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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999
Commission File Number 0-8828
OPTELECOM, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE
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(State or other jurisdiction of incorporation or organization)
52-1010850
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(IRS employer identification number)
9300 GAITHER ROAD, GAITHERSBURG, MARYLAND 20877
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(Address of principal executive offices)(Zip code)
Registrant's telephone number, including area code: (301) 840-2121.
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock $0.03
Par Value.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
At March 16, 2000, shares of the registrant's Common Stock, $0.03 Par Value,
held by persons other than "affiliates" of the registrant had an aggregate
market value of $29,151,192 based on the average closing bid and asked prices as
reported by the National Association of Securities Dealers Automated Quotation
System for such date.
At March 16, 2000, the registrant had outstanding 2,131,304 shares of Common
Stock, $.03 Par Value.
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I
Item 1. BUSINESS
GENERAL
Optelecom, Inc. (the Company) is a Delaware corporation that was organized in
1972. The Company's business consists primarily of the development,
manufacture, and sale of fiber optic communications products and laser systems
for commercial and military customers and, through it's subsidiary, the Company
provides multi-media integrated products for sending data to the desktop over
copper wire.
The Company is organized into three operating segments: the Communications
Products Division (CPD) which develops, manufactures, and sells optical fiber-
based data communication equipment to the commercial marketplace, the Government
Products Division (GPD) which is primarily focused on electro-optic technology
development for government-related defense business, and Paragon Audio Visual
Ltd. (Paragon) which designs and markets electronic communication products and
systems utilizing copper cabling as the primary transmission medium. Paragon, a
wholly-owned UK subsidiary, was acquired in December 1997.
Fiber optic communication equipment, the main thrust of the Company's sales, is
an area of unprecedented growth and change. Technology development is
constantly and rapidly improving the capability to transmit ever increasing data
rates over even greater distances with fiber-based communication systems.
Most signals, voice, video and data, are in electrical form. The transmission
of electrical signals from one point to another by converting them to optical
(light) signals has many advantages over electrical transmissions. Compared to
copper wire, optical fibers can transmit signals at a much greater data rate
over a greater distance and without disturbance from electrical machinery,
lightning or other noise sources.
The fiber optic communication business has many parts but can be divided
generally into two segments: the optical fiber/cable portion which supplies the
media for transporting optical signals, and the transmission equipment portion
which generates and receives optical signals. A few companies manufacture
optical fiber, while many more manufacture optical fiber cables. Optelecom
provides the equipment that interfaces electrical signals to optical signals at
the transmitter end of a fiber optic communication link and provides
complementary equipment that converts the optical signals to electrical form at
the other end of the communications link. Optelecom sells its equipment to
users of these communication systems or to system integrators that install the
Company's equipment in large communication nets.
There are a large number of communication applications that require different
communication rates, distances and signal formats. Optelecom and its Paragon
subsidiary provide equipment specifically designed for transmission over both
copper wire and optical fiber media of various combinations of voice, data and
video for a range of applications. The Company also addresses U.S. Government
defense related markets for specialized and proprietary applications of fiber
optic and laser system technology which the Company believes makes it unique
among traditional fiber optic communication equipment manufacturers. While
government business can provide an offset to periodic cycles in the commercial
sector, it is also subject to changing world conditions. Therefore, the Company
attempts to balance revenues generated by both types of markets to avoid severe
changes in its business posture. In January 2000, the Company's primary
government contract terminated and the Company is unable to predict future
defense business activity or the related impact on the Company's business.
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The table below displays the Company's three-year revenue and pretax income
(loss) by segment.
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------------------------------------------------------------
Pretax Pretax Pretax
(Loss) Income Income
Operating Segments Revenue Income Revenue (Loss) Revenue (Loss)
<S> <C> <C> <C> <C> <C> <C>
Company $12,636,892 $(495,742) $16,333,749 $(3,130,652) $12,271,057 $1,367,219
Totals
CPD 8,468,936 173,846 $ 8,742,232 $ (237,357) $ 9,734,088 $ 574,789
GPD 971,868 73,729 $ 1,549,730 $ 107,423 $ 2,372,950 $ 806,011
PARAGON AUDIO
VISUAL LIMITED $ 3,196,088 $(743,317) $ 6,041,787 $(3,000,718) $ 164,019 $ (13,581)
</TABLE>
See Note 14 to the financial statements for segment information.
PRODUCTS AND MARKETS
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GPD consists of two operating groups: 1) The Electro/Optics Technology Group
("E/O") that provides technology development and engineering services to the
U.S. Government and its prime contractors. It also investigates techniques for
design and manufacture of specialized sensing coils for fiber optic gyros which
is a unique field and has few competitors; and 2) the Laser Illuminator
Technology Group ("L/I") that derives its revenues entirely from the U.S.
Government and its agencies. During 1998, GPD started a research and
development effort focused on high speed optical components for the commercial
market sector. That effort was terminated in 1999, however, the intellectual
property created in the form of patent applications filed during the research
effort continues to be pursued.
In 1999 the E/O group's activities continued to concentrate on interferometric
fiber optic gyros (IFOGs), which are rotation sensing instruments that are
beginning to replace mechanical and laser gyros in aircraft, missiles, and other
vehicles. Optelecom has used its expertise derived from prior activities to
develop winding technology for IFOG coils and to manufacture these coils in
production. In 1999 continued improvements were to increase production
capacity.
All the revenues generated by the L/I Group are related to its contract with the
U.S. Air Force GLINT program. GLINT is an acronym associated with the U.S. Air
Force's C-130 Gunship laser illuminator system supported by Optelecom. Due to
the nature of the application of this system, contractual revenues are dependent
on government budgets, the worldwide political situation, and specific crew
training schedules. In January 1996 the Company received a $6.5 million, four-
year contract (one base year and three one-year options) to provide services for
refurbishment of equipment for this system. At the end of 1999, the contract was
completed and the facility that supported this contract was vacated and the
personnel were reassigned within the organization.
COMMUNICATION PRODUCTS DIVISION (CPD)
The Communication Products Division addresses business opportunities in the
worldwide commercial communication equipment marketplace, and specializes in
optical fiber technology. Currently, the majority of its revenues are provided
from several niche market areas including original equipment manufacturer (OEM)
equipment for process control, communications systems for highway traffic
monitoring, and advanced air traffic control video monitor displays.
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The CPD segment offers many product solutions to address its customers' needs.
The products are classified into the following categories:
Data Communications Products
Data Communications Products include Fiber Optic RS232, RS422, RS485, T1 and E1
Modems for market applications, including specialty data and timing distribution
modems for the military, aerospace and satellite earth station markets as well
as commercial, industrial, traffic control and surveillance markets. These
products are included in or are compatible with products in our new Series 9000
product line, as discussed in the next paragraph.
CCTV & Broadcast Video (FM), Audio and Data Products
This category includes fiber optic video only, audio only, video and data, audio
and data, and video, audio and data products, which use our traditional FM, PFM
and PCM transmission techniques. Most of these products are included in our
9000 series product line, which began shipping in late 1998, with a full
promotion being launched in March of 1999. Initial product offerings were an
eight-channel video multiplexer, a four-channel video multiplexer with bi-
directional data and/or audio and a new rack mount chassis and power supplies
which provide dense packaging and operate over a wide temperature range. During
1999, additional modules were added which expanded the number of video channels
and a four-channel audio multiplexer. The series also includes a Windows based
Graphical User Interface System Management Software which allows the user to
view the operating status of the whole fiber optic transmission network from a
PC, greatly facilitating maintenance. Markets for these products include video
surveillance, intelligent highways, robotics, process control, military,
distance learning and simulation markets.
High Resolution RGB Video Transmission Products
RGB Video Transmission Products include those used to remote a high-resolution
display, such as a monitor or projector, from the video source. Because of the
high bandwidth and fidelity required to transmit these signals, fiber optics may
be the only means to transmit them farther than a few hundred feet. While
relatively low resolution VGA video, in the 600 x 400 pixel range, may be
transmitted via copper using copper baluns (such as offered by Paragon) up to
distances approaching 1000 feet. The bandwidth required to transmit ultra high
resolution 2048 x 2048 pixel RGB video limits the transmission distance possible
over copper to less than 100 feet. Optelecom is not aware of any other fiber
optic RGB video transmission system that meets the performance requirements for
the SONY 2Kx2K video monitor.
Applications for this technology include air traffic control, military control
rooms, remote conference rooms, financial trading desks and process control.
Compressed Digital Video Products
These products involve the digitization and compression of NTSC and PAL video
signal sources, allowing transmission via T1, E1, or Ethernet, via IP (Internet
Protocol). Currently this product group includes three products. One, the DVS-
100, using motion JPEG compression standards and a second, the Transform 100,
using MPEG-2 compression standards, include a T1/E1 inverse multiplexing network
interface for video, audio and data transmission over one or two telecom
standard T1 or E1 channels. A third, the Transform 200, uses MPEG-2 compression
standards and includes a 10base10/100 interface for transmission using IP.
Applications include remote surveillance, distance learning and video
conferencing.
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PARAGON AUDIO VISUAL, LTD. (Paragon)
Paragon was organized in 1994 and designs and markets electronic products and
systems for multi-media applications utilizing unshielded twisted-pair copper of
"structured" cabling for in-house computer data networking applications. Such
products include baluns (Balanced to Unbalanced) devices that match the
different impedance of traditional coaxial and data networking cables. The use
of active baluns with higher-grade cables and high performance integrated
circuit devices facilitates the transmission of high-resolution video, voice and
data signals without noticeable signal degradation. Paragon has been very
active in supporting networking applications for market data information and
business television services pertaining to financial markets.
Structured cable communications systems and fiber optic communications systems
offer comparable services in some applications and have distinct advantages or
disadvantages in others. For example, the use of baluns with structured cabling
has become common for in-house computer networking applications, while fiber
optic systems afford increased distance and higher bandwidths to information
systems. The Company believes that its acquisition of Paragon will enable it to
participate in and benefit from the development and growth of both technologies
and their joint applications.
Paragon markets a range of advanced product components for the display and
integration of multimedia information at the user's desktop. Not all products
are proprietary to Paragon, and the Company has close relationships with other
product suppliers where appropriate. Together, these products comprise a
complete family of product components that can be flexibly configured to build
complete multimedia information integration solutions to meet customer's
specific requirements.
Paragon is focused primarily (but not exclusively) on the financial systems
marketplace; i.e., financial and commercial organizations that deal on
national/international financial markets trading in a variety of instruments
(e.g. equities, foreign exchange, commodities, money markets, and derivatives).
The Company also markets to non-financial commercial organizations requiring the
integration of business television and video telephony services.
Paragon's products and services are grouped into four major categories:
o Multimedia Integration (Paragon active baluns, multi-function keyboards,
specialized display adapters)
o Business Television Distribution (head-end, switching and distribution
products)
o Video telephony
o Services (consultancy, integration of 3rd party products, configuration,
installation and support)
Paragon is completely independent of any underlying trading room platform
technology, utilized for the distribution of digital market data, and is able to
operate independently of any distribution platform. In 1999, Optelecom began a
design effort to improve existing Paragon products and to develop new equipment
designs, which, if successful, will allow Optelecom to manufacture Paragon
products with the objective of improving Paragon's gross margins.
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SALES AND MARKETING
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GOVERNMENT PRODUCTS DIVISION
The E/O Group markets its services to both Government and commercial customers.
However, for the past five years all of its business has been obtained from
systems based on requirements of the Government, its prime contractors, and
contractors of foreign Governments. Successfully marketing new technology
initiatives directly to Government applications is difficult due to increased
competition from larger companies with far greater resources. As a result of the
utilization of IFOG sensing coil technology developed by Optelecom in 1993 and
the Company's prior experience with the development of fiber coils for high
speed payout, the Company identified the area of optical fiber gyro coil winding
as providing opportunity for new business development. Gyro coils are a defense
related Government program area that the Company sees receiving continued focus
amid shrinking defense spending. Although the customer base is small, the
demand is expected to increase over the next few years. Revenue from
manufacturers of custom optical fiber gyro coils represented the majority of
income for the group in 1999 and is expected to be a major source of income in
2000.
The marketing efforts undertaken in 1999 are expected to provide additional
contracts in 2000 with technology development contracts in the IFOG
manufacturing and other areas.
The sole customer for the L/I Group is the Warner-Robins Air Logistics Support
Center of the U.S. Air Force. Optelecom had maintained a very close working
relationship with the individual component item managers assigned at Warner-
Robins and the operations group at Hurlburt Field, Florida. This relationship
was discontinued at the end of 1999 with the completion of work under the supply
contract.
COMMUNICATION PRODUCTS DIVISION
The Communication Products Division (CPD) sells its products domestically
through direct sales and through select commercial integrators and resellers.
Additionally, CPD has several OEM accounts in different market sectors. Foreign
sales are made through agents and OEM accounts. During 1999, CPD added three
new direct sales personnel and two sales representative firms in territories
within the United States, accomplishing enhanced domestic market coverage.
The sales process for new contracts generally requires a significant investment
in time and money and takes several months. This process involves senior
executives, sales and engineering personnel, and systems integrators. The
collective sales group works together to properly specify and apply highly
technical products in the intelligent transportation control and surveillance
market segment.
PARAGON
Paragon has developed close and mutually productive partnerships with suppliers
of "system component" products, where the partner has strong technical expertise
but very weak routes to market or poorly developed integration skills. These
products include multi-functional keyboard solutions, specialized graphic
display adapters and video conferencing systems.
This business model enables Paragon to deliver a broad portfolio of products,
establishing a single source of cohesive multimedia solutions and integration
services to the financial marketplace. This has enabled Paragon to derive
additional revenue from its existing client base, and also to appeal to new
prospects within the financial marketplace as well as new markets.
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Paragon currently offers technical consulting and various product solutions
consisting of both its own and third party products, which matches the evolving
requirements currently required within the financial marketplace. Paragon's
offerings now range from complex integration of video delivery to the individual
user desk through video distribution technologies to multiple users.
RESEARCH AND DEVELOPMENT
<TABLE>
<CAPTION>
Financial Information Relating to Company
Sponsored Research and Development 1999 1998 1997
<S> <C> <C> <C>
Expenditures on Company sponsored research
and development activities $731,000 $1,309,000 $874,000
</TABLE>
There was a large decrease in spending on Research and Development in 1999
compared to 1998. While the Company continues to fund research for new
products, in 1999 management decided to discontinue work on the high-speed
optical component project that had been started in 1998.
The Company's major effort in the CPD engineering area continues to focus on
compressed digital video development. Another significant engineering effort
within CPD has been directed to the ongoing upgrade and improvement of our
current product line with the introduction of the new 9000 Series at the end of
1998.
Paragon defines all product specifications but currently subcontracts actual
product development and manufacturing. In late 1999, it began to utilize
Optelecom's engineering and manufacturing capabilities to increase Paragon's
competitive advantage in reducing manufacturing costs and improving product
performance. This effort will be expanded in 2000 to incorporate advanced
functionality into existing and new products.
MANUFACTURING PROCESSES
QUALITY ASSURANCE
Beginning in mid-1996, the Company initiated a corporate-wide effort to
implement a Quality Assurance system fully compliant with the requirements of
ISO-9001 (an internationally recognized quality system standard for companies
that design and manufacture products). In June 1996, all operating divisions of
the Company received certification to the standard. In July of 1999, the
Company's certification was re-validated. Paragon outsources all of its
manufacturing to specialized manufacturers and does not maintain manufacturing
facilities. During 1999 Paragon received certification of the ISO-9002
standard, which fits Paragon's non-manufacturing status.
GOVERNMENT PRODUCTS DIVISION
E/O TECHNOLOGY GROUP
In 1991 the Company developed a winding machine to fabricate coils of optical
fiber wound in very specific configurations for fiber gyro systems. Additional
work in this area through 1996 was conducted to develop a winding machine
concept directed toward automated techniques. During 1999 Optelecom invested in
the manufacture of additional winding machinery to meet customer demands.
Currently, four machines are employed in satisfying contract winding production
requirements. The number of companies from which the group obtains raw
materials
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and optical fiber to meet these requirements is limited; however, the Company
does not anticipate any problems with adequate supplies.
LASER ILLUMINATOR TECHNOLOGY GROUP
In 1992 Optelecom established a specialized facility adjacent to its
headquarters to support fabrication and repair operations for the GLINT laser
illuminator system. The processes used to fabricate laser modules for this
system are proprietary to Optelecom and depend on sophisticated understanding of
specific semiconductor processing techniques. Proper use of the equipment and
materials associated with these activities depends on highly skilled personnel
whose technical knowledge is key to the successful fabrication of the final
product. The number of companies from which the group obtains raw materials is
limited, although the materials are considered general items of commerce.
Consequently, the Company does not anticipate any problems with adequate
supplies. At the end of 1999, the Company disbanded this facility since its
primary contract terminated.
COMMUNICATION PRODUCTS DIVISION
The Company performs routine and specialized manufacturing, assembly, and
product testing functions in its corporate headquarters. The Company uses
equipment which automatically assembles components onto printed circuit boards
at high speed, which lowers manufacturing costs and reduces the time-to-market
for new product designs. The Company also maintains a quality assurance
function and testing area that performs optical and electrical testing and
quality control. Raw materials and supplies used in the Company's business
include optical materials, plastic products, and various electronic components,
most of which are available from numerous sources. The number of companies from
which the division can obtain optical emitters and detectors for use in its
circuit assemblies is limited. Although Optelecom has negotiated long-term
supply contracts with some of these vendors and does not anticipate significant
supply problems, certain components are becoming more difficult to obtain as
general demand for all electronic components has been increasing.
PARAGON
Paragon currently subcontracts all product manufacture and it is not the
intention to change this in the short-term. In the medium term, however,
Paragon intends to work closer with Optelecom and to utilize Optelecom's
manufacturing capabilities where practical and possible.
COMPETITION
The Company's products fall within three (3) separate and distinct markets. As
such, the characteristics of competition in these markets differ greatly.
Optelecom's Communication Products Division competes mainly with other companies
of roughly equal size that have similar resources. For low technology products,
such as fiber optic data modems, competition is intense, because these products
have reached a commodity status. In the areas of engineering products for
specific applications, Optelecom competes against companies of the same size or
larger. Competitors with larger research staffs have an advantage in these
markets.
Larger defense prime contractors dominate the market in which the E/O Technology
group competes. These companies have greater marketing, manufacturing,
financial, research, and personnel resources than Optelecom. In addition, as
Department of Defense contracting activity
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has declined, these companies have started to compete in markets which were
primarily addressed by companies with resources similar to Optelecom's. As a
result, the E/O Technology group is at a competitive disadvantage when competing
against prime contractors. Optelecom feels that its IFOG coil winding technology
is at least equal to the technology developed by much larger prime contractors
and in this market, can compete equally. The L/I Group is a sole-source provider
of the products it supplies to the U.S. Air Force. The services it provides are
relevant only to its current contract with the U.S. Air Force that expired at
the end of 1999.
Paragon competes primarily with both large and similar sized companies that have
similar products and addresses worldwide markets in financial market data
information and business television services. These markets have numerous
suppliers who compete with Paragon. However Paragon's strategy of providing its
customers with superior products and support services has enabled it to achieve
a pre-eminent position in the financial data information market.
SEASONALITY
The Company's products are based on communications equipment technology. As
such, seasonality does not materially affect the Company's revenues.
PATENTS
The Company holds certain patents. However, its business as a whole is not
materially dependent upon its ownership of any one patent or group of patents.
The Company does not license any patents from other parties, nor is it aware of
any restrictions on its current backlog business imposed by patents of other
parties.
BACKLOG
At the end of 1999 the backlog for each segment was as follows: Communications
Products Division $811,000, Paragon Audio Visual $35,000 and Government Products
Division $135,000.
EMPLOYEES
At December 31, 1999, the Company had a total of 68 full-time employees
worldwide, including 19 in research, development and engineering, 16 in sales,
marketing and service, 22 in manufacturing and 11 in general management,
administration and finance. The number of employees by operating segment is as
follows: Communication Products Division - 54; Paragon Audio Visual -12;
Government Products Division - 2. The Company intends to hire additional
personnel during the next 12 months in all areas except general management,
administration and finance. The Company's future success will depend in part on
its ability to attract, train, retain and motivate highly qualified employees,
who are in great demand. There can be no assurance that the Company will be
successful in attracting and retaining such personnel. The Company's employees
are not represented by any collective bargaining organization and its employee
relations are good.
RISK FACTORS
The statements contained in this report on Form 10-K that are not purely
historical are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 and Section 21E of the Securities
Exchange Act of 1934, including, without limitations,
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statements regarding the Company's expectations, hopes, beliefs, anticipations,
commitments, intentions and strategies regarding the future. Forward-looking
statements include, but are not limited to, statements contained in "Item 1.
Business," and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" regarding the Company's business and
strategies, product markets, sales, marketing, customer support and service,
research and development, manufacturing, competition, backlog, employees,
financial performance, revenue and expense levels in the future and the
sufficiency of its existing assets to fund future operations and capital
spending needs in Business regarding the Company's products and its strategy.
Actual results could differ from those projected in any forward-looking
statements for the reasons, among others, detailed under "Risk Factors" in this
Report on Form 10-K. The fact that some of the risk factors may be the same or
similar to the Company's past filings means only that the risks are present in
multiple periods. The Company believes that many of the risks detailed here are
part of doing business in the industry in which the Company competes and will
likely be present in all periods reported. The fact that certain risks are
endemic to the industry does not lessen the significance of the risk. The
forward-looking statements are made as of the date of this Form 10-K and the
Company assumes no obligation to update the forward-looking statements, or to
update the reasons why actual results could differ from those projected in the
forward-looking statements.
FLUCTUATIONS IN FINANCIAL PERFORMANCE
The Company has experienced and may in the future continue to experience
fluctuations in its quarterly and annual operating results. Factors that may
cause the Company's operating results to vary include, among other things,
customer purchasing patterns, changing technology, new product transitions,
delays in new product introductions, shortages of system components, changes in
the mix of products and services sold, the timing of investments in additional
personnel, facilities and research and development. As a result of the impact
of these and other factors, past financial performance should not be considered
to be a reliable indicator of the future performance in any particular fiscal
period. The Company is limited in its ability to reduce expenses quickly in
response to any revenue shortfalls, therefore the Company's business, financial
condition and operating results would be adversely affected if increased
revenues were not achieved. For example, the Communications Products Division
had revenues of $8,468,936 for the twelve months ended December 31, 1999
compared to $8,742,232 for the same period in 1998, but an operating gain of
$173,846 in 1999 compared to operating loss of $237,357 for the same period in
1998. The change in operating profits resulted in part because the Division
lowered its product development expenses and reduced its selling and marketing
costs as a result of fewer personnel in these departments. Total revenues
increased to $16,333,749 for the twelve months ended December 31, 1998 compared
to $12,271,057 for the same period in 1997. The increase was attributable in
large part to the acquisition of Paragon Audio Visual Limited ("Paragon") in
December, 1997; Paragon's revenues of $6,041,787 were included with those of
the Company for the twelve months ended December 31, 1998 but not for the same
period in 1997. The Company's results of operations were a net loss of
$2,811,344 for the twelve months ended December 31,1998 compared to net income
of $948,729 for the same period in 1997. The major factors contributing to the
loss in 1998 included: acquisition expenses of Paragon of $2,200,000 (valuation
write-down of $1.4 million, amortization expense of goodwill and intangibles in
the amount of $465,000 and interest expense of $335,000), an increase of
inventory and accounts receivables reserves of $543,000, employee termination
related charges of $620,000 and a change in product mix as revenues shifted from
Glint to Paragon. The Company has taken significant steps to reduce its
expenses, but there can be no assurance that the Company will return to
profitability in any future period.
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DEPENDENCE ON MAJOR CUSTOMERS
Historically, a relatively small number of customers have accounted for a
significant portion of the Company's revenues in any particular period. For the
twelve months ended December 31, 1999 approximately 22% of the Company's
revenues were accounted for by sales to the U.S. Government and two commercial
customers. The Company anticipates that sales of its products to relatively few
customers will diminish in magnitude over the next few years. In the event of a
reduction, delay or cancellation of orders from one or more significant
customers or if one or more significant customers select products from one of
the Company's competitors for inclusion in future product generations, the
Company's business, financial condition and operating results could be
materially and adversely affected. There can be no assurance that the Company's
current customers will continue to place orders with the Company, that orders by
existing customers will continue at current or historical levels or that the
Company will be able to obtain orders from new customers. The loss of one or
more of the Company's current significant customers could materially and
adversely affect the Company's business, financial condition and operating
results.
One contract with the U.S. Air Force accounted for 5% of the Company's revenues
and contributed $240,000 in operating income. The contract with the U. S. Air
Force expired on January 15, 2000, and the U.S. Air Force declined to extend the
contract due to availability of new technology from other sources. By December
31, 1999, the Company had delivered all units to the U. S. Air Force and had
completed all tasks associated with the contract.
RISK OF GOVERNMENT AUDIT
Government contracts are subject to audits, and contract payments in excess of
allowable costs are subject to adjustment and repayment. Audits have been
completed through 1996. Based on its interpretation of contracting regulations
and past experience, the Company believes that cost disallowances, if any, on
Government contracts will not be material, but there can be no assurance in that
regard.
TECHNOLOGICAL CHANGE
The Company's communication products are sold in markets that are subject to
rapid technological change. The Company's future success will depend in part
upon its ability to enhance its current products and to develop and introduce
new products that keep pace with technological developments and emerging
industry standards and that address the increasingly sophisticated needs of its
customers. There can be no assurance that the Company will be successful in
developing and marketing such products or producing enhancements that meet these
changing demands, that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of these
products or that its new products and product enhancements will adequately meet
the demands of the marketplace and achieve market acceptance. The Company's
inability to develop and introduce new products or product enhancements in a
timely manner, or its failure to achieve market acceptance of a new product
could have a material adverse effect on the Company.
COMPETITION
The Company faces intense and increasing competition from a large number of
competitors, some of which are larger than the Company and have larger product
development, research and sales staffs. To enhance the technological innovation
of its products, the Company has recently increased the size of its engineering
and development staff. There can be no assurance, however, that the Company's
competitors will not develop products that are more effective than the Company's
or that would render the Company's products obsolete or non-competitive.
11
<PAGE>
Furthermore, the Company's ability to expand commercial sales of its products is
dependent in part upon its becoming more competitive with respect to
manufacturing efficiency and marketing capabilities. The Company has recently
increased its investment in manufacturing facilities and the size of its sales
and production staffs for communication products. There can be no assurance,
however, that these additions will provide the efficiencies and experience
necessary for an expansion of sales.
PARAGON OPERATIONS
Paragon Audio Visual Ltd. ("Paragon") was acquired in December 1997. The
integration did not go smoothly and a great amount of time and resources were
expended in 1998 and 1999 to fully integrate Paragon within Optelecom. Paragon
suffered losses in 1999 and 1998 of $743,317 and $3,000,718 respectively. At
the end of 1998, the Chairman of Paragon was terminated, and in March of 1999
the remaining Paragon Directors were also terminated. In the fourth quarter of
1999, Paragon recorded costs of $150,000 associated with settling legal actions
with the former directors (see Legal Proceedings.) A new management team was
put into place in the second quarter of 1999 and they made significant
reductions in expenses including the closing of the New York City office,
termination of employees, the elimination of most company vehicles and the
elimination of non-essential travel and entertainment costs. Paragon expects to
return to profitability in 2000 by increasing its revenue while maintaining its
current cost structure. However, there can be no assurance that profitability
will, in fact, be achieved.
With the acquisition of Paragon, the Company expects to expand its presence in
international markets and may in the future derive an even more significant
portion of its revenues from these markets. The Company's current and future
international business activities are subject to a variety of potential risks,
including political, regulatory and trade and economic policy risks. The
Company will also be subject to the risk attendant to translations in foreign
currencies. These factors could have a material adverse effect on the Company.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING
The Company believes that its existing capital resources and future operating
cash flows will generate the funds needed for its long-term cash requirements.
If the Company's growth rate should exceed expectations, or if the Company
should fail to generate the anticipated operating cash flows, the Company would
be required to seek additional funding. In those circumstances, the Company
would consider public or private debt or 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 may result. If adequate funds are not
available when needed, the Company may be required to delay, scale back or
eliminate its product research and development and overhead costs.
NEED TO ATTRACT AND RETAIN KEY EMPLOYEES
The Company is substantially dependent on the business and technical expertise
of its senior management and on its ability to attract and retain key management
and technical employees. The loss of members of senior management or of other
key employees or the Company's inability to attract and retain other employees
with necessary business or technical skills in the future would have a material
adverse effect on the Company's business.
12
<PAGE>
YEAR 2000 POTENTIAL ISSUES
Optelecom engaged in a comprehensive program to upgrade its information,
technology, manufacturing and financial software to properly recognize the Year
2000. Based on this program, the Company purchased and installed hardware and
software upgrades to its existing systems that are Year 2000 compliant including
new telephone hardware, new computer hardware as well as upgraded manufacturing
and financial software. Also, Optelecom analyzed all of its product offerings
for any Year 2000 issues. None were discovered. In addition, product
development was reviewed and modifications, if needed, were made to make all
future products Year 2000 compliant.
Optelecom also demanded and received assurance from all of its vendors and
suppliers that any products purchased by Optelecom were Year 2000 compliant.
This included raw materials as well as services. All products and services were
tested and determined to be Year 2000 compliant.
During 1999, Optelecom spent approximately $200,000 on hardware, software and
labor costs to bring all of its systems and products in Year 2000 compliance.
Also included in these costs were training and external resources needed to
implement any new software purchased.
Optelecom determined that there was no material adverse effect of the Year 2000
transition on any of its operations, including Paragon. The Company believes
that, while it continues to monitor and review its purchases, products and
systems, there are no material risks or exposures to its operations in
connection with the Year 2000 issue.
PRICE VOLATILITY IN PUBLIC MARKET
The Company's Common Stock currently trades on the NASDAQ SmallCap Market. The
securities markets have from time-to-time experienced significant price and
volume fluctuations that may be unrelated to the operating performance of the
Company. In addition, the market prices of the common stock of many publicly
traded technology companies have in the past been, and can in the future be
expected to be, especially volatile. Announcements of technological innovations
or new products of the Company or its competitors, developments or disputes
concerning proprietary rights, publicity regarding products under development by
the Company or its 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 the Company's operating and product
development results, may have a significant impact on the market price of the
Company's Common Stock.
ABSENCE OF DIVIDENDS; DILUTION
The Company has not paid any cash dividends since its inception and does not
intend to pay any cash dividends in the foreseeable future. Dilution will occur
upon the exercise of outstanding stock options of the Company and may occur upon
future equity financing of the Company that could be required to fund
operations.
CONTRACT RENEGOTIATION AND TERMINATION
None of the Company's current contracts are subject to price re-negotiation.
However, the Company's contracts with the U.S. Government are always subject to
termination, which is a standard clause in any contract with the Government.
The Company's primary government contract terminated in January 2000.
13
<PAGE>
Item 2. PROPERTIES
The Company began the year with three separate facilities in Gaithersburg,
Maryland. During 1999, two of these facilities were closed: one in June and one
in December. The assets and personnel were moved to the main facility at 9300
Gaither Road, Gaithersburg, Maryland, located near Washington, DC. This
facility has 21,000 square feet of space and a monthly rent of $18,120. The
lease expires on August 31, 2002. The facility is in good repair and is
adequate for Optelecom's current requirements. Paragon rents facilities in
Beedon and London, England, and they consist of approximately 3,300 square feet
of office space. In the fourth quarter of 1999, Paragon sublet one-third of its
Beedon space. Current monthly rent is approximately $3,500. These leases
expire in March 2001, are all in good repair, and are adequate for current
requirements.
Item 3. LEGAL PROCEEDINGS
David Brown, formerly Chairman and Managing Director of Paragon Audio Visual
Ltd., lodged an Originating Application in March 1999 with the Employment
Tribunal of the United Kingdom in Reading, England. Mr. Brown alleged that
Paragon dismissed Mr. Brown unlawfully and in breach of his alleged employment
contract rights. Mr. Brown's three sons, who also worked for Paragon, filed for
the same reasons and all actions were combined into one. In the fourth quarter
of 1999, an agreement was reached whereby all matters before the Employment
Tribunal were settled.
On November 10, 1999 Optelecom filed a complaint for injunctive relief and
damages against the Browns alleging, among other actions, Breach of Contract,
Breach of Duty and Interference with Contractual Relations. The court issued a
Temporary Restraining Order against the Browns forbidding them, among other
things, from competing against Optelecom or Paragon, soliciting business from
any customer of Paragon and using any of Paragon's confidential technology. An
agreement in principal to settle these charges was reached on November 22, 1999
whereby the Browns agreed to cease trading using the name Paragon or any
confusingly similar names, logos or descriptions of business operations. Also,
the Browns returned the 162,672 shares of Optelecom common stock issued to them
as part of the purchase of Paragon by Optelecom in December of 1997. A
definitive settlement of all of these charges was finalized in January 2000.
From time to time, the Company is involved in legal proceedings and litigation
arising in the ordinary course of business. As of the date of this report,
except as described above, the Company is not a party to any litigation or other
legal proceeding that, in the opinion of management, could have a material
adverse effect on the Company's business, financial condition or results of
operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Two items were submitted to a vote of security holders at the Company's Annual
Meeting held October 13, 1999. (Reference is made to the Company's Proxy
Statement filed September 15, 1999). A total of 1,931,153 shares were voted as
follows:
Item One Election of Directors
Director One For 1,563,200 Authority withheld 367,953
Director Two For 1,853,895 Authority withheld 77,258
Item Two Stockholder Proposal
For 380,811 Against 750,838 Abstain 34,424
14
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, $0.03 par value (Common Stock) is traded in the
over-the-counter market. Set forth below are the highest and lowest closing bid
prices for the Common Stock as reported by the National Association of
Securities Dealers Automated Quotation Service (NASDAQ) during each quarter for
the two years ended December 31, 1999 and 1998, respectively. Such quotations
do not necessarily reflect actual transactions.
<TABLE>
<CAPTION>
Bid Price
-----------------------------
Quarter Ended High Low
- ------------- ------ -------
<S> <C> <C>
December 31, 1999 6 1/2 - 1 5/8
September 30, 1999 3 1/16 - 1 3/4
June 30, 1999 3 1/2 - 2 1/4
March 31, 1999 3 3/4 - 2 5/16
December 31, 1998 5 13/16 - 2 3/8
September 30, 1998 10 7/16 - 6
June 30, 1998 11 1/2 - 6 1/8
March 31, 1998 10 1/8 - 6 1/2
</TABLE>
There are approximately 663 record-holders of the Common Stock as of March 16,
2000.
The Company has not declared any cash dividends to date and does not expect to
do so in the foreseeable future.
Item 6. SELECTED FINANCIAL DATA
Set forth below is selected financial data for the Company's most recent five
fiscal years.
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997 1996 1995
-------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Revenue $12,636,692 $16,333,749 $12,271,057 $8,910,263 $6,430,136
Net (Loss) Income $ (211,359) $(2,811,344) $ 948,729 $ 722,081 $ (208,384)
Basic (Loss) Earnings per Common Share $ (0.10) $ (1.34) $ 0.51 $ 0.41 $ (0.12)
Diluted (Loss) Earnings per Share $ (0.10) $ (1.34) $ 0.48 $ 0.39 $ (0.12)
Total Assets $ 8,615,614 $ 8,631,948 $12,209,741 $4,466,463 $3,674,004
Long-Term Obligations $ 1,380,575 $ 1,726,672 $ 2,291,668 $ 11,607 $ 46,426
Stockholders' Equity $ 2,896,620 $ 3,290,632 $ 5,799,819 $3,041,631 $2,188,777
Cash Dividends Declared per Common Share $ .00 $ .00 $ .00 $ .00 $ .00
</TABLE>
15
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
The Company's key components of its financial condition are made up of accounts
receivable, inventory, fixed assets, accounts payable and debt. From 1998 to
1999, there was a decrease in the Company's Net Worth to $2,896,620 from
$3,290,632 in 1998 and $5,799,819 in 1997. Optelecom's current ratio has also
decreased to 1.18 in 1999 compared to 1.34 in 1998 and 1.62 in 1997. This
decrease is attributed to the increase in debt and accounts payable and a
decrease in cash offset by an increase in accounts receivable.
Accounts receivable increased this year to $2,228,726 from $1,426,306 at
December 31, 1998. This increase resulted from the long-term nature of the
receivable on the large shipment made to Korea in October 1999. All funds for
this shipment have subsequently been collected. The Allowance for Doubtful
accounts decreased as a result of some receivables being written off by
Optelecom and its Paragon unit. Also, because of the Company's aggressive
accounts collection program and careful screening process for any new accounts,
the Company has been able to significantly reduce problem accounts and the need
for additional expenses in the allowance. This aggressive approach will continue
and all accounts receivable will be reviewed on an ongoing basis.
The make-up of the inventory accounts changed slightly in 1999 with the
Company's decision to reduce its reliance on keeping items in Work in Process
and make products for stock. The following chart shows the composition of
inventory for the past three years, with Paragon inventory included in finished
goods:
<TABLE>
<CAPTION>
Inventory Composition 1999 1998 1997
<S> <C> <C> <C>
Production Materials (net of allowance) $ 416,199 $ 407,022 $ 499,084
Work In Process 280,680 381,659 455,648
Finished Goods 1,197,276 1,058,432 798,141
---------- ---------- ----------
TOTAL $1,894,155 $1,847,113 $1,752,873
</TABLE>
The increase in Finished Goods reflects growth in CPD inventory and the addition
of the Paragon inventory. Although the Company's objective is to reduce
inventory levels as much as possible, the value of finished goods inventory
increased in 1999 to provide products available from stock. This action was
taken to meet competitive pressures, as customers are demanding shorter product
delivery times. Production Material Inventory remained at a similar level to
1998. However, this category's composition has changed to stock more items for
products ordered routinely to continue to meet customers' demand for product
delivery time. The Company believes that its reserve for inventory obsolescence
is adequate to properly value any excess quantities of this inventory.
In 1999, fixed asset additions, including capital leases, were $455,721 compared
to $505,616 in 1998 and $701,529 in 1997, excluding the Paragon acquisition.
16
<PAGE>
RESULTS OF OPERATIONS
1999 versus 1998
- ----------------
Revenue on a consolidated basis was lower by $3.7 million or 23% in 1999
compared to 1998 and is primarily attributed to the lower sales of the Company's
Paragon unit, where sales fell $2.85 million. This decline in revenues is a
result of a lack of significant sales from their major customer from 1998 due to
the customers changing equipment needs as well as a resistance from potential
customers to placing orders in the fourth quarter prior to the Year 2000. Also,
revenue from the Glint contract was curtailed during the year in anticipation of
contract completion at December 31, 1999. Optelecom's net loss of $211,359 or
$(0.10) per share was 93% lower than the $2.8 million or $(1.34) per share loss
recorded in 1998. The lower loss reflects the attention management paid to cost
containment especially at Paragon where non-essential expenses established in
conjunction with the original purchase were eliminated. 1998's loss included a
$1.46 million write off of intangibles related to employment commitments by the
former Paragon shareholders. Additionally, the company had lower selling and
marketing costs as a result of personnel changes made during the year. The
Company had a full complement of sales personnel at December 31, 1999, and
believes it is structured properly for revenue growth in 2000.
Outside funding was not obtained for the high-speed optical components project
and management discontinued work on this project in the second quarter of 1999
with fewer funds being spent on the project in 1999. The Company continues to
expend funds on research and development of other new products.
General and administrative costs were also reduced significantly in 1999,
further evidence that the Company's cost containment program was successful. It
is expected that the current level of expenditures in these categories will
continue into 2000 to properly support the Company's efforts.
These cost reduction activities were offset by the approximately $150,000 spent
on legal expense and related costs associated with the settlement of a lawsuit
with former principals of its Paragon subsidiary (see Legal Proceedings.) Also,
in connection with the closing and consolidation of its facilities during 1999,
the Company recorded approximately $150,000 in charges against earnings.
Optelecom believes it now has facilities appropriate for its current level of
operations.
The Glint contract ended January 15, 2000, but the Company had performed all of
its requirements under the contract by December 31, 1999. Revenues and profits
from this contract were materially lower in 1999 than in 1998.
Optelecom had an income tax benefit as a result of the losses from 1998 and 1999
being carried back to profits from prior years.
1998 versus 1997
- ----------------
Consolidated sales in 1998 were $16.3 million, which represents an increase over
1997 sales of $4.06 million or 33%. The increase in sales in 1998 is directly
related to Optelecom's acquisition of Paragon whose sales contributed $6.04
million in 1998. Although the company achieved record revenues in 1998, the
operating results were significantly lower than expectations. The Company
recorded a net loss of $2.81 million or $(1.34) per share in 1998 compared to a
profit of $949,000 or $0.48 per share in 1997. These losses were attributed to
various factors with the most significant factor the costs incurred related to
the acquisition of Paragon. Paragon had a loss of $3,000,718 during 1998.
17
<PAGE>
In total, the Company recorded losses before income tax benefit aggregating $3.4
million relating to the acquisition of Paragon, which includes the write off of
$1.4 million in intangibles related to employment commitments by the former
Paragon shareholders. In the beginning of 1999, the Company replaced the former
owners with a new management team.
The Company made a significant investment in its research and development
efforts. The most significant investment was the allocation of $426,000 to a
new research effort related to the development of high-speed optical components.
The Company is committed to invest in this project until the middle of 1999, by
which time it intends to seek outside funding to continue with the product
development efforts. There can be no assurance that the Company will be
successful in securing outside funding.
Additional valuation reserves aggregating $543,000 were recorded in 1998 to
write-down inventory and accounts receivables. They were recorded to account
for obsolescence of some products and for failure to collect a portion of
current accounts receivable.
Another factor contributing to the downturn in profits from 1997 was lower sales
from the GLINT program and lower sales in the CPD segment. The GLINT contract
is slowly winding down and, as such, revenues are expected to decline. The
Company expects that revenues from the GLINT contract will terminate after 1999.
CPD sales were down as a result of a lack of new large contract sales in 1998
compared to 1997 and the delay in the introduction of a new product, the 9000
series.
Operating Segments
Optelecom's products and services are categorized into three operating segments:
Communications Products, Government Products and Paragon Products. The
financial results for the three operating segments have been prepared on a basis
that is consistent with the manner in which Optelecom management internally
evaluates financial information for the purpose of assisting in making internal
operating decisions. In this regard, certain common expenses have been
allocated among segments differently than would be required for stand alone
financial information prepared in accordance with generally accepted accounting
principles.
COMMUNICATION PRODUCTS DIVISION
<TABLE>
<CAPTION>
1999 % 1998 % 1997 %
<S> <C> <C> <C> <C> <C> <C>
Net sales $8,468,936 100.0 $8,742,232 100.0 $9,734,087 100.0
Gross profit 3,179,437 37.5 4,039,724 46.2 4,387,639 45.1
Total operating expense 3,005,591 35.5 4,277,081 48.9 3,812,850 39.2
Operating (loss) income 173,846 2.0 (237,357) (2.7) 574,789 5.9
</TABLE>
1999 sales for the CPD group were down 3% from 1998 to $8.5 million from $8.7
million. Included in the sales for 1999 was a $1.2 million shipment to Korea
during the fourth quarter. Sales volume was down also as a result of
competitive pressures. The gross profit for 1999, $3.2 million or 37.5% of
sales is down materially from the $4.0 million or 46.2% in 1998 and is also a
result of competitive pressures as well as a lower than average gross margin on
the Korean order. Margins on products are expected to be more in line with
historical figures such as 1998.
Operating expenses were $3.0 million in 1999, a reduction of over $1.2 million
from 1998 reflecting management's cost containment efforts. Selling and
marketing costs were down from 1998 due to fewer sales personnel for most of the
year and due to more focused marketing efforts. Engineering costs were down as
work on the high speed optical components project was
18
<PAGE>
discontinued and research and development efforts were focused on digital video
products as well as enhancements and improvements to Paragon's line of products.
In 1998, the CPD group underwent significant changes. Key members of management
were replaced as the group regained its focus on its core competencies.
Expansion efforts in 1997 severely impeded the organization, as revenue growth
expectations did not materialize. The Company implemented cost reductions in
1998 and recorded approximately $300,000 related to legal costs associated with
employee terminations.
Sales in the CPD segment for 1998 were down almost $1 million compared to 1997.
The decline in sales was partly due to a delay in the introduction of the 9000
product series. Additionally, significant changes in the sales organization
during 1998 had a negative impact on sales expectations. Two large contracts in
1997 resulted in a significant growth from the previous year. However, these
contracts did not repeat in 1998. Gross profits declined by $348,000 due to the
reduction in sales levels from 1997. The gross profit margin was 46% in 1998
compared with 45% in 1997. Operating expenses increased by $464,000 or 12.0%
primarily due to increases in engineering and general and administrative costs.
Engineering increased by $235,000 to reflect additional resources added to the
engineering group. General and administrative costs increased as a result of
termination charges related to employee terminations.
GOVERNMENT PRODUCTS DIVISION
<TABLE>
<CAPTION>
1999 % 1998 % 1997 %
<S> <C> <C> <C> <C> <C> <C>
Net sales $971,867 100.0 $1,549,731 100.0 $2,372,950 100.0
Gross profit 437,415 45.0 875,628 56.5 1,371,284 57.8
Total operating expense 363,686 37.4 768,205 49.6 565,273 23.8
Operating income 73,729 7.6 107,473 6.9 806,011 34.0
</TABLE>
The 37% decline in revenues to $971,867 in 1999 from $1.55 million in 1998 is
primarily attributed to an approximately $400,000 drop in revenue from the Glint
contract. The Company completed all of its requirements under the contract by
December 31, 1999 and the lower revenue reflects the winding down of the
contract through the year. The E/O group had a decline of $175,000 in its
revenue, a result of lower revenues to government sub-contractors. The gross
profit margin decline is a reflection of the lower Glint revenue. The gross
profit margin % decline to 45% from 56.5% is indicative of the effect fixed
costs had compared to the revenue levels. E/O had additional costs as the
result of a facility move during the year. E/O remains the revenue base of this
group and has retained capacity and efficiencies despite the move.
Sales decreased by $823,000 in 1998 compared with 1997. The decline in sales
was related to lower revenue on the GLINT contract ($585,000) and a reduction in
sales in the Electro/Optics group related to DARPA and Honeywell Systems
($239,000). The decline in revenue is expected to continue in 1999 as the GLINT
contract requirements are completed. Gross profit declined by $495,000 in 1998
due to the decline in sales. The gross profit margin remained unchanged at 56%
in 1998 and in 1997. Operating expenses increased by $203,000 as a result of a
$426,000 investment in new research and development efforts and was offset by
declines in allocated administrative charges.
19
<PAGE>
PARAGON AUDIO VISUAL LIMITED
Paragon was acquired in December 1997. Accordingly, 1998 was the first year of
its operations within Optelecom. The components of Paragon's losses for 1999 and
1998 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
--------------- ---------------
<S> <C> <C>
Revenues $ 3,196,087 $ 6,041,784
Gross margins 671,666 1,545,596
Operating expenses 955,124 2,560,776
Operating (loss) (283,458) (1,015,180)
Other Paragon related expenses
Amortization of other intangibles 350,974 427,678
Amortization of goodwill 28,765 38,222
Acquisition interest 183,126 233,207
License fee 175,000 175,000
Write down of intangible assets related to employment
commitments - 1,462,500
Interest expense of working capital loan 76,994 61,206
--------------------------------------
(Loss) before taxes $(1,098,317) $(3,412,993)
</TABLE>
Paragon's 1999 revenue of $3.2 million was 47% lower than the revenue recorded
in 1998 of $6.0 million, and can be traced to two factors: first, the effect the
termination of all of the prior Directors of Paragon and the resulting legal
issues causing its customers to buy from competitors; and second, England and
Europe encountered tremendous reluctance from customers, particularly in the
finance and banking sectors, to purchase new equipment due to the Year 2000
issue. This is reflected in the revenue level in the fourth quarter of 1999 of
approximately $400,000. This concern may continue into 2000 but Paragon expects
their customers to have completed their analysis of the effects of the Year 2000
issue early in the first quarter, and for the level of orders to begin to
increase at that time.
The gross margin % decreased slightly to 21% from 25.6% in 1998 and is due to
increased costs of the new products introduced in 1999. Paragon expects to see
margins increase as the new products are placed into production and as
Optelecom's CPD unit engineers and manufactures more of these products.
The operating expenses were significantly lowered in 1999 to $955,124 from $2.56
million in 1998. Salary costs are down as a result of the termination of the
prior Directors of Paragon, the elimination of the New York City office, and
other reductions in staff, properly sizing Paragon for its revenue levels.
Also, they eliminated most of the company cars and other non-essential expenses
incurred from the acquisition. Paragon also reduced travel cost to the US and
Asia and eliminated all non-essential entertainment costs. Paragon has taken
steps to keep these and other administrative costs in line with revenues, and
they expect to return to profitability during 2000.
Revenues for 1998 represented increased sales in Paragon's products in its
traditional market. Paragon sold minimal Optelecom fiber products, as there
were product certification and market issues that delayed the selling efforts.
The gross margin was 26%. This rate reflects the fact that Paragon subcontracts
its product design and manufacturing. Significant improvements in gross margins
are expected to be realized once Paragon products are developed and manufactured
by the Company. Operating expenses increased at a much higher rate than
expected. The number of employees doubled in 1998 from 1997 and facilities
increased both by expanding the
20
<PAGE>
headquarters and opening a sales office in London and New York City. Significant
reserves were recorded for accounts receivable and inventory. Paragon previously
had not recorded provisions for bad debts or inventory obsolescence.
OTHER OPERATING EXPENSES
Corporate
Income tax (benefit) expense was $(284,383) in 1999, $(319,308) in 1998 and
$418,490 in 1997. The effective tax rate was (57.4)% in 1999, (10.2)% in 1998
and 30.6% in 1997. The 1999 effective tax rate was as a result of the net
operating loss and stock transactions during the year. The effective tax rate
in 1997 is positively influenced by increased overseas sales, since certain tax
advantages can be realized through our Foreign Sales Corporation (FSC).
Interest expense was $309,885 in 1999 compared to $334,749 for 1998 and $19,653
in 1997. Interest expense for 1999 decreased as a result of principal payments
on the outstanding debt offset by the increased level of borrowing on the line-
of-credit and higher interest rates during the year. In 1999 the average
borrowing under the line of credit was $1,200,000 compared to an average of
$950,000 for 1998. The interest rate averaged 8.90% in 1999 and 8.77% in 1998.
Impact of Inflation
Inflation has not had any significant effect on the operations of the Company
during 1999, and we do not expect it to have any significant effect during 1999.
LIQUIDITY AND CAPITAL RESOURCES
In 1999, Optelecom financed its operations through cash generated from financing
activities, primarily borrowings on its bank line-of-credit. The Company
borrowed $1,200,000 on its line-of-credit during 1999 to bring the balance to
$1,700,000, the maximum borrowing available under its line-of-credit agreement.
The balance at December 31, 1998 was $650,000. Cash used in operating activities
in 1999 was $700,094 compared to cash provided by operating activities of
$519,160 in 1998. 1999 showed an increase in accounts receivable of $802,420
reflecting the large receivable from the Korean shipment outstanding at December
31, 1999, compared to a net decrease, or collections, in 1998 of $1,676,598.
Non-cash items such as depreciation and amortization, remained basically
constant at $845,394 compared to $872,165 in 1998. Cash used in investing in
1999 was $249,117 compared to $502,644 in 1998 and reflects a decrease in
capital expenditures to $312,117 in 1999 from $505,616 in 1998. One area where
1999 was materially lower than in 1998 was in cash from proceeds from the
exercise of stock options. In 1999, there were no stock options exercised while
in 1998 the Company received $296,124 from the exercising of stock options.
The Company has the ability, provided there are sufficient accounts receivable
and inventory, to borrow up to $1,700,000 under its existing bank line-of-credit
as of December 31, 1999. During 1999, the Company experienced negative cash
flows from operations and at December 31, 1999, the Company had borrowed the
maximum amount available under its revolving line-of-credit agreement. In
September 1999, the Company obtained a six-month deferral on principal payments
due under a promissory note agreement in return for continued interest payments
and increased principal payments over the remaining term of the note. As
described in Note 8, the Company was not in compliance with certain provision of
its line-of credit agreement for which the bank has provided a waiver. These
conditions resulted primarily from a high operating cost structure, particularly
at the Paragon subsidiary, expenses incurred in resolving ongoing litigation
21
<PAGE>
associated with the Paragon acquisition, a decline in revenue at the Paragon
subsidiary related to a reluctance by European customers to make new equipment
purchases due to Year 2000 issues, and extended payment terms provided to
certain customers making major purchases.
During 1999, the Company implemented significant cost cutting measures and it
settled its Paragon litigation (see Notes 3 and 11). Subsequent to December 31,
1999, cash was collected from the customers who made the major purchases, the
Company received approximately $600,000 from the exercise of stock options, the
Company paid approximately $400,000 under the line-of-credit agreement, and the
Company commenced making principal payments under the promissory note agreement.
As of March 7, 2000, the Company had no availability under its existing line-of-
credit and the Company currently expects that its bank will extend the line-of-
credit agreement through May 2001. The Company is continuing its cost
containment measures and management currently believes that the Company will
have sufficient liquidity from its operations and line-of credit agreement to
meet its current obligations. Should the bank not extend the line of credit
agreement or if the Company continues to experience negative cash flows from
operations, the Company may be required to seek new sources of financing to meet
its current obligations. Continued negative cash flows or the inability to
obtain alternative financing could have a material adverse affect on the
Company's operations.
This bank line-of-credit expires May 31, 2000; however, management expects to
renew the line-of-credit under substantially similar terms through May 31, 2001.
Optelecom is required to comply with certain financial ratios including
maintaining a minimum current ratio, a minimum cash flow to fixed obligations as
well as a maximum debt to worth ratio. The Company was in violation of its
current ratio as well as its cash flow covenants at December 31, 1999. The
bank, however, has provided a waiver of such covenants at December 31, 1999.
Paragon's future working capital needs are expected to be financed by its
operating cash flows or inter-company loans from the Company. Paragon is
operating as a stand-alone entity. Should the need arise for increased cash due
to increased business activity, additional funding needs will be addressed.
Management anticipates that operating cash flows will generate the long-term
cash requirements of Optelecom and Paragon. If the level of business should
dictate, other infusions of capital may be needed. Paragon's business is
transacted in British Pounds. The results of operations may be affected by
foreign exchange gains/losses. Currently neither Optelecom nor Paragon have
hedging strategies in place.
CONTINGENCIES
None
YEAR 2000
Optelecom engaged in a comprehensive program to upgrade its information,
technology, manufacturing and financial software to properly recognize the Year
2000. Based on this program, the Company purchased and installed hardware and
software upgrades to its existing systems that are Year 2000 compliant including
new telephone hardware, new computer hardware as well as upgraded manufacturing
and financial software. Also, Optelecom analyzed all of its product offerings
for any Year 2000 issues. None were discovered. In addition, product
development was reviewed and modifications, if needed, were made to make all
future products Year 2000 compliant.
Optelecom also demanded and received assurance from all of its vendors and
suppliers that any products purchased by Optelecom were Year 2000 compliant.
This included raw materials as well
22
<PAGE>
as services. All products and services were tested and determined to be Year
2000 compliant.
During 1999, Optelecom spent approximately $200,000 on hardware, software and
labor costs to bring all of its systems and products in Year 2000 compliance.
Also included in these costs was training and external resources needed to
implement any new software purchased.
Optelecom determined that there was no material adverse effect of the Year 2000
transition on any of its operations, including Paragon. The Company has not
experienced significant Year 2000 issues subsequent to 1999's fiscal year end.
The Company believes that, while it continues to monitor and review its
purchases, products and systems, there are no material risks or exposures to its
operations in connection with the Year 2000 issue.
NEW ACCOUNTING STANDARDS
In June 1998 the Financial Accounting Standards Board (FASB) issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities", (as amended by
SFAS No. 137). The new standard will become effective for the Company on January
1, 2001. The Company does not currently use derivatives, and has not determined
the impact, if any of these Standards on its financial position or results of
operations.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Market risk is the potential change in an instrument's value caused by, for
example, fluctuations in interest and currency exchange rates. The Company has
not purchased any futures contracts nor purchased or held any derivative
financial instruments for trading purposes during the twelve months ended
December 31, 1999. The primary market risk exposure is the risk that interest
rates on our outstanding borrowings may increase.
Optelecom currently has a bank line-of-credit and various term notes payable
with aggregate maximum borrowings totaling approximately $3.7 million. An
increase in the prime rate (a benchmark pursuant to which interest rates
applicable to borrowings under the credit facilities may be set) equal to
another 100 basis points to the current prime rate, for example, would have
increased our consolidated interest by approximately $30,000 for the twelve
months ended December 31, 1999. Optelecom has not entered into any hedging
arrangements with respect to the interest obligations under these lines of
credit.
CERTAIN RISKS OF FOREIGN OPERATIONS
In December 1997, Optelecom purchased Paragon which operates primarily in
countries outside the United States and is subject to certain risks such as
currency exchange rates. There can be no assurances that these factors will not
have an adverse impact on our future international sales or operating results.
We do not currently enter into foreign currency hedging transactions and
therefore may be exposed to possible losses on international transactions.
23
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
OPTELECOM, INC.
Consolidated Financial Statements as of December 31, 1999 and 1998,
and the Three Years in the period ended December 31, 1999, and
Independent Auditors' Report
24
<PAGE>
OPTELECOM, INC.
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
INDEPENDENT AUDITORS' REPORT............................................. 26
CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 1999, 1998 and 1997:
Consolidated Balance Sheets........................................... 27
Consolidated Statements of Operations................................. 28
Consolidated Statements of Comprehensive (Loss) Income................ 29
Consolidated Statements of Stockholders' Equity....................... 30
Consolidated Statements of Cash Flows................................. 31
Notes to Consolidated Financial Statements............................ 32
Schedule of Valuation and Qualifying Accounts......................... 49
25
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Stockholders of Optelecom, Inc.:
We have audited the accompanying consolidated balance sheets of Optelecom, Inc.
and subsidiaries (the Company) as of December 31, 1999 and 1998, and the related
consolidated statements of operations, comprehensive (loss) income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. Our audits also included the financial statement
schedule listed in the accompanying index. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on the financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 1999
and 1998, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1999, in conformity with
generally accepted accounting principles. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
/s/Deloitte & Touche LLP
- ------------------------
McLean, VA
March 7, 2000
(March 28, 2000 as to Note 2)
26
<PAGE>
OPTELECOM, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
ASSETS 1999 1998
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 51,314 $ 394,096
Restricted cash (Note 11) - 328,700
Accounts and contracts receivable, net (Note 4) 2,228,726 1,426,306
Inventories, net (Note 5) 1,894,155 1,847,113
Prepaid expenses and other assets 486,302 344,448
Deferred tax asset 303,363 307,960
----------- ----------
Total current assets 4,963,860 4,648,623
Other intangible assets, net (Notes 3 and 6) 2,000,589 2,351,563
Goodwill, net (Note 3) 209,728 238,493
Property and equipment, net (Note 7) 1,206,635 1,361,095
Deferred tax asset 116,410 32,174
Other assets 118,392 -
----------- ----------
TOTAL ASSETS $ 8,615,614 $8,631,948
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank line-of-credit payable (Note 8) $ 1,700,000 $ 650,000
Accounts payable 1,280,248 765,971
Accrued payroll 180,934 204,888
Income taxes payable (Notes 9 and 14) - 328,700
Other current liabilities 390,249 892,848
Current portion of leases payable (Note 12) 46,330 -
Current portion of notes payable (Note 10) 625,000 624,996
----------- ----------
Total current liabilities 4,222,761 3,467,403
----------- ----------
LONG-TERM LIABILITIES:
Notes payable (Note 10) 1,310,004 1,726,672
Leases payable (Note 12) 70,571 -
Deferred rent liability 115,658 147,241
----------- ----------
Total liabilities 5,718,994 5,341,316
----------- ----------
Commitments and contingencies (Note 11) - -
STOCKHOLDERS' EQUITY (Note 12):
Common stock, $.03 par value - shares authorized, 15,000,000; issued
And outstanding, 1,993,885 and 2,156,557 shares as of 1999 and
1998 respectively 59,817 64,697
Discount on common stock (11,161) (11,161)
Additional paid-in capital 4,105,029 4,105,029
Additional paid-in capital - Stock options 97,515 -
Less: Deferred compensation expense (38,031) -
Foreign currency translation adjustment 7,904 6,033
Treasury stock, 162,672 shares, at cost (1,265,047) -
Accumulated (deficit) (59,406) (873,966)
----------- ----------
Total stockholders' equity 2,896,620 3,290,632
----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 8,615,614 $8,631,948
=========== ==========
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997
<S> <C> <C> <C>
Revenues $12,636,892 $16,333,749 $12,271,057
Cost of goods sold 8,375,982 9,967,408 6,462,447
----------- ----------- -----------
Gross profit 4,260,910 6,366,341 5,808,610
Operating expenses:
Engineering 1,014,515 1,773,904 1,031,724
Selling and marketing 1,465,389 2,367,408 1,548,005
General and administrative 1,966,863 3,558,432 1,842,009
----------- ----------- -----------
Total operating expenses 4,446,767 7,699,744 4,421,738
Operating (loss) income (185,857) (1,333,403) 1,386,872
Other expenses:
Interest expense 309,885 334,749 19,653
Write-down of intangible assets (Note 16) - 1,462,500 -
----------- ----------- -----------
Total other expenses 309,885 1,797,249 19,653
(Loss) income before (benefit) provision for income
taxes (495,742) (3,130,652) 1,367,219
(Benefit) provision for income taxes (284,383) (319,308) 418,490
----------- ----------- -----------
Net (loss) income (211,359) (2,811,344) 948,729
=========== =========== ===========
Basic (loss) earnings per share $ (0.10) $ (1.34) $ 0.51
=========== =========== ===========
Diluted (loss) earnings per share $ (0.10) $ (1.34) $ 0.48
=========== =========== ===========
Weighted Average Shares Outstanding 2,150,318 2,098,819 1,845,399
=========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
28
<PAGE>
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net (Loss) Income $(211,359) $(2,811,344) $948,729
Foreign Currency Translation Adjustments 1,871 6,033 -
--------- ----------- --------
Comprehensive (Loss) Income $(209,488) $(2,805,311) $948,729
========= =========== ========
</TABLE>
See notes to consolidated financial statements.
29
<PAGE>
TELECOM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Additional Capital
-----------------------------------
Number Common Discount Paid-in Paid-in Deferred Retained
Of Stock On Common Capital Capital- Compens- Earnings/
Shares Stock Stock Ation Accumulated
Options Expense (Deficit)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1997 1,207,574 36,227 (11,161) 2,027,916 - - 988,649
Common stock issued from exercise of 49,511 1,485 - 124,608 - - -
options and for services provided
Tax effect of options exercised - - - 67,352 - - -
Three-for-two stock split (see Note 11) 603,800 18,114 - (18,114) - - -
Issuance of Common stock for acquisition 171,252 5,138 - 1,610,876 - - -
of Paragon, net of issuance $8,986 cost
Net Income - - - - - - 948,729
--------- ------- -------- ---------- ------- -------- -----------
BALANCE, DECEMBER 31, 1997 2,032,137 60,964 (11,161) 3,812,638 - - 1,937,378
Common stock issued from exercise of 124,420 3,733 - 292,391 - - -
Options
Foreign currency translation adjustment - - - - - - -
Net Loss - - - - - - (2,811,344)
--------- ------- -------- ---------- ------- -------- -----------
BALANCE, DECEMBER 31, 1998 2,156,557 $64,697 $(11,161) $4,105,029 - - (873,966)
Foreign currency translation adjustment - - - - - - -
Shares returned to treasury (162,672) (4,880) - - - - 1,025,919
Deferred Compensation - - - - 97,515 (38,031) -
Net Loss - - - - (211,359)
--------- ------- -------- ---------- ------- -------- -----------
BALANCE, DECEMBER 31, 1999 1,993,885 $59,817 $(11,161) $4,105,029 $97,515 $(38,031) $ (59,406)
========= ======= ======== ========== ======= ======== ===========
</TABLE>
See notes to consolidated financial statements.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
Foreign Treasury Total
Currency Stock Stockholders
Translation Equity
Adjustment
<S> <C> <C> <C>
BALANCE, January 1, 1997 - - 3,041,631
Common stock issued from exercise of
options and for services provided - - 126,093
Tax effect of options exercised - - 67,352
Three-for-two stock split (see Note 11) - - -
Issuance of Common stock for acquisition
of Paragon, net of issuance $8,986 cost - - 1,616,014
Net Income - - 948,729
------- ----------- -----------
BALANCE, DECEMBER 31, 1997 - - 5,799,819
Common stock issued from exercise of
Options - - 296,124
Foreign currency translation adjustment 6,033 - 6,033
Net Loss - - (2,811,344)
------- ----------- -----------
BALANCE, DECEMBER 31, 1998 $ 6,033 - $ 3,290,632
Foreign currency translation adjustment 1,871 - 1,871
Shares returned to treasury - (1,265,047) (244,008)
Deferred Compensation - - 59,484
Net Loss - - (211,359)
------- ----------- -----------
BALANCE, DECEMBER 31, 1999 $ 7,904 $(1,265,047) $ 2,896,620
======= =========== ===========
</TABLE>
See notes to consolidated financial statements.
30
<PAGE>
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
1999 1998 1997
<S> <C> <C> <C>
Cash Flows From Operating Activities
Net (loss) income $ (211,359) $(2,811,344) $ 948,729
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization 845,394 872,165 300,232
Write-down of intangible assets - 1,462,500 -
Loss (gain) on sale/disposal of equipment 81,730 835 (15,357)
Deferred rent (31,583) (25,372) (19,343)
Common stock issued for services - - 8,000
Deferred taxes (79,639) (125,753) (68,560)
Effect of currency translations 1,871 6,033 -
Additional paid-in capital-stock options, net 59,484 - -
Return of common stock to Treasury stock, net (244,008) - -
Change in assets and liabilities:
Accounts and contracts receivable (802,420) 1,676,598 (880,155)
Inventories (47,042) (94,240) (50,828)
Prepaid expenses and other assets (141,854) 40,472 (1,595)
Restricted cash 328,700 399,300 (728,000)
Other assets (118,392) - -
Accounts payable 514,277 (874,489) 316,214
Accrued payroll (23,954) (200,709) 111,554
Other current liabilities (502,599) 592,464 (122,097)
Income taxes payable (328,700) (399,300) 728,000
---------- ----------- -----------
Net cash (used in) provided by operating activities (700,094) 519,160 526,794
Cash Flows From Investing Activities
Proceeds from sale of equipment 63,000 2,972 22,000
Capital expenditures (312,117) (505,616) (701,529)
Investment in Paragon, net of cash acquired - - (2,750,851)
---------- ----------- -----------
Net cash used in investing activities (249,117) (502,644) (3,430,380)
Cash Flows From Financing Activities
Borrowings on bank line-of-credit payable 1,200,000 2,158,526 800,000
Payments on bank line-of-credit payable (150,000) (1,808,526) (500,000)
Payments under factoring agreement - (362,868) -
Payments on long term debt (416,664) (208,332) (46,426)
Borrowings on long term debt - 60,000 2,500,000
Payments on capital leases (26,907) - -
Proceeds from exercise of stock options - 296,124 126,093
---------- ----------- -----------
Net cash provided by financing activities 606,429 134,924 2,879,667
Net (decrease) increase in cash and cash equivalents (342,782) 151,440 (23,919)
Cash and cash equivalents - beginning of year 394,096 242,656 266,575
---------- ----------- -----------
Cash and cash equivalents - end of year $ 51,314 $ 394,096 $ 242,656
========== =========== ===========
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for interest $ 309,041 $ 336,250 $ 12,715
========== =========== ===========
Cash paid during the year for income taxes $ 3,000 $ 403,846 $ 604,948
========== =========== ===========
Capital lease obligations incurred for the purchase of
new equipment $ 143,807 $ - $ -
========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
OPTELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business - Optelecom, Inc. (the Company) is a Delaware
corporation that was organized in 1972. The Company designs, manufactures
and markets video communication products, specializing in transmission and
distribution equipment for the delivery of real time video.
The Company is organized into three operating segments: the Communications
Products Division (CPD), which develops, manufactures, and sells optical
fiber based data communication equipment to the commercial marketplace, the
Government Products Division (GPD) which is primarily focused on electro-
optic technology development for government-related defense business and
the Paragon division (acquired in December 1997), which designs and markets
electronic communication products and systems utilizing copper cabling.
The Company sells its products and services throughout the US and also to
several countries in Europe and Asia. Additionally, Paragon generates most
of its revenue from the UK and other countries within Europe.
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries, Optelecom UK
Limited (Optelecom UK), and Paragon Audio Visual Limited. All significant
intercompany transactions and balances have been eliminated.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from
those estimates.
Revenue Recognition - Revenues from fixed-price contracts are recognized on
the percentage-of-completion method based on costs incurred in relation to
total estimated costs. Revenues from time-and-materials contracts are
recorded at the contract rates times the labor hours plus other direct
costs as incurred. Sales of products are recognized at the time completed
units are delivered.
Inventories - Production materials are valued at the lower of cost or
market applied on a weighted average cost basis. Work-in-process represents
direct labor, materials, and overhead incurred on products not delivered to
date. Finished goods inventories are valued at the lower of cost or market,
cost being determined using standards that approximate actual costs on a
specific identification basis.
Property, Equipment, and Depreciation - Property and equipment are stated
at cost. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets, which range from 5 to 10 years.
Leasehold improvements are amortized over the terms of the respective
leases or the service lives of the assets, whichever is shorter.
32
<PAGE>
Goodwill and Other Intangible Assests - Intangible assets consist primarily
of technology, trade names and customer lists that are being amortized on
the straight-line method over their estimated useful lives, which range
from three to fifteen years. Goodwill represents the cost in excess of fair
value of the identifiable net assets acquired, which is being amortized on
the straight-line method over 10 years. The Company periodically reviews
the carrying value of intangible assets, including goodwill, for impairment
under methodologies required by SFAS 121. If the facts and circumstances
indicate an asset is impaired, the asset will be reduced to its estimated
fair value.
Research and Development Costs - Research and development costs are
expensed as incurred. The Company incurred research and development costs
of approximately $731,000, $1,309,000 and $874,000 for the years ended
December 31, 1999, 1998, and 1997, respectively.
Income Taxes - The Company recognizes income tax expense (benefit) for
financial statement purposes following the asset and liability approach for
computing deferred income taxes. Under this method, deferred tax assets and
liabilities are determined based on the difference between financial
reporting and tax basis of assets and liabilities based on enacted tax
rates. Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some portion or
all of the deferred tax assets will not be realized.
Stock-Based Compensation - The Company follows Statement of Financial
Accounting Standard No. 123 (SFAS No. 123), Accounting for Stock-Based
Compensation, for disclosure purposes only. The Company continues to
measure compensation expense for its stock-based employee compensation
plans using the intrinsic value method prescribed by APB No. 25, Accounting
for Stock Issued to Employees, and has provided pro forma disclosures of
the effect on net (loss) income and (loss) earnings per share as if the
fair value-based method prescribed by SFAS 123 had been applied in
measuring compensation expense.
Foreign Currency Translation - The Company translates the assets and
liabilities of its foreign subsidiaries into U.S. dollars at the current
exchange rate in effect at the end of the year. The gains and losses that
result from this process, and gains and losses on inter-company
transactions that are long-term in nature and that the Company does not
intend to repatriate, are shown in the foreign currency translation
adjustment balance in the stockholder's equity section of the balance
sheet. The revenue and expense accounts of the foreign subsidiaries are
translated into U.S. dollars at the average rates that prevailed during the
period.
Restricted Cash - At December 31, 1998, Optelecom had deposited into escrow
amounts that it was obligated to pay to U.K. tax authorities resulting from
the December 1997 purchase of Paragon (see note 2 and 10). These amounts
were classified as restricted cash. The complete balance in this account
was paid to the U.K. tax authorities in the fourth quarter of 1999.
Cash and Cash Equivalents - For the purpose of presentation in the
statements of cash flows, cash and cash equivalents are defined as cash and
liquid investments with original maturities of three months or less.
Fair Value of Financial Instruments - The fair value of the Company's long-
term debt is estimated using discounted cash flow analysis based on the
incremental borrowing rates currently available to the Company for loans
with similar terms and maturities. At
33
<PAGE>
December 31, 1999 and 1998, the fair value approximated the carrying
amount. The fair value of trade receivables, trade payables, payable under
factoring agreement, and the revolving credit agreement approximate their
carrying amount because of the short maturity of these instruments.
Reclassifications - Certain reclassifications have been made to prior
years' amounts to conform to current year presentation.
2. NATURE OF OPERATIONS AND BUSINESS CONDITIONS
The Company has the ability, provided there are sufficient accounts
receivable and inventory, to borrow up to $1,700,000 under its existing
bank line-of-credit as of December 31, 1999. During 1999, the Company
experienced negative cash flows from operations and at December 31, 1999,
the Company had borrowed the maximum amount available under its revolving
line-of-credit agreement. In September 1999, the Company obtained a six-
month deferral on principal payments due under a promissory note agreement
in return for continued interest payments and increased principal payments
over the remaining term of the note. As described in Note 8, the Company
was not in compliance with certain provision of its line-of credit
agreement for which the bank has provided a waiver. These conditions
resulted primarily from a high operating cost structure, particularly at
the Paragon subsidiary, expenses incurred in resolving ongoing litigation
associated with the Paragon acquisition, a decline in revenue at the
Paragon subsidiary related to a reluctance by European customers to make
new equipment purchases due to Year 2000 issues, and extended payment terms
provided to certain customers making major purchases.
During 1999, the Company implemented significant cost cutting measures and
it settled its Paragon litigation (see Notes 3 and 11). Subsequent to
December 31, 1999, cash was collected from the customers who made the major
purchases, the Company received approximately $600,000 from the exercise of
stock options, the Company paid approximately $400,000 under the line-of-
credit agreement, and the Company commenced making principal payments under
the promissory note agreement. As of March 7, 2000, the Company had no
availability under its existing line-of-credit. On March 28, 2000, the
Company had $600,000 available under its existing line-of-credit and the
Company currently expects that its bank will extend the line-of-credit
agreement through May 2001. The Company is continuing its cost containment
measures and management currently believes that the Company will have
sufficient liquidity from its operations and line-of credit agreement to
meet its current obligations. Should the bank not extend the line of credit
agreement or if the Company continues to experience negative cash flows
from operations, the Company may be required to seek new sources of
financing to meet its current obligations. Continued negative cash flows or
the inability to obtain alternative financing could have a material adverse
affect on the Company's operations.
3. ACQUISITION
On December 12, 1997, the Company acquired Paragon Audio Visual Limited
(Paragon), a United Kingdom company. Paragon designs and markets
electronic products and systems utilizing copper cabling for in-house
computer data networking applications. The total cost of the acquisition
was $4,422,000, consisting of $2.5 million in cash and 171,252 shares of
common stock of the Company (with a fair value of $1,625,000 at the
acquisition date), plus acquisition costs, in exchange for all common
shares of Paragon. The cash payment was financed under a new debt
agreement entered into by
34
<PAGE>
the Company (see Note 11). The acquisition was accounted for as a purchase
and the purchase price was allocated to the net assets acquired based upon
the estimated fair value of such assets. Goodwill recorded as a result of
this transaction will be amortized on a straight-line basis over its
estimated useful life of 10 years. The Company's consolidated financial
statements include the operating results of Paragon since December 12,
1997.
In 1998, the Company evaluated the fair value of the assets acquired from
Paragon and the goodwill associated with the purchase. As a result of this
evaluation, the Company determined that a portion of the purchase price
paid related to contractual employment obligations by Paragon's four
selling shareholders, who were related family members, employees, officers
and Board members of Paragon (hereafter "the Paragon individuals"). The
purchase agreement required the Paragon individuals to fulfill these
employment obligations or return up to $1,625,000 of the purchase price to
the Company (see Note 11). Optelecom reclassified $1,625,000 from goodwill
to other intangibles - employment agreements, and such amounts were to be
amortized over the employment period of three years. Additionally, the
Company performed an internal valuation and analysis of the assets acquired
and determined that identified intangibles acquired included technology,
customer lists and trade names. Accordingly, the Company reclassified the
fair value of the acquired intangibles to these specific intangible assets.
In November 1999, Optelecom filed a complaint for injunctive relief and
damages against the Paragon individuals. In December an agreement was
reached settling these charges (See Note 11, Commitments and
Contingencies). As part of this settlement, the Paragon individuals
returned 162,672 shares of Optelecom common stock originally issued to them
as part of Optelecom's acquisition of Paragon in December 1997. These
shares were taken into Treasury Stock (Note 12).
4. ACCOUNTS AND CONTRACTS RECEIVABLE
Accounts and contracts receivable at December 31, 1999 and 1998, consisted
of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Billed $2,346,851 $1,727,778
Unbilled - net of cumulative progress billings of
$ 0 for 1999 and $124,891 for 1998 360 760
Less: Allowance for doubtful accounts (118,485) (302,232)
---------- ----------
$2,228,726 $1,426,306
========== ==========
</TABLE>
35
<PAGE>
Approximately 11%, 18%, and 25% of the Company's revenues in 1999, 1998,
and 1997, respectively, were derived from contracts with agencies of the
United States Government and their prime contractors. The Company performs
the services and ships equipment according to the specific contract terms.
Contracts with the United States Department of Defense allow the Defense
Contract Audit Agency (DCAA) to audit the contract costs and the Company's
compliance with the Federal Acquisition Regulations. The DCAA has audited
the costs under contracts for years through 1996. The Company believes that
the ultimate outcome of DCAA audits for subsequent years will not have a
material effect on the financial statements. Generally, the contract terms
for both government and commercial customers require payment of invoices in
30 days.
5. INVENTORIES
Inventories at December 31, 1999 and 1998 consist of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Production materials $ 658,849 $ 618,222
Work in process 280,680 381,659
Finished goods 954,626 847,232
---------- ----------
Net $1,894,155 $1,847,113
========== ==========
</TABLE>
6. INTANGIBLE ASSETS
Intangible assets at December 31, 1999 and 1998 (see Note 3) consist of
the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Technology $ 800,000 $ 800,000
Customer lists 725,000 725,000
Trade names 1,100,000 1,100,000
---------- ----------
2,625,000 2,625,000
Accumulated amortization (624,411) (273,437)
---------- ----------
Net $2,000,589 $2,351,563
========== ==========
</TABLE>
The current Paragon management has been in control since March 1999 and has
taken the necessary steps to eliminate unnecessary expenses and properly
situate Paragon to take advantage of its technology and market presence.
Optelecom evaluated the recoverability of Paragon's assets, intangibles and
goodwill and based on its cash flow projections, believes that these assets
continue to be recoverable. During 1998, the Company wrote off $1,462,500
of intangibles assets related to the employment agreements for terminated
employees (see Note 11).
36
<PAGE>
7. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1999 and 1998 consist of the
following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Laboratory equipment $ 1,217,699 $ 1,419,678
Office equipment 1,428,121 1,275,850
Furniture and fixtures 73,103 99,776
Leasehold improvements 571,007 641,560
Assets under Capital Leases 143,807 -
Motor vehicles 13,318 13,524
----------- -----------
3,447,055 3,450,388
Less accumulated depreciation and amortization (2,240,420) (2,089,293)
----------- -----------
Net property and equipment $ 1,206,635 $ 1,361,095
=========== ===========
</TABLE>
In 1999 Optelecom entered into leases for computer and test equipment which
are recorded as capital leases.
8. DEMAND NOTE PAYABLE TO BANK
The Company has a revolving credit agreement with a bank whereby it may
borrow up to $1,700,000 with interest at the bank's prime rate plus 1%
(9.5% at December 31, 1999). The total amount of borrowings that may be
outstanding at any given time is based on the sum of a percentage of
certain eligible accounts receivable plus a percentage of qualifying
inventory. The maximum borrowing against inventory was originally
established at $400,000 but was increased to $600,000 in the fourth quarter
of 1999. Amounts under the agreement are due in full on May 31, 2000. The
Company expects the credit agreement to be renewed for one year with
substantially similar terms. The balance outstanding under the agreement
was $1,700,000 and $650,000 at December 31, 1999 and 1998, respectively.
There was no available borrowing under the agreement as of December 31,
1999.
The Company is required to comply with certain financial ratios including
maintaining a minimum current ratio, a minimum ratio of cash flow to fixed
obligations and a maximum debt to worth ratio. The Company was in
violation of the cash flow and the current ratio covenants as of December
31, 1999. The bank has provided a waiver of such covenant violation at
December 31, 1999.
9. INCOME TAXES
The components of the (benefit) provision for income taxes for the years
ended December 31, 1999, 1998, and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Current $(236,456) $(174,487) $487,050
Deferred 597,073 (789,821) (68,560)
Valuation allowance (645,000) 645,000 -
--------- --------- --------
$(284,383) $(319,308) $418,490
========= ========= ========
</TABLE>
No U.S. income taxes have been provided for unremitted earnings of foreign
subsidiaries as the Company intends to reinvest those profits overseas.
The Company's 1999 and 1998 tax provisions include the benefit of the
carryback of net
37
<PAGE>
taxable losses to prior years. The difference between the Federal income
tax expense (benefit) and the amount computed applying the statutory
Federal income tax rate for the years ended December 31, 1999, 1998, and
1997 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
% % %
<S> <C> <C> <C>
Federal income tax (benefit) expense at statutory rates (34) (34) 34
(Reduction) increase of taxes:
State taxes, net of federal benefit (1.5) (1.8) 3.5
Valuation allowance related to net deferred tax assets - 20.5 -
Losses of foreign subsidiary 19.2 5.6 -
NOL Carryback (13.3) (0.5) (7)
Equity adjustment related to litigation settlement (13.7) - -
Commission (15.5) - -
Other 1.4 - -
----- ----- ----
Effective income tax rate (57.4) (10.2) 30.5
===== ===== ====
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the amount of assets and liabilities for income tax and financial
reporting purposes. The components of deferred income tax liabilities and
assets as of December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Deferred liabilities:
Amortization $ (8,632) $ (8,632)
State taxes (14,643) (33,080)
-------- ----------
Gross deferred tax liabilities (23,275) (41,712)
Deferred tax assets:
Excess book depreciation 43,831 3,529
Capitalized overhead and inventory obsolescence reserve 153,267 217,650
Accrued vacation 33,805 39,470
Deferral of rent expense 44,033 56,057
Amortization 90,730 694,911
Note reserve 15,229
Bad debt reserve 16,098 -
Other 38,009 -
-------- ----------
Gross deferred tax assets 419,773 1,026,846
Less: valuation allowance _ (645,000)
-------- ----------
Net deferred tax assets $419,773 $ 340,134
======== ==========
</TABLE>
As a result of the return of stock related to the Paragon litigation, the
Company no longer has deferred tax assets related to amortization of
intangible assets, or the valuation allowance associated with the deferred
tax assets, recognized in 1998.
Prepaid expenses and other assets as of December 31, 1999 and 1998 included
income tax receivables of approximately $245,000 and $28,000, respectively.
10. NOTES PAYABLE
Optelecom has a promissory note agreement with a bank that is
collateralized by substantially all the assets and contracts of the
Company. The original note principal was $2,500,000 payable in monthly
installments of $52,083 through August 2002, with interest payable monthly
at the rate of prime plus 1%. On September 12, 1999
38
<PAGE>
the bank modified the term note whereby principal payments were suspended
from September 1999 through February 2000, with interest only paid during
this time. The remaining principal balance, $1,875,004 will be paid from
March 2000 through August 2002, the original ending date, in monthly
installments of $62,500 and an interest rate of 1% above prime. The
interest rate was 9.5% at December 31, 1999 and 8.75% at December 31, 1998.
In December 1998, the Company received a loan of $60,000 from the Economic
Development Fund of Montgomery County, Maryland to maintain or establish
jobs and an economic presence in Montgomery County, Maryland. Under the
terms of the loan agreement, the loan will convert to a grant if certain
conditions at specific dates are met, primarily certain job levels and the
maintaining of a place of business within Montgomery County, Maryland.
All grants convert back to a loan if the Company does not maintain a
majority of its business interests within Montgomery County, Maryland for
at least eight years from the date of the receipt of the loan.
Interest is at the rate of five percent (5%) per annum. No principal or
interest is payable until January 2002, at which time principal and
interest payments, including interest during 1999-2001, will be made over a
five year period.
The required principal payments of the notes payable are as follows:
<TABLE>
<S> <C>
2000 $ 625,000
2001 750,000
2002 512,004
2003 12,000
2004 12,000
Thereafter 24,000
----------
Total $1,935,004
==========
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
Operating Lease - During 1992, the Company entered into a 10-year non-
cancelable operating lease expiring August 31, 2002 for corporate office
and manufacturing facilities. As an inducement to enter the new lease, the
Company received certain incentives such as a rent abatement and assumption
of existing lease obligations. Additionally, the lease provided for
scheduled rent increases. These lease incentives are being amortized over
the lease period. Rent expense is being recognized on a straight-line
basis. In addition to the basic rentals, the lease agreement provides for
increases based on payment by the Company of its share of real estate and
insurance taxes.
Paragon has entered into leases for office and sales facilities, which
expire March 24, 2001.
As of December 31, 1999, future net minimum rental payments required under
operating leases that have initial or remaining non-cancelable terms in
excess of one year are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
<S> <C>
2000 $259,500
2001 234,500
2002 230,700
--------
$724,700
========
</TABLE>
39
<PAGE>
Rental expense was approximately $365,000, $364,000 and $242,000 in 1999,
1998, and 1997, respectively.
During 1999, Optelecom leased various computer and test equipment. All
leases had terms of three years and were recorded as capital leases. The
future minimum payments under these leases are:
<TABLE>
<CAPTION>
Year Ended December 31,
<S> <C>
2000 $ 56,205
2001 56,205
2002 20,225
--------
132,665
Less amount representing interest (15,763)
--------
Total Minimum Payments $ 116,902
========
</TABLE>
Paragon Acquisition - In conjunction with the acquisition described in Note
3, the Company deposited $728,000 into a restricted escrow account to pay
income tax liabilities to U.K. tax authorities assumed upon acquisition of
Paragon. During 1998, a payment was made to the U.K. tax authorities in the
amount of $400,000 and the remaining $328,000 was paid in the fourth
quarter of 1999.
Legal Proceedings - David Brown, formerly Chairman and Managing Director of
Paragon Audio Visual Ltd., lodged an Originating Application in March 1999
with the Employment Tribunal of the United Kingdom in Reading, England. Mr.
Brown alleged that Paragon dismissed Mr. Brown unlawfully and in breach of
his alleged employment contract rights. Mr. Brown's three sons, who also
worked for Paragon, filed for the same reasons and all actions were
combined into one. In the fourth quarter of 1999, an agreement was reached
whereby all matters before the Employment Tribunal were settled.
On November 10, 1999 Optelecom filed a complaint for injunctive relief and
damages against the Browns alleging, among other actions, Breach of
Contract, Breach of Duty and Interference with Contractual Relations. The
court issued a Temporary Restraining Order against the Browns forbidding
them, from among other things, from competing against Optelecom or Paragon,
soliciting business from any customer of Paragon and using any of Paragon's
confidential technology. An agreement in principal to settle these charges
was reached on November 22, 1999 whereby the Browns agreed to cease trading
using the name Paragon or any confusingly similar names, logos or
descriptions of business operations. Also, during December 1999, the Browns
returned 162,672 shares of Optelecom common stock issued to them as part of
the purchase of Paragon by Optelecom in December of 1997. This settlement
included the return of 108,448 shares of stock valued at $9.49 per share in
accordance with purchase price return provisions of the Paragon purchase
agreement. The additional 54,224 shares represent settlement of litigation
and have been valued at $244,008, the fair value n the date of return of
the stock. A definitive settlement of all of these charges was finalized in
January 2000.
The Company is involved in certain other legal proceedings that arise in
the ordinary course of business. Management believes that the final
disposition of these matters in the aggregate, will not have a material
effect on the Company's financial position, results of operations or cash
flows.
40
<PAGE>
12. STOCKHOLDER'S EQUITY
On November 11, 1997, the Company's Board of Directors approved a three-
for-two common stock split to be distributed in the form of a stock
dividend. As a result, 603,800 shares were issued to shareholders of record
on November 17, 1997. Par value remained at $0.03 per share that resulted
in the Company transferring $18,114 to common stock from paid-in capital,
representing the aggregate par value of the shares issued under the stock
split. Share amounts presented in the consolidated financial statements
reflect the actual share amounts outstanding for each period presented. All
agreements concerning stock options and other commitments payable in shares
of the Company's common stock provide for the issuance of additional shares
due to the declaration of the stock split. All references to number of
shares, except shares authorized, stock option agreements, and to per-share
information in the consolidated financial statements have been adjusted to
reflect the stock split. At December 31, 1999, 380,511 shares were reserved
for issuance under stock option agreements and the employee stock bonus
plan.
Treasury Stock - Optelecom received into treasury stock on December 17,
1999 162,672 shares of its common stock in settlement of litigation filed
against former owners and employees of the Company's Paragon subsidiary
(see Note 11). The return of these shares reduced the amount of weighted
average common shares outstanding at December 31, 1999.
Reconciliation of the numerator and denominator for earnings per common
share and diluted earnings per common share are shown below.
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Basic Earnings Per Share:
(Loss) Income available to common stockholders $ (211,359) $(2,811,344) $ 948,729
========== =========== ==========
Weighted average common shares outstanding 2,150,318 2,098,819 1,845,399
========== =========== ==========
Basic (Loss) Earnings per share $ (0.10) $ (1.34) $ 0.51
========== =========== ==========
Diluted Earnings Per Share:
(Loss) income available to common stockholders $ (211,359) (2,811,344) 948,729
========== =========== ==========
Weighted average common shares
Shares outstanding 2,150,318 2,098,819 1,845,399
========== =========== ==========
Dilutive Shares - - 120,799
---------- ----------- ----------
Diluted Shares 2,150,318 2,098,819 1,966,198
========== =========== ==========
Diluted (loss) earnings per share $ (0.10) $ (1.34) $ 0.48
========== =========== ==========
</TABLE>
Shareholders Rights Plan
------------------------
On June 15, 1998, the Company adopted a shareholders rights plan that
provides for a dividend distribution of one right for each outstanding
share of common stock. In the event that, following the Distribution Date
(as defined) a person is or becomes the beneficial owner of 10% or more of
the then-outstanding shares of Common Stock, each Right Holder may purchase
three (3) shares of Common Stock at a price per share equal to 50% of the
then current market price of the Common Stock. As of December 31, 1999, the
Company has reserved 5,400,000 shares of authorized but unissued common
stock for issuance under the shareholders rights plan.
41
<PAGE>
Stock Options
-------------
In May 1996, the 1991 Stock Option Plan (the 1991 Plan) was amended to
increase the number of options available to purchase shares of common stock
from 200,000 to 800,000 shares. The options may be granted to officers
(including officers who are directors), other key employees of, and
consultants to, the Company.
The exercise price of each option is the fair market value of the stock at
the grant date. Options are exercisable after one year from the date of
grant and in equal increments over four years. Options expire five years
from the date of grant and, in most cases, upon termination of employment.
The 1991 Plan will terminate on May 31, 2001, unless terminated sooner by
the Board.
In March 1999, as part of the 1991 Stock Option Plan, the company
established an employee incentive stock option plan, granting certain
employees options at a set price dependent upon reaching incentive goals
during the year. The number of shares granted was determined at year-end
and was based on a measurement of the goals achieved. This plan is
accounted for as a variable stock compensation plan and deferred
compensation expense is calculated based on the difference in the price of
the stock at the grant date compared to the price of the stock at the
measurement date. The deferred compensation is expensed over four years,
the vesting period of the stock awards. The total deferred compensation
expense under this plan was $97,515 of which $38,031 was expensed in 1999.
A summary of stock option activity during the years ended December 31,
1999, 1997, and 1996 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding, January 1 292,149 $7.23 309,012 $5.11 205,460 $2.78
Granted 197,231 2.57 117,650 7.96 127,927 8.36
Exercised - - (115,129) 2.34 (23,625) 2.16
Canceled 162,804 6.44 (19,384) 7.48 (750) 2.08
------- ----- -------- ----- ------- -----
Outstanding, December 31 326,576 $4.83 292,149 $7.23 309,012 $5.11
======= ===== ======== ===== ======= =====
Exercisable options, end of year 143,121 $5.83 130,163 $6.82 163,021 $3.10
======= ===== ======== ===== ======= =====
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------------------
Weighted
Average Weighted
Remaining Weighted Average
Total Life In Average Total Exercise
Outstanding Years Price Exercisable Price
<S> <C> <C> <C> <C>
141,242 4.4 $2.37 45,398 $2.32
47,441 3.5 3.27 14,588 3.26
94,268 2.8 7.07 51,070 7.28
43,625 3.0 9.64 32,065 9.64
------- -------
326,576 143,121
======= =======
</TABLE>
42
<PAGE>
On December 7, 1992, the Board of Directors approved the 1993 Directors'
Stock Option Plan (1993 Directors' Plan). Under this plan, each non-
employee director who attends a Board of Directors meeting is, at his
election, granted an option to purchase 675 shares of common stock at the
fair market value at the grant date in lieu of receiving a certain dollar
value of the stock on the date of such Board meeting. The options are
exercisable upon grant and expire three years thereafter. The Board of
Directors replaced this plan with a 1996 Director's Plan and no additional
options were granted under this plan after December 31, 1995.
A summary of stock option activity during the years ended December 31,
1998, and 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------------------- ---------------------------------
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
<S> <C> <C> <C> <C>
Outstanding, January 1 2,025 $1.92 14,175 $2.28
Granted - - - -
Exercised (2,025) 1.92 (12,150) 2.34
Canceled - - - -
------ ----- ------- -----
Outstanding, December 31 - $ - 2,025 $1.92
====== ===== ======= =====
Exercisable options - $ - 2,025 $1.92
====== ===== ======= =====
</TABLE>
In February 1996, the Board of Directors approved the 1996 Directors' Stock
Option Plan (1996 Directors' Plan), which replaced the 1993 Directors'
Plan. Under this plan, each non-employee director who attends a Board of
Directors meeting is granted an option to purchase 750 shares of common
stock at fair market value on the date of such Board meeting. The options
are exercisable upon grant and expire five years thereafter.
A summary of stock option activity during the year ended December 31, 1999,
1998 and 1997 (as adjusted for the three-for-two stock split) is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding, January 1 60,750 $7.43 45,000 $7.16 24,000 $3.49
Granted 43,500 1.80 19,500 7.30 32,250 8.59
Exercised - - (3,750) 3.48 (11,250) 3.25
Canceled - - - - - -
------- ----- ------ ----- ------- -----
Outstanding, December 31 104,250 $5.48 60,750 $7.43 45,000 $7.16
======= ===== ====== ===== ======= =====
Exercisable options 104,250 $5.48 60,750 $7.43 45,000 $7.16
======= ===== ====== ===== ======= =====
</TABLE>
43
<PAGE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------------------
Weighted
Average Weighted
Remaining Weighted Average
Total Life In Average Total Exercise
Outstanding Years Price Exercisable Price
<S> <C> <C> <C> <C>
36,000 3.8 $ 2.44 36,000 $ 2.44
18,750 3.5 3.70 18,750 3.70
29,250 2.5 7.16 29,250 7.16
20,250 3.0 10.11 20,250 10.11
------- -------
104,250 104,250
======= =======
</TABLE>
In June 1990, the Board of Directors adopted a stock option plan (the
Chairman's Plan) under which the Chairman of the Board is the sole
participant. On each January 1, the Participant was granted an option to
purchase 2,500 shares of common stock at fair market value on the grant
date. Each option granted under this plan would expire three years after
the date of grant. Effective December 31, 1996, no additional options were
granted under this plan and all options granted were either exercised or
cancelled during 1997.
A summary of stock option activity during the year ended December 31, 1997
is as follows:
<TABLE>
<CAPTION>
1997
------------------------------
Weighted
Average
Number of Exercise
Shares Price
<S> <C> <C>
Outstanding, January 1 5,000 $2.59
Granted - -
Exercised (2,500) 1.92
Canceled (2,500) 3.25
------ -----
Outstanding, December 31 - $ -
====== =====
Exercisable options - $ -
====== =====
</TABLE>
The Company has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), Accounting for Stock Based
Compensation. The required disclosures include pro forma net income (loss)
and basic earnings (loss) per share as if the fair value-based method of
accounting had been used.
44
<PAGE>
If compensation cost for the Company's 1999, 1998, and 1997 grants for
stock-based compensation had been determined consistent with the fair value
based method of accounting per SFAS 123, the Company's pro forma net income
(loss) and pro forma basic (loss) earnings per share for the years ended
December 31, 1999, 1998, and 1997, would be as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net (loss) income
As reported $(211,359) $(2,811,344) $948,729
Pro forma $(402,010) $(3,048,288) $708,932
Basic (loss) earnings per share
As reported $ (0.10) $ (1.34) $ 0.51
Pro forma $ (0.19) $ (1.45) $ 0.38
</TABLE>
The weighted average fair value at date of grant for options granted during
1999, 1998 and 1997 was $1.39, $4.14 and $4.27 per option. The fair value
of the option grant is estimated on the date of grant using the Black-
Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Expected dividend yield 0% 0% 0%
Expected stock price volatility 77% 74% 300%
Risk-free interest rate 5.67% 5.13% 6.12%
Expected option term 3 years 3 years 5 years
</TABLE>
On December 31, 1998, the Company authorized the cancellation and
reissuance of employee stock options held by employees at the manager level
and lower with exercise prices in excess of fair market value. The
employees had 30 days during which they could elect to accept the repricing
offer. A total of 49,469 options with an average price of $8.23 were
cancelled in January 1999 and reissued at an average price of $3.06.
13. EMPLOYEE BENEFIT PLANS
The Company has a noncontributory Profit-Sharing Retirement Plan covering
substantially all employees. Vesting occurs over a period of four years
from the date of entry into the plan (date of employment). Under the plan,
the Company's contribution is determined annually by the Board of Directors
and is funded as accrued. The profit-sharing expense for 1999, 1998 and
1997 was $0, $0 and $152,722, respectively.
The Company has established a contributory cash and deferred profit sharing
plan qualified under Section 401(k) of the Internal Revenue Code for all of
the Company's full-time employees. The Company matches employee
contributions to the plan up to a maximum of 2.5%. Total matching
contributions were $80,425, $101,831 and $83,203 in 1999, 1998 and 1997,
respectively.
In 1980, the Company adopted an employee cash/stock bonus plan for which
12,500 shares of the Company's common stock have been set aside to be
issued to employees at the discretion of management. During 1999, no shares
were issued under the plan and 1,000 shares were issued in 1998 and no
shares were issued in 1997. In the aggregate, 4,320 shares have been issued
under the plan.
45
<PAGE>
14. SEGMENT INFORMATION
Optelecom has three reportable segments: the Communications Products
Division (CPD), which develops, manufactures, and sells optical fiber-based
data communication equipment to the commercial marketplace, the Government
Products Division (GPD) which is primarily focused on electro-optic
technology development for government-related defense business and the
Paragon division (acquired in December 1997), which designs and markets
electronic products and systems utilizing copper cabling. The segments
reflect management's internal reportable information analysis and
approximates the Company's strategic business units' financial results
reported before income taxes. The accounting policies of the segments are
the same as those described in the summary of significant accounting
policies. The Company accounts for intersegment revenues as if the revenues
were from third parties, that is, at current market prices. There were no
intersegment revenues or expenses during 1997. The Company does not
allocate income taxes, interest or other corporate expenses to segments.
<TABLE>
<CAPTION>
Year ended December 31, 1999
---------------------------------------------------------------------
Communication Government Paragon
Products Products Audio
Division Division Visual Ltd. Total
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 8,507,745 $971,868 $ 3,196,088 $12,675,701
Intersegment revenues (38,809) - - (38,809)
----------- -------- ----------- -----------
Total Revenues 8,468,936 971,868 3,196,088 12,636,892
Operating (loss) income 528,846 73,729 (1,098,317) (495,742)
Intersegment expenses (355,000) - 355,000 -
----------- -------- ----------- -----------
Total (loss) income before taxes 173,846 73,729 (743,317) (495,742)
=========== ======== =========== ===========
Corporate assets 1,016,873
Identifiable assets 9,422,323 176,687 1,088,294 10,687,304
Intersegment assets (3,088,563) - - (3,088,563)
----------- -------- ----------- -----------
Total identifiable assets $ 6,333,760 $176,687 $ 1,088,294 $ 8,615,614
=========== ======== =========== ===========
Gross additions to property and equipment:
Identifiable $ 406,939 $ 21,890 $ 26,892 $ 455,721
----------- -------- ----------- -----------
Depreciation and amortization:
Identifiable $ 420,604 $ 20,269 $ 404,521 $ 845,394
=========== ======== =========== ===========
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31, 1998
---------------------------------------------------------------------
Communication Government Paragon
Products Products Audio
Division Division Visual Ltd. Total
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 8,860,852 $1,549,730 $ 6,041,787 $16,452,369
Intersegment revenues (118,620) - - (118,620)
----------- ---------- ----------- -----------
Total Revenues 8,742,232 1,549,730 6,041,787 16,333,749
Operating (loss) income 174,916 107,423 (3,412,991) (3,130,652)
Intersegment expenses (412,273) - 412,273 -
----------- ---------- ----------- -----------
Total (loss) income before taxes (237,357) 107,423 (3,000,718) (3,130,652)
=========== ========== =========== ===========
Corporate assets - - - 958,566
Identifiable assets 7,935,721 370,587 1,541,808 9,848,116
Intersegment assets (2,174,734) - - (2,174,734)
----------- ---------- ----------- -----------
Total identifiable assets $ 5,760,987 $ 370,587 $ 1,541,808 $ 8,631,948
=========== ========== =========== ===========
Gross additions to property and equipment:
Identifiable $ 290,121 $ 142,485 $ 73,010 $ 505,616
----------- ---------- ----------- -----------
Depreciation and amortization:
Identifiable $ 337,692 $ 28,497 $ 505,976 $ 872,165
=========== ========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1997
---------------------------------------------------------------------
Communication Government Paragon
Products Products Audio
Division Division Visual Ltd. Total
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $9,734,088 $2,372,950 $ 164,019 $12,271,057
Operating income (loss) 574,789 806,011 (13,581) 1,367,219
Identifiable assets 9,885,518 367,113 1,165,543 11,418,174
Corporate assets - - - 791,567
---------- ---------- ---------- -----------
Total assets 9,885,518 367,113 1,165,543 12,209,741
========== ========== ========== ===========
Gross additions to property and
equipment:
Identifiable 592,150 36,757 - 628,907
Corporate - - - 72,622
---------- ---------- ---------- -----------
Total $ 592,150 $ 36,757 $ - $ 701,529
========== ========== ========== ===========
Depreciation and amortization:
Identifiable $ 299,623 $ - $ 609 $ 300,232
========== ========== ========== ===========
</TABLE>
The Company is engaged primarily in the development, manufacture, and sale
of optical fiber communications products and laser systems. Revenue
represents shipments and services provided to third parties. Contract costs
and operating expenses directly traceable to individual segments were
deducted from revenue to arrive at operating income. Identifiable assets by
segment are those assets that are used in the Company's operations in each
segment. Corporate assets consist primarily of cash, prepaid expenses,
deferred taxes, and long-term assets.
47
<PAGE>
15. SIGNIFICANT CUSTOMERS AND FOREIGN EXPORTS
The Company does most of its business with commercial customers with some
sales to the U.S. Government and its prime contractors. In 1999, one
commercial customer accounted for 10% of sales and one accounted for 7%. No
other customer accounted for more than 5% of sales. In 1998, one commercial
customer accounted for 14% of sales and no other customer accounted for
more than 5%. In 1997, two commercial customers each accounted for 10% and
one customer accounted for 7%. Included in revenues are export sales of
$3,094,897, $2,097,000 and $2,130,000 for 1999, 1998 and 1997,
respectively. The Company has operations in England through its Paragon
Audio Visual, Ltd. subsidiary and it had sales of $3,196,088 for 1999 and
$6,042,000 for 1998 (see Note 2). Long-lived assets reported for the
Paragon segment are located in the United Kingdom. All other long-lives
assets are located in the United States.
16. EFFECT OF NEW ACCOUNTING PROUNCEMENTS
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities", (as amended by SFAS No. 137). This
statement requires companies to record derivatives on their balance sheet
as assets or liabilities, measured at fair value. Gains or losses resulting
from changes in the values of those derivatives would be accounted for
depending on the use of the derivative and whether it qualifies for hedging
accounting. SFAS No. 133 will be effective for the Company's fiscal year
ending December 31, 2001. The Company had no derivative or hedging activity
in any of the periods presented. The Company has not determined the impact,
if any, of these standards on its financial position or results of
operations.
* * * * * *
48
<PAGE>
SCHEDULE II
OPTELECOM, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1997, AND 1996
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Balance Charged to Balance
At Beginning Costs and at End
Description of Period Expenses Deductions of Period
<S> <C> <C> <C> <C>
Year Ended December 31, 1997
Reserves and allowances deducted
from assets accounts:
Obsolescence reserve for
Inventory $ 76,249 $ 88,466 $ (72,031) $ 92,684
Allowance for uncollectible
Accounts receivable 78,186 (15,000) (11,649) 51,537
Year Ended December 31, 1998
Reserves and allowances deducted
from asset accounts:
Obsolescence reserve for
Inventory $ 92,684 $292,790 $ (21,339) $364,135
Allowance for uncollectible
Accounts receivable 51,537 250,695 - 302,232
Year Ended December 31, 1999
Reserves and allowances deducted
from asset accounts:
Obsolescence reserve for
Inventory $364,135 $107,180 $ (60,037) $411,278
Allowance for uncollectible
Accounts receivable 302,232 40,419 (224,166) 118,485
</TABLE>
49
<PAGE>
Item 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
1. Directors of the Company
See the Company's Proxy Statement, incorporated by Reference as Part III
of this Form 10-K under the heading "Proposal 1."
2. Executive Officers of the Company
See the Company's Proxy Statement, incorporated by Reference as Part III
of this Form 10-K under the heading "Proposal 1."
Item 11. EXECUTIVE COMPENSATION
See the Company's Proxy Statement, incorporated by Reference as Part III
of this Form 10-K under the heading "Summary Compensation Table."
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
See the Company's Proxy Statement, incorporated by Reference as Part III
of this Form 10-K.
Item 13. CERTAIN RELATIONSHIPS AND RELATED PARTIES
See the Company's Proxy Statement, incorporated by Reference as Part III
of this Form 10-K, under the heading "Miscellaneous".
50
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement
No. 33-53145 of Optelecom, Inc. on Form S-3 of our report dated March 7, 2000,
appearing in this Annual Report on Form 10-K of Optelecom, Inc. for the year
ended December 31, 1999.
McLean, VA
March 24, 2000
51
<PAGE>
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
1. Consolidated Financial Statements and Financial Statement Schedules
Report of Independent Certified Public Accountants
Statements
----------
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Operations for the
Years Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Comprehensive (Loss) Income for the
Years Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1999, 1998 and 1997
Summary of Accounting Policies
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule II Valuation and Qualifying Accounts, Years Ended December 31, 1999
and 1998 and 1997
Other schedules are omitted because they are not applicable or information is
shown elsewhere in the financial statements or notes thereto.
3. Exhibits
None
4. Reports on Form 8-K
None
52
<PAGE>
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.
OPTELECOM, INC.
Date: By /s/ Edmund D. Ludwig
------------------------------
Edmund D. Ludwig
Director and President and CEO
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.
OPTELECOM, INC.
Date: By /s/ Clyde Heintzelman
------------------------------
Clyde Heintzelman
Chairman
Date: By /s/ Richard C. Kreter
------------------------------
Richard C. Kreter
Director
Date: By /s/ Carl Rubbo, Jr.
------------------------------
Carl Rubbo, Jr.
Director
Date: By /s/ Thomas F. Driscoll
------------------------------
Thomas F. Driscoll
Vice President of Finance and
Administration
53
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CURRENCY> US
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<CASH> 51,314
<SECURITIES> 0
<RECEIVABLES> 2,347,211
<ALLOWANCES> (118,485)
<INVENTORY> 1,894,155
<CURRENT-ASSETS> 5,023,344
<PP&E> 3,447,055
<DEPRECIATION> (2,240,420)
<TOTAL-ASSETS> 8,615,614
<CURRENT-LIABILITIES> 4,222,761
<BONDS> 0
0
0
<COMMON> 59,817
<OTHER-SE> 2,836,803
<TOTAL-LIABILITY-AND-EQUITY> 8,615,614
<SALES> 12,636,892
<TOTAL-REVENUES> 12,636,892
<CGS> 8,375,982
<TOTAL-COSTS> 4,446,767
<OTHER-EXPENSES> 0
<LOSS-PROVISION> (185,857)
<INTEREST-EXPENSE> 309,885
<INCOME-PRETAX> (495,742)
<INCOME-TAX> (284,383)
<INCOME-CONTINUING> (211,359)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (211,359)
<EPS-BASIC> (.10)
<EPS-DILUTED> (.10)
</TABLE>
