also agreed to restrict $1.9 million of cash as collateral for the term loan and revolving credit facilities. The cash collateral is restricted pursuant to a deposit account security agreement.
On March 5, 2010, we entered into an amended and restated subordinated promissory note (the "Note") with Draka Holding N.V. ("Draka"), pursuant to which Draka agreed to extend the term of the Note to March 8, 2011. The current principal amount under the Note is €9.1 million Euros ($12.5 million on March 5, 2010). In consideration of Draka's agreement to extend the term of the Note, we agreed to pay Draka €155 thousand Euros ($222 thousand at December 31, 2009) under the Note and to make quarterly interest payments on the Note at an annual interest rate of 10%. Additionally, we agreed that if we have cash on hand in excess of $2.5 million at the end of any calendar quarter, we will pay such excess cash to Draka as a prepayment on the Note. Our obligations under the Note are secured by the assets of the Company and a pledge of 65% of the shares of Optelecom-NKF Holding B.V., our holding company in The Netherlands. Fair value of the 65% approximates $14.0 million at December 31, 2009. We are permitted under the Note to obtain up to a $750 thousand revolving line of credit that will be senior in priority to the Note and the Company's operating subsidiary in The Netherlands is permitted to obtain up to a $250 thousand revolving line of credit. Immediately prior to the amendment and restatement of the Note, we paid in full the senior term loan and our line of credit facilities were terminated.
Cash on our balance sheet was $4.2 million at year-end, including restricted cash of $1.9 million. This cash is predominately in our European subsidiaries. Approximately €1.0 million Euros ($1.4 million as of December 31, 2009) of the unrestricted cash may be unavailable to support debt requirements and global operations due to cash collateral, legal and tax implications.
The balance of our subordinated debt obligation totals $12.8 million at December 31, 2009. We continue to work through our options for refinancing this debt. In the current credit environment the availability of senior and subordinated financing is constrained. Therefore, we negotiated with the current holder of the subordinated debt to extend the due date to March 2011. The negative performance in recent periods combined with significant tightening of credit markets may make it unlikely that we will be able to finance a portion of or the full amount of debt owed in March 2011. We are not likely to be able to generate sufficient cash to pay the debt in March 2011.
We need to secure additional financing to meet these obligations and are working to secure such financing. However, the current economic environment is marked by limited availability of credit in the business sector and we may be required to pursue refinancing of the debt on less than favorable terms, if we are able to refinance. Further, the current economic environment, as well as concerns regarding future economic conditions, may continue to cause businesses and governments to defer or cancel purchases. If demand for our products continues to decline, it will adversely impact our financial results and negatively impact our ability to secure additional financing. There can be no assurance that additional financing will be available in a timely manner or on acceptable terms if it is available at all. If we are unable to extend or refinance the subordinated debt and default on repayment of the subordinated debt, the holder of the debt would have claims against Optelecom-NKF, Inc. and its subsidiaries. The subordinated note is secured by 65% interest in our European holding company effective March 5, 2010. If we default on repayment of the subordinated debt, this 65% interest in our European holding company would be available to the subordinated debt holder, subject to the rights of the senior debt. Fair value of this 65% approximates $14.0 million at December 31, 2009. Should this collateral prove insufficient to satisfy the obligation then the debt holder may have claims against additional assets of the holding company and the Company. Because cash payment of the subordinated note is unlikely, the debt holder may pursue claims against both the European holding company and the Company.
We plan to finance our future working capital needs with our operating cash flow and use of senior credit on accounts receivable as needed. In the event these sources become insufficient to meet funding needs, the Company may be required to scale back sales and marketing expenses, product research and development costs, and overhead costs. Additionally, the Company would pursue additional debt or equity financing, and/or make dividend payments from its European operations. Dividends from international operations could result in an increased tax liability and tax expense to the Company and such dividends are limited based on cash available from operations and legal restrictions.
As discussed previously, we continue to work toward refinancing our debt obligations which come due in March 2011. However, there is no guarantee that financing will be available for all or part of our outstanding debt. As a result, the Company announced that it has authorized its investment banker, Seale & Associates, to expand its role and conduct a broad evaluation of strategic options.
NEW ACCOUNTING STANDARDS
In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 requires new disclosures and clarifies some existing disclosures regarding fair value measurements. ASU 2010-06 is effective in the first quarter of 2010.
In October 2009, the FASB issued authoritative guidance altering the scope of revenue recognition guidance for software deliverables to exclude items sold that include hardware with software that is
essential to the hardware's functionality. This authoritative guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal periods beginning on or after June 15, 2010. Early adoption is permitted. The Company is still assessing the potential impact of adopting the new authoritative guidance.
In October 2009, the FASB issued authoritative guidance related to the recognition of revenue for multiple-deliverable arrangements. Under the authoritative guidance, revenue may be allocated to the different elements in an arrangement based on relative selling price using the best estimate of selling price if vendor-specific or other third-party evidence of value is not available. This authoritative guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal periods beginning on or after June 15, 2010. Early adoption is permitted. The Company is still assessing the potential impact of adopting the new authoritative guidance.
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, income taxes, financing operations, warranty obligations, and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We consider certain accounting policies related to revenue recognition, impairment of long lived assets, valuation of accounts receivable, inventory, income taxes and foreign currency exchange to be critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Notes to the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.
Revenue Recognition-Revenue from commercial sales is recognized when products are shipped and/or title passes pursuant to the terms of the agreement with the customer, the amount from the customer is fixed, and collectability is reasonably assured. In the ordinary course of business, the Company warrants its products against defect in design, materials, and workmanship over various time periods. Warranty reserve and allowance for product returns is established based upon management's best estimates of amounts necessary to settle future and existing claims on products sold through the balance sheet date. Management evaluates the warranty reserve on at least a quarterly basis.
Impairment of Long Lived Assets-In connection with our acquisition of NKF during 2005, the Company's long-lived assets increased significantly primarily related to acquired goodwill and other intangibles. With respect to acquired goodwill and intangibles with indefinite lives that are not amortized, we are required to perform an impairment test annually. This requires us to make certain difficult, subjective and complex judgments on a number of matters, including assumptions and estimates used to determine the fair value of our reporting units. We measure fair value primarily on the basis of discounted expected future cash flows. Our estimates are based upon our historical experience, our current knowledge from our commercial relationships, and available external
information about future trends. For long-lived assets with definite lives that are subject to amortization, we exercise judgment in assessing whether an event of impairment has occurred by comparing the carrying value of these assets with the expected future cash flows generated by the assets. As of December 31, 2009, no such impairments have occurred.
Allowance for Doubtful Accounts-The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The Company regularly monitors and assesses its risk of not collecting amounts owed by its customers. This evaluation is based upon an analysis of amounts current and past due along with relevant history and facts particular to the customer such as collection history and the results of credit inquiries. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories-Production materials are valued at the lower of cost or market applied on an actual cost basis. Work-in-process and finished goods inventory includes direct labor, materials and overhead and are valued at the lower of cost or market, cost being determined using actual costs on a specific identification basis. The Company writes down its inventory for estimated obsolescence or unmarketable inventory based upon assumptions about future demand and market conditions as well as historical inventory turnover. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Income Taxes-The Company accounts for income taxes in accordance with the FASB's guidance which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. The FASB's guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. We maintain a full valuation allowance on our U.S, deferred tax assets and no valuation allowance on foreign deferred tax assets as we have historically been, and expect to be in the future, profitable in those foreign jurisdictions.
Foreign Currency Effect on Cash Flows-The Company prepares its statement of cash flows in accordance with FASB Accounting Standard Codification 230, "Statement of Cash Flows". As such the Company computes the foreign currency impact on cash flows by first computing the statement of cash flows for its foreign subsidiaries using the functional currency for that subsidiary followed by a translation of these foreign currency cash flows, using the current exchange rate at the time of the cash flows into U.S. dollars. The effect of exchange rate changes on foreign cash balances is reported as a separate item in the reconciliation of the beginning and ending balances of cash and cash equivalents.
Item 6A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Market Risk
Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of financial instruments. We are exposed to financial market risks, primarily related to changes in foreign currency exchange rates. We currently do not have any derivative financial instruments to protect against adverse currency movements. We manage our exposure to market risks related to operations through regular operating and financing activities. All of the potential impacts noted are based on a sensitivity analysis performed as of December 31, 2009. Actual results may differ materially.
Foreign Currency Risk
We are exposed to the fluctuations in foreign currency exchange rates. Such fluctuations impact the recorded values of our investments in foreign subsidiaries in our consolidated balance sheet, and
our foreign currency translation adjustment, a component of other comprehensive income. For the year ended December 31, 2009, a 10% change in the spot exchange rate would have changed our reported currency translation adjustment of $2.8 million by approximately $1.7 million. Additionally, fluctuations result in the remeasuring of non functional currency liabilities at reported balance sheet dates. The impact from the fluctuations in foreign exchange on these liabilities is included in other income (expense).
Interest Rate Risk
At December 31, 2009, we have interest rate risk to the extent that interest rate changes expose our fixed rate long-term debt to changes in fair value. As of December 31, 2009, we had $10.5 million of fixed rate debt. In addition, the Company accrues deferred interest on the fixed rate debt which totals $2.2 million at December 31, 2009. This debt is denominated in Euros and results from our acquisition of NKF in March 2005. During 2009 and 2008, the interest on this debt was 6.0%. We renegotiated the debt in March 2010 to extend the due date to March 2011, and agreed to a fixed interest rate of 10%. There is no further interest rate risk on the senior note as we paid this off in full in March 2010.
Item 7.
Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to the Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Optelecom-NKF, Inc.:
We have audited the accompanying consolidated balance sheet of Optelecom-NKF, Inc. and subsidiaries as of December 31, 2009, and the related consolidated statements of operations and comprehensive income (loss), stockholders' equity, and cash flows for the year ended December 31, 2009. In connection with our audit of the consolidated financial statements, we have also audited financial statement Schedule II for the year ended December 31, 2009. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Optelecom-NKF, Inc. and subsidiaries as of December 31, 2009, and the results of their operations and their cash flows for the year ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for the year ended December 31, 2009, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements and financial statement schedule have been prepared assuming that the Company will continue as a going concern. As discussed in note 13 to the consolidated financial statements, the Company has suffered losses from operations, has substantial debt maturing, and its viability is dependent on the success of its future operations and ability to obtain future financing. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in note 13. The consolidated financial statements and financial statement schedule do not include any adjustments that might result from the outcome of this uncertainty.
/s/ KPMG LLP
McLean, VA
March 30, 2010
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Optelecom-NKF, Inc.
We have audited the accompanying consolidated balance sheet of Optelecom-NKF, Inc. and subsidiaries (the Company) as of December 31, 2008, and the related consolidated statement of operations and comprehensive income (loss), stockholders' equity and cash flows for the year ended December 31, 2008. Our audit of the basic financial statements included the financial schedule listed in the index appearing under Item 8.
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 8A(T). CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed with the objective of providing reasonable assurance that information required to be disclosed in our reports filed under the Securities and Exchange Act of 1934, or the Exchange Act, such as this Annual Report on Form 10-K is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of December 31, 2009, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e). This type of evaluation is performed on a quarterly basis so that conclusions of management, including our Chief Executive Officer and Chief Financial Officer, concerning the effectiveness of the disclosure controls can be reported in our periodic reports on Form 10-Q and Form 10-K. The overall goals of these evaluation activities are to monitor our disclosure controls and to modify them as necessary. We intend to maintain the disclosure controls as dynamic systems that we adjust as circumstances merit. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.
Management's Report on Internal Control over Financial Reporting
Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, and includes those policies and procedures that:
(1)Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(2)Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
(3)Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.
Management has used the framework set forth in the report entitled "Internal Control-Integrated Framework" published by the Committee of Sponsoring Organizations of the Treadway Commission to evaluate the effectiveness of the Company's internal control over financial reporting. Management has concluded that the Company's internal control over financial reporting was effective as of the end of the most recent fiscal year.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.
Changes in Internal Control over Financial Reporting
There has been no change in our internal controls over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Item 8B. OTHER INFORMATION
None.
PART III
Item 9.
Item 9. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Sections entitled "Election of Directors", "Security Ownership of Beneficial Owners, Management, and Directors" and "The Board of Directors and its Committees" and is incorporated herein by reference.
We have adopted a Code of Ethics that applies to all of our directors and employees including, our principal executive officer and principal financial officer and all of our employees performing financial and accounting functions. Our Code of Ethics is posted to our website www.optelecom-nkf.com under the "Corporate Governance" section. We intend to satisfy the disclosure requirement under Item 10
Item 10. EXECUTIVE COMPENSATION
The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Section titled "Executive Compensation" and is incorporated herein by reference.
Item 11.
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Section entitled "Security Ownership of Beneficial Owners, Management and Directors" and is incorporated herein by reference.
Item 12.
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Sections titled "Certain Relationships and Related Transactions" and "The Board of Directors and its Committees" and is incorporated by reference herein.
Item 13.
Item 13. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Section entitled "Independent Public Accountants' Fees" and is incorporated herein by reference.
PART IV
Item 14.
Item 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 30, 2010
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Schedule II
OPTELECOM-NKF, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008