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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, 1997
Commission File Number 0-8828
OPTELECOM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
52-1010850
(IRS employer identification number)
9300 GAITHER ROAD, GAITHERSBURG, MARYLAND 20877
(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. [ ]
At March 18, 1998, 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 $14,224,959, 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 18, 1998, the registrant had outstanding 2,032,137 shares of Common
Stock, $.03 Par Value.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K -- Proxy Statement for the 1998 Annual Meeting of
Stockholders.
Form 8-K filed on December 23, 1997 reporting acquisition of Paragon Audio
Visual Ltd.
Form 8-KA filed on February 25, 1998 reporting required financial information
from the Paragon acquisition.
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.
Through 1997, the Company was organized into three operating divisions; 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 Research and Development Division (R & D), which pursued opportunities
in application of advanced concepts to communication system technologies. At the
end of 1997, the Company disbanded the Research and Development Division. In
December 1997, the Company acquired Paragon Audio-Visual Ltd. located in the
United Kingdom. Paragon is a wholly owned subsidiary of Optelecom reporting to
CPD. Paragon designs and markets electronic communication products and systems
utilizing copper cabling as the transmission media. GPD is composed of two
operating groups, Electro/Optics (E/O) Technology and Laser Illuminator
Technology. GPD was formed in 1996 from two former divisions, R&D and GLINT.
These divisions were combined into one to provide a natural grouping of similar
operations and functions. Currently, the business addressed by the individual
groups is essentially the same as in prior years.
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 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 provides equipment
specifically designed for transmission 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 that make it unique among
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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. The Company is unable to predict future defense business
activity or the related impact on the Company's business.
Because of the advanced nature of the technology inherent in the Company's
products, the expertise of certain of the officers, managers, and directors of
the Company is one of its principal assets. In particular, Mr. Edmund D. Ludwig,
who is President, CEO and a director of the Company, as well as the managers of
the operating divisions and groups, provide the Company with important technical
expertise and have major responsibilities in managing the Company. Although the
Company pays for and is the beneficiary of $1,200,000 in insurance policies on
the life of Mr. Ludwig, the loss of his services or the services of the managers
of the operating divisions and groups, through death or otherwise, could have a
negative impact on the Company. Furthermore, because of the Company's relatively
small size, the loss of the services of certain other key employees could have a
disruptive effect on the Company's operations. On December 31, 1997, Dr. William
H. Culver, founder and Chairman of the Company, retired. Dr. Culver continued to
serve his term on the Company's Board of Directors.
On March 18, 1998, the Company had 95 employees.
The table below displays the Company's three-year revenue and operating income
(loss) by division.
1997 1996 1995
----------------- --------------- ---------------- --------------- ---------------- --------------
PRETAX PRETAX PRETAX
INCOME INCOME INCOME
OPERATING DIVISIONS REVENUE (LOSS) REVENUE (LOSS) REVENUE (LOSS)
Company $12,271,057 $1,408,393 $8,910,263 $1,075,338 $6,430,136 $(427,427)
Totals
CPD $ 9,734,088 $ 615,963 $6,453,686 $ 60,664 $5,319,556 $(470,866)
GPD
E/O TECHNOLOGY GROUP $ 688,690 $ 18,296 $ 592,981 $ (31,903) $ 395,284 $(263,930)
(formerly R&D)
PARAGON AUDIO VISUAL
LIMITED $ 164,019 $ (13,581) 0 0 0 0
R & D $(136,459) 0 0 0 0
LASER ILLUMINATOR
TECHNOLOGY GROUP
(formerly GLINT) $ 1,684,260 $ 924,174 $1,863,596 $1,046,577 $ 715,296 $ 307,369
See Note 14 to the financial statements for identifiable assets by segment.
2
GOVERNMENT PRODUCTS DIVISION (GPD)
ELECTRO/OPTICS TECHNOLOGY GROUP (FORMERLY R & D DIVISION)
INTERFEROMETRIC FIBER OPTIC GYROS (IFOGS)
The E/O Technology group's business consists of providing technology development
and engineering services to the U.S. Government and its prime contractors. This
field of investigating techniques for design and manufacture of specialized
sensing coils for fiber optic gyros is unique and has few competitors. A small
portion of revenue is also derived from sales of custom optical fiber coils for
communication applications.
In 1997, the 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
limited production. These complex coils present key technical and cost
challenges to the future of IFOG viability.
In prior years, the group's activities and major source of revenue were
concentrated on fiber optic missile payout technology, payout experiments, and
field demonstrations. These activities evolved into the development of the IFOG
coil winding capability and products. The U.S. Department of Defense (DOD) has
identified the IFOG as a critical technology that will benefit from
manufacturing technology (MANTECH) funding and, in 1993, had authorized a $15
million Air Force MANTECH program. The Company received multi-year contracts
under the MANTECH program from the Defense Advanced Projects Research Agency
(DARPA) and Honeywell, Inc. beginning in 1995. Through 1997, total funding from
these contracts was $557,228 (DARPA) and $470,476 (Honeywell) as part of the
MANTECH effort. Both the DARPA and Honeywell contracts were active through 1997
and together contributed $355,902 in revenue; these contracts are continuing in
1998 and represent $31,862 of the year-end backlog of approximately $129,003.
LASER ILLUMINATOR TECHNOLOGY GROUP (FORMERLY GLINT DIVISION)
The group derives its revenues entirely from the U.S. Government and its
agencies. 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. During 1997 and 1996, the Company
recorded revenues of $1,684,260 and $1,863,596, respectively under the contract;
the Company anticipates additional refurbishment requirements in succeeding
years. Backlog at the end of 1997 was $425,862. Continued revenue under the
contract is highly dependent on the continued requirements of the United States
Air Force.
3
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, video signal transmission equipment for financial
brokerage desks, and communications systems for highway traffic monitoring and
advanced air traffic control video monitor displays. In 1997, CPD order booking
levels and shipments increased significantly, resulting in a substantial profit.
BUSINESS ACTIVITY 1997 1996 CHANGE
Order Booking $10.68 million $6.03 million +77%
Shipments $ 9.83 million $6.45 million +52%
The Division's year-end backlog was approximately $1,255,478, up from $417,000
at year-end 1996.
PRODUCT MIX SALES ANALYSIS
Although revenues from sales of data products increased in terms of absolute
dollars, they continued a decreasing trend as a portion of total revenues, due
to our increased emphasis on video products for the transportation market. Sales
of RGB video systems (i.e., Red, Green, Blue - a transmission standard for high
quality video displays) increased during the year with continued business
providing terminal display communications equipment used in trading floor
workstations for a major New York City investment bank. Products transmitting
closed circuit TV (CCTV) video using Optelecom's proprietary pulse frequency
modulated (PFM) technology continued strong sales with installation of systems
in new intelligent transportation systems (ITS) projects for state Departments
of Transportation in Florida and California. The percentage of sales decreased
in 1997, but the relative dollar volume increased. Sales of ancillary products
such as cables, connectors, and custom-engineered communication products
increased somewhat slightly, since many customers ordered complete system
configurations rather than procuring individual items from multiple vendors. The
following table summarizes sales by product line as a percentage of total sales:
COMMUNICATION FIBER OPTIC PRODUCT CATEGORIES 1997 1996 1995
Data Transmission Products 25% 29% 32%
High Resolution RGB Video 22% 18% 9%
Standard PFM Video 34% 42% 50%
Cables/Connectors 8% 3% 2%
Other 11% 8% 7%
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MARKET MIX ANALYSIS
The mix of CPD product sales for different market segments over the last three
years was as follows:
MARKETS 1997 1996 1995
Government 22% 18% 11%
Industrial (including process control) 11% 21% 18%
International 22% 19% 16%
Commercial Integrators and Resellers 45% 42% 55%
The proportion of sales to government organizations increased to 22% due to our
focus on selling Commercial Off-The-Shelf (COTS) products into military
communications applications. Although down as a percent of total revenue,
process control and industrial sales increased in absolute dollars, primarily
due to increased sales to Optelecom's major OEM customer. International sales
increased slightly, reflecting Optelecom's increased emphasis on Europe and
Pacific Rim countries. Currently, Optelecom has a sales presence in 19 countries
through distributors and resellers. Revenue from commercial integrators and
resellers increased over 1996. This reflects a joint effort by internal sales
force and system integrators for a "consultative" sales approach to properly
specify and apply highly technical products in the intelligent transportation
control and surveillance market segments.
CUSTOMER MIX ANALYSIS
In 1997, the mix of customer types changed compared to 1996. OEM sales as a
percentage of total revenue was 11%, compared to 26% in 1996, and 21% in 1995.
Of the total revenue, 42% was generated by sales to the top 10 customers for the
division; in 1996 the figure was 50%.
FINANCIAL INFORMATION RELATING TO COMPANY SPONSORED
RESEARCH AND DEVELOPMENT 1997 1996 1995
Expenditures on Company sponsored research and development
activities $874,134 $517,654 $538,977
Research and Development expense for 1997 had significant increases over 1996
and a variety of factors contributed to that increase. The Company invested over
$170,000 in engineering work for air traffic control systems which resulted in
approximately $900,000 in revenue for 1997 and has notable future business
potential. The Engineering Group continues to modify the trading floor video for
our financial market products and the expenditures in 1997 were $70,000 with
overall revenues of $800,000 in this area. The major effort in the engineering
area was in compressed digital video development. This has been the major focus
of expenditures in 1997 with approximately $250,000 in disbursements. The
current product release has occurred in 1998 and market acceptance has yet to be
determined. However, the capabilities we have achieved by this product
development have improved our current products. The balance of the engineering
effort has been directed to the ongoing upgrade and improvement of our current
product line.
5
MARKETING
GOVERNMENT PRODUCTS DIVISION
E/O TECHNOLOGY GROUP
The group markets its services to both Government and commercial customers.
However, for the past four 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
our 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 we see receiving continued focus amid shrinking
defense spending. As a result of our efforts, we have developed a growing
revenue base in manufacturing custom optical gyro coils on a contract basis for
a variety of Government contractors. We continue to seek to develop other new
markets for the group's services and products in these technical areas.
LASER ILLUMINATOR TECHNOLOGY GROUP
The sole customer for this division is the Warner-Robins Air Logistics Support
Center of the U.S. Air Force. Optelecom maintains a very close working
relationship with the individual component item managers assigned at
Warner-Robins and the operations group at Hurlburt Field, Florida. The Company
insures that these support personnel fully understand Optelecom's capabilities
and capacity to perform the required work. Bids are carefully reviewed to be
sure that the customer's requirements are satisfied. The value of this approach
to a working relationship can be judged by the receipt in 1996 of a four year,
$6.5 million dollar contract to provide training and equipment refurbishment
services for the C-130 Gunship GLINT laser illuminator system. We are attempting
to develop business servicing other similar electro-optic systems installed on
the Gunship.
COMMUNICATION PRODUCTS DIVISION
In 1997, the Company invested heavily in the Communication Products Division.
This is a continuation of the Company's strategy of re-positioning from a
Government contractor to the commercial communication product market. Staffing
levels increased in engineering, sales and production departments. This enabled
Optelecom to substantially increase sales as well as achieve a significant
increase in new product development activities. Continued investment was made in
the manufacturing area, which increased our internal manufacturing capability
without sacrificing targeted gross margins. Engineering capabilities have
increased with the hiring of engineers who have a knowledge base that was
previously outsourced.
PARAGON
The addition of Paragon as an operating group allows Optelecom to address the
copper-wire markets for audio, video and data products. This acquisition
provides Optelecom with additional products and expertise that can be offered to
our current customers as well as total high bandwidth information systems
solutions to financial trading organizations and other users of video terminal
equipment.
6
MANUFACTURING PROCESSES
QUALITY ASSURANCE
Beginning in mid-1995, 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,
which design and manufacture products). In June 1996, all operating divisions of
the Company received certification to the standard. Our U. K. subsidiary,
Paragon, outsources all of its manufacturing to specialized manufacturers and it
does not maintain manufacturing facilities. It is, however, seeking
certification to the requirements 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 for Smiths
Industries. Additional work in this area through 1995 was conducted to develop a
winding machine concept directed toward automated techniques for fabricating
similar fiber gyro coils. Currently, three machines are employed in satisfying
contract winding production requirements. The number of companies from which the
group obtains raw materials and optical fiber to meet these requirements is
limited, however the Company does not anticipate any problems with adequate
supplies.
LASER ILLUMINATOR TECHNOLOGY GROUP
Optelecom has 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.
COMMUNICATION PRODUCTS DIVISION
The Company performs routine and specialized manufacturing, assembly, and
product testing functions in its corporate headquarters. In past years, routine
fabrication had been subcontracted to other manufacturers. During 1995, the
Company purchased, installed and placed into service equipment which
automatically assembles components onto printed circuit boards at high speed.
This action was taken to lower manufacturing costs and reduce the time-to-market
for new product designs. The success of this decision has been apparent in the
significant manufacturing cost reduction realized on all assemblies produced
using the equipment. 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
7
assemblies is limited. However, Optelecom has negotiated long-term supply
contracts with these vendors and does not anticipate significant supply
problems.
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 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 it can compete
equally.
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.
The Laser Illuminator Technology group is a sole-source provider of the products
it supplies to the U.S. Air Force. Optelecom is not aware of any competition in
this market.
SEASONALITY
The Company's products are based on communications equipment technology. As
such, seasonality does not materially affect our 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 business imposed by patents of other parties.
RECENT DEVELOPMENTS
Effective December 12, 1997, the Company completed the purchase of Paragon Audio
Visual Limited, a United Kingdom company ("Paragon"), and Paragon is now an
indirect, wholly-owned subsidiary of the Company. The consideration paid by the
Company in the purchase
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aggregated $4.422 million, consisting of $2.5 million in cash and 171,252 shares
of Common Stock valued at $1.625 million plus acquisition costs. The SEC Form
8-K describing this transaction in greater detail was filed on December 23,1997.
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 which 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 allows for the transmission of high-resolution video, voice and
data signals without noticeable signal degradation. Paragon has been most 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.
The results of Paragon operations during 1997 were not material to Optelecom's
revenue or net income.
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.
ITEM 2. PROPERTIES
In 1992, the Company moved its operations to new leased facilities at 9300
Gaither Road, Gaithersburg, Maryland, near Washington, DC. The facilities
consist of space in two adjacent buildings, one occupying 21,000 square feet,
with a ten-year lease term, beginning September 1, 1992, and the other occupying
4,000 square feet, with a one-year term, beginning in December, 1992, and
one-year renewal options. Current monthly rent is $17,079 on the larger space
and $2,662 on the smaller one. On September 1, 1997, Optelecom rented additional
space of 8,056 square feet co-located with its existing facilities. Current
monthly rent on this space is $5,035. All of the facilities are in good repair
and are adequate for the Company's current production requirements. Paragon
facilities consist of approximately 2,500 square feet of office space at $5,125
per month. Their current lease expires as of April 1998 and negotiations are in
place for a new facility.
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ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1997 to a vote of
security-holders.
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 three years ended December 31, 1997, 1996 and 1995, respectively. The quoted
prices are reflective of a three-for-two common stock split issued to
shareholders of record on November 17, 1997 Such quotations do not necessarily
reflect actual transactions.
Bid Price
Quarter Ended High/Low
December 31, 1997 10 1/8 - 6
September 30, 1997 12 - 11 11/16
June 30, 1997 9 3/8 - 9 3/16
March 31, 1997 8 5/16 - 6 7/8
December 31, 1996 8 5/8 - 3 7/16
September 30, 1996 4 1/4 - 2 1/4
June 30, 1996 4 7/16 - 2 7/16
March 31, 1996 3 3/8 - 1 13/16
December 31, 1995 2 - 1 11/16
September 30, 1995 2 3/4 - 1 15/16
June 30, 1995 3 3/16 - 1 15/16
March 31, 1995 2 3/4 - 2
On December 1, 1997, the Company declared a 50% stock dividend that was effected
through a three-for-two stock split.
There are approximately 1,095 record-holders of the Common Stock as of March 18,
1998.
The Company has not declared any cash dividends to date and does not expect to
do so in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
Set forth below is selected financial data for the Company's most recent five
fiscal years. Earnings per share for 1997-1993 have been restated to reflect the
adoption of SFAS No. 128 in December 1997 and a three-for-two stock split
declared in November 1997. The 1997 data is reflective of the December 1997
acquisition of Paragon.
YEAR ENDED DECEMBER 31,
1997 1996 1995 1994 1993
------------------ ------------------ ----------------- ------------------ ----------------
Net Revenue $12,271,057 $8,910,263 $6,430,136 $7,036,069 $7,083,229
Net (Loss) Income $948,729 $722,081 $(208,384) $382,347 $95,633
Basic Earnings (Loss) per $0.51 $0.41 $(0.12) $0.25 $0.06
Common Share
Diluted Earnings (Loss) per $0.48 $0.39 $(0.12) $0.25 $0.06
Share
Total Assets $12,209,741 $4,466,463 $3,674,004 $3,617,298 $3,115,032
Long-Term Obligations $2,291,668 $11,607 $46,426 ------ ------
Stockholders' Equity $5,799,819 $3,041,631 $2,188,777 $2,384,303 $1,981,821
Cash Dividends Declared per ------ ------ ------ ------ ------
Common Share
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FINANCIAL CONDITION
Due to the nature of the Company's business, the key components of its financial
condition constitute receivables, inventory, fixed assets, accounts payable, and
debt. The Company saw an increase in net worth to $5,799,819 in 1997. Prior year
trends of key financial indicators show a change in corporate net worth of
$3,041,631 for 1996 compared to $2,188,777 in 1995. The 1997 current ratio
decreased to 1.44 from 2.95 in 1996 and 2.33 in 1995. This was due to increases
in current note payable, trade payables, and the dilutive effect of the Paragon
acquisition on the current ratio.
Total corporate accounts receivable including Paragon were $3,102,904. Year-end
1997 billed accounts receivable was $3,052,207. Billed accounts receivable were
$1,324,564 at year-end 1996 and $1,475,429 in 1995. The increase in accounts
receivable was due to the general increase in business and the addition of
Paragon's receivable base. In 1997, outstanding days for receivables was 58
days. Accounts receivable outstanding averaged 52 days in 1996, and 69 days in
1995. The increase in days receivable occurred primarily because of extended
payment terms requested by some of our larger customers. Optelecom continues to
maintain an aggressive accounts collection program. Bad debt write-offs
represent less than 1/10 of one percent of the total yearly revenues. The low
level of bad debts is due partly to the percentage of business the Company does
with the U.S. Government and Fortune 500 companies. The Company also uses a
careful screening process and performs credit qualification of customers before
accepting their
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orders. For any new account, credit checks are always conducted, and
questionable situations are either placed on a COD or a letter of credit basis.
Accounts receivable is closely monitored; those that are delinquent are
continuously contacted until payment is received.
The overall composition of the inventory has changed somewhat over the last
three years as shown in the following chart: (Paragon inventory is included
which is composed solely of finished goods.)
INVENTORY COMPOSITION 1997 1996 1995
Production Materials $499,084 $ 765,783 $ 549,277
(net of allowance)
Work In Process $455,648 $ 397,123 $ 153,203
Finished Goods $798,141 $ 342,062 $ 377,861
-------- ---------- ----------
TOTAL $1,752,873 $1,504,968 $1,080,341
One of the tools the Company uses for trend analysis is a comparison of our
inventory levels to total sales. In 1997, this level was 14% compared to 17% in
1996 and 17% in 1995. The value of the raw material and work in process
inventory decreased by approximately $208,174 in 1997 compared to 1996. The
small increase in 1997 work in process reflects orders to be shipped in early
1998. The increase in Finished Goods reflects growth in CPD inventory and the
addition of the Paragon inventory $181,077. Although our objective is to reduce
inventory levels as much as possible, the value of finished goods inventory
increased substantially in 1997 to provide products available from stock. This
action was taken to meet competitive pressures, as customers are demanding
shorter product delivery times. The Company has reduced the amount of raw
material inventory to partially offset the higher level of finished goods
inventory. The Company believes that its reserve for inventory obsolescence is
adequate to properly value any excess quantities of this inventory.
In 1997, fixed asset additions, excluding the Paragon acquisition, were $701,529
compared to $219,119 in 1996 and $287,854 in 1995.
RESULTS OF OPERATIONS
Consolidated 1997 revenues were 38% higher than 1996 and 91% higher than 1995.
Consolidated 1997 revenues include $164,040 from Paragon subsequent to the
December 12, 1997 acquisition date. A net profit of $948,729 which represented
8% of revenue for 1997, compares to a net profit of $722,081 (8%) for 1996, and
loss of $(208,384) for 1995. Reasons for these changes are explained below.
GOVERNMENT PRODUCTS DIVISION (GPD)
ELECTRO/OPTICS TECHNOLOGY GROUP
E/O Technology Group's 1997 revenues increased 16% compared to 1996. The
increase occurred primarily due to additional work from DARPA and Honeywell
Systems and contract coil winding work. We believe that the unique work
performed by this group may have enough market potential to maintain break-even
or profitability in 1998. Revenue for the last three years was $688,690 in 1997,
$592,981 in 1996, and $395,284 in 1995. Comparable period profits (losses) were
$17,264, $(31,903), and $(263,930).
12
COST OF SALES
The cost of sales as a percent of revenue has decreased significantly due an
increase in revenue as mentioned above and a decrease in overhead costs as
discussed below. Given below are the last three years' results:
COST COMPARISON 1997 1996 1995
Cost of Sales $535,504 $501,148 $440,411
Gross Sales $688,690 $592,981 $395,284
Cost as a Percent of Revenue 78% 85% 111%
OVERHEAD AND G&A
OVERHEAD
Overhead costs for the E/O Technology group were $291,606 in 1997, $297,862 in
1996 and $316,493 in 1995. Overhead expenses have decreased due to lower labor
costs within the group and a lower corporate expense allocation. The allocated
costs are apportioned as a percent of floor space assigned to revenue generating
activities and have been reduced as the group's facility space requirements have
been optimized to meet their current needs.
G&A
G&A expenses for the division were $118,546 in 1997, $143,982 in 1996 and
$218,801 in 1995. These numbers reflect a lower expense in 1996, due to a
reassignment of some of the activities of the management personnel from
divisional work to the corporate area.
LASER ILLUMINATOR TECHNOLOGY GROUP
1997 was another very successful year for this group. The Air Force will require
ongoing support for the GLINT laser illuminator system for at least the next
several years. While it is difficult to quantify the level of potential
business, it is likely that Optelecom will provide products and maintenance
support during that period. Revenue for 1997 was $1,684,260 compared to
$1,863,596 in 1996 and $715,296 in 1995. Net profits were $712,987 for 1997,
$1,046,577 for 1996, and $307,369 for 1995. The slight decrease in the level of
revenue in 1997 compared to 1996 was due to fewer Air Force requirements based
on the number of serviceable aircraft. In 1996, contract work consisted of
refurbishment of complete illuminator systems; in 1995, work consisted
essentially of fabrication of spare laser arrays, with a small additional effort
associated with contract development work.
COST OF SALES
Although overhead costs for the three-year period were relatively constant, the
large increase in revenue in 1997 and 1996 caused the cost of sales as a percent
of revenue to decrease compared to 1995. The lower percentage cost is also due
to manufacturing efficiencies and lower part cost.
COST COMPARISON 1997 1996 1995
Cost of Sales $466,160 $572,142 $305,769
Gross Sales $1,684,260 $1,863,596 $715,296
Cost as a Percent of Revenue 28% 31% 43%
13
OVERHEAD
Overhead costs for the GLINT Division were $105,936 for 1997 compared to
$112,099 for 1996 and $118,197 for 1995. Overhead expenses have remained
relatively stable for the last several years due to stable work force and
facility size.
G&A
The general and administrative expenses were $293,924 in 1997, $244,875 in 1996
and $102,158 for 1995. The increase over 1996 and 1995 reflects higher corporate
allocation, which is apportioned on the basis of percent revenue compared to
corporate revenue.
RESEARCH AND DEVELOPMENT DIVISION (R&D)
In 1997, Optelecom started a separate development project distinct from all
other company activities to work on a new telecommunications product. This
effort had no revenues and incurred $(136,459) in cost. Work in this area was
discontinued at the end of 1997.
COMMUNICATION PRODUCTS DIVISION (CPD)
In 1997, the Communication Products Division revenues increased by 51% over 1996
and resulted in an operating profit of $615,963 compared to a profit of $60,664
in 1996. The product sales mix was more favorable in 1997, with system
integrator sales up significantly and low margin product sales down compared to
1996. New products in fiber optic trader desk and air traffic control video
monitors and lower cost designs helped increase revenues. The Company was
successful in implementing product designs specifically intended to be produced
by automatic assembly processes to minimize direct costs. Revenues and profits
generated by Paragon were insignificant to the Division's and Company's
consolidated results of operations for the year.
COST OF SALES
Cost of Sales is the sum of direct costs to produce the product and overhead
costs. Although the comparative direct costs rose slightly as a percent of
revenue (see discussion below), the Company did not have to discount prices as
much as in 1997 to achieve these sales, therefore the relative cost of sales
declined compared to 1996.
COST COMPARISON 1997 1996 1995
Cost of Sales $5,346,446 $3,796,628 $3,595,328
Gross Sales $9,734,088 $6,453,685 $5,319,556
Cost as a Percent of Revenue 55% 59% 68%
14
DIRECT COSTS
In 1997, direct costs increased slightly in relation to revenue. This reflected
the impact of the introduction into manufacture of several new products which
required some design changes to meet all performance criteria. However, the cost
to produce products continued to decrease due to the investment in automated
manufacturing facilities. As more of our product designs evolve toward automated
assembly, our ability to successfully compete at lower sale prices will continue
to improve.
DIRECT COSTS VERSUS SALES 1997 1996 1995
Direct Costs $4,262,434 $2,773,182 $2,472,318
Percent of Sales 44% 43% 46%
OVERHEAD
Overhead costs include facilities costs, indirect labor costs in manufacturing,
applied overhead, and inventory write-offs. In 1997, overhead cost as a percent
of sales fell by 5% due to an increase in sales which resulted in positive
manufacturing efficiencies and greater applied overhead. Absolute overhead costs
increased in 1997 by approximately $60,566 compared to 1996. Included below is a
comparison of overhead costs for the past three years:
COST COMPARISON 1997 1996 1995
Overhead Costs $1,084,012 $1,023,446 $1,103,323
Overhead Costs as a Percent of Revenue 11% 16% 20%
APPLIED OVERHEAD
Applied overhead allocates costs in overhead to a final product. The Company
uses a computation method in which overhead costs are divided by direct labor
costs. This establishes the percent of overhead costs to be applied to the final
product. Examples of these costs include rent, utilities, telephone, inventory
variances, and depreciation of production capital equipment costs. Applied
overhead amounts for the past three years were $(892,503) in 1997, $(593,871) in
1996, and $(571,837) in 1995.
INVENTORY WRITE-OFFS
Direct inventory write-offs decreased slightly in 1997 to $72,031 compared to
$113,250 in 1996 and $92,119 in 1995. Generally, these write-offs are due to
engineering changes, which result in obsolete raw materials and subassemblies
used on products we no longer intend to sell, and also to overstocking of
particular items. Although we make every attempt to minimize obsolete inventory,
the rapid engineering evolution of our product line and the changes in our
product mix makes some obsolescence unavoidable. Inventory reserves have
increased in relative dollar amounts due to the increase in sales and
production.
15
G&A
General and Administrative costs consist primarily of expenses related to sales,
marketing and engineering activities and other administrative operational costs.
Commercial Product engineering development costs have increased, reflecting
increased staff size and workload. During 1997, development focussed on
additions to the product line for compressed digital video equipment and air
traffic control equipment. The three-year record of these engineering costs
(exclusive of fringe) is $833,586 in 1997, $475,399 in 1996 and $489,771 in
1995. The Company implemented changes to the sales and marketing staff to more
closely align the technical aspects of the selling process with customer
requirements and also changed the corporate management staff to strengthen the
division's efforts. Advertising costs increased substantially in 1997. These
costs include advertising in trade magazines, participation in trade shows and
product literature, including catalogs and specification sheets. Compared to
prior years, the type of advertising changed as a result of a redirection of our
advertising emphasis. Advertising expenditure increases occurred mainly in the
areas of magazines and trade shows. The costs of advertising and other marketing
efforts for the last three years were $280,106 in 1997, $115,073 in 1996 and
$255,675 in 1995. The cost of this effort as well as profit sharing expenses and
reserves for bad debt are reflected in the increased G&A expenses for this year,
which were $3,713,017. Prior-year costs were $2,596,398 in 1996 and $2,205,094
in 1995.
OTHER OPERATING EXPENSES
CORPORATE
Income tax expense (benefit) was $418,490 in 1997, $310,136 in 1996 and
$(233,756) in 1995. This reflects the Company's continued profitability. The
effective tax rate was 31% in 1997 and 30% in 1996. In 1995 the effective tax
rate was (53%) as a result of the net operating loss during the year. The
effective tax rate is positively influenced by increased overseas sales, since
certain tax advantages can be realized through our Foreign Sales Corporation
(FSC).
Interest expense was $19,653 in 1997 compared to $19,460 for 1996 and increased
from $3,763 in 1995. The majority of the interest expense, $11,000 in 1997, is
reflective of increased borrowings related to the Paragon acquisition.
IMPACT OF INFLATION
Inflation has not had any significant effect on the operations of the Company
during 1997, and we do not expect it to have any significant effect during 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements are largely generated by working capital
needs. These needs are primarily focussed on financing inventories and accounts
receivable. In 1997, net cash provided by operating activities was $526,794
compared to $387,304 in 1996. In 1995, as a result of a net operating loss and
increases in inventory balances, net cash used in operational activities was
$(110,497). Non-cash outlays such as depreciation and amortization were $300,232
in 1997.The depreciation for 1996 was $235,431and $213,470 in 1995. Cash used in
investing activities in 1997 was $3,447,935, and included expenditures of
$2,791,620 for Paragon, capital equipment for manufacturing operations, facility
upgrades, and general office equipment. To finance these activities, Optelecom
used existing cash flows, borrowing in short term notes, long term borrowings
for equipment and a new $2.5 million debt agreement to finance
16
the purchase of Paragon. No other material changes in cash flow are expected.
The Company has the ability, provided there are sufficient eligible receivables,
to borrow up to $1,250,000 under its line of credit as of December 31, 1997. The
Company also has the ability to borrow funds for specific capital asset
purchases to a maximum of $150,000 from a local bank. Loans for these assets are
collateralized by the specific equipment asset and payable over no more than
five (5) years. At the end of 1997, the outstanding balance under the line of
credit agreement was $300,000 and no accounts were outstanding under the
available equipment loan.
On December 31, 1997, the Company's subsidiary, Paragon, had been advanced
$363,000 under a factoring agreement. In February 1998, the Company terminated
the factoring agreement and settled all outstanding liabilities under the
agreement. 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. The expectation is that it will operate off
its own line of credit. 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.
YEAR 2000
Many of the world's computer systems currently record years in a two-digit
format. Such computer systems will be unable to properly interpret dates beyond
the year 1999, which could lead to business interruptions. Optelecom has
established an internal committee to address this problem.
The Company is currently engaged in a comprehensive project to upgrade its
information, technology, and manufacturing and facilities computer software to
programs that will consistently and properly recognize the Year 2000. Many of
the Company's systems include new hardware and packaged software recently
purchased from large vendors who have represented that these systems are already
Year 2000 compliant. The Company is in the process of obtaining assurances from
vendors that timely updates will be made available to make all remaining
purchased software Year 2000 compliant.
The Company will utilize both internal and external resources to preprogram or
replace and test all of its software for Year 2000 compliance, and the Company
expects to complete the project in early 1999. The estimated cost of this
project is not deemed to be significant. This cost is being funded through
operating cash flows. Failure by the Company and/or vendors and customers to
complete Year 2000 compliance work in a timely manner could have a material
adverse effect on certain of the Company's operations.
17
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
OPTELECOM, INC.
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31,
1997 AND 1996, AND THE
THREE YEARS ENDED DECEMBER 31, 1997,
AND INDEPENDENT AUDITORS' REPORT
18
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, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. 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 at December 31, 1997
and 1996, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1997, 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
Washington, DC
March 20, 1998
OPTELECOM, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
ASSETS 1997 1996
CURRENT ASSETS:
Cash and eash equivalents $ 242,656 $ 266,575
Restricted cash (Note 13) 728,000 -
Accounts and contracts receivable (Note 3) 3,102,904 1,463,426
Note receivable - related party (Note 16) 40,000 -
Inventories (Note 4) 1,752,873 1,504,968
Prepaid expenses and other assets 334,530 306,620
Deferred tax asset 200,874 66,145
----------- -----------
Total current assets 6,401,837 3,607,734
INTANGIBLE ASSETS - Net of accumulated amortization
of $10,938 (Notes 2 and 5) 2,614,062 -
GOODWILL - Net of accumulated amortization of $8,259 (Note 2) 1,914,785 -
PROPERTY AND EQUIPMENT - At cost less accumulated
depreciation (Note 6) 1,265,550 779,053
DEFERRED TAX ASSET 13,507 79,676
----------- -----------
TOTAL ASSETS $12,209,741 $ 4,466,463
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Demand note payable to bank $ 300,000 $ -
Accounts payable 1,640,460 591,682
Payable under factoring agreement (Note 13) 362,868 -
Accrued payroll 266,936 127,172
Accrued annual leave 138,661 104,788
Income taxes payable (Notes 11 and 13) 728,000 -
Other current liabilities 300,384 362,808
Current portion of notes payable (Note 8) 208,332 34,819
----------- -----------
Total current liabilities 3,945,641 1,221,269
----------- -----------
LONG-TERM LIABILITIES:
Notes payable (Note 8) 2,291,668 11,607
Deferred rent liability 172,613 191,956
----------- -----------
Total long-term liabilities 2,464,281 203,563
----------- -----------
COMMITMENTS AND CONTINGENCIES - -
Total liabilities 6,409,922 1,424,832
----------- -----------
STOCKHOLDERS' EQUITY (Note 9):
Common stock, $.03 par value - shares authorized,5,000,000;
issued and outstanding,2,032,137 and 1,207,574 shares 60,964 36,227
Discount on common stock (11,161) (11,161)
Additional paid-in capital 3,812,638 2,027,916
Retained earnings 1,937,378 988,649
----------- -----------
Total stockholders' equity 5,799,819 3,041,631
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $12,209,741 $ 4,466,463
=========== ===========
See notes to consolidated financial statements.
20
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
- --------------------------------------------------------------------------------
1997 1996 1995
REVENUE:
Product sales $11,582,367 $8,317,282 $6,034,852
Engineering services 688,690 592,981 395,284
----------- ---------- ----------
Total revenue 12,271,057 8,910,263 6,430,136
----------- ---------- ----------
COSTS AND EXPENSES:
Direct labor 305,451 267,509 211,419
Other direct costs 4,807,314 3,169,004 2,582,075
Overhead 1,505,337 1,433,410 1,538,015
General and administrative 4,244,562 2,965,002 2,526,054
----------- ---------- ----------
Total costs and expenses 10,862,664 7,834,925 6,857,563
----------- ---------- ----------
Income (loss) from operations 1,408,393 1,075,338 (427,427)
----------- ---------- ----------
OTHER EXPENSE:
Interest 19,653 19,460 3,763
Other 21,521 23,661 10,950
----------- ---------- ----------
Total other expense 41,174 43,121 14,713
----------- ---------- ----------
INCOME (LOSS) BEFORE PROVISION
(BENEFIT) FOR INCOME TAXES 1,367,219 1,032,217 (442,140)
PROVISION (BENEFIT) FOR INCOME TAXES 418,490 310,136 (233,756)
----------- ---------- ----------
NET lNCOME (LOSS) $ 948,729 $ 722,081 $ (208,384)
=========== ========== ==========
BASIC EARNINGS (LOSS) PER SHARE (Note 9) $ 0.51 $ 0.41 $ (0.12)
=========== ========== ==========
DILUTED EARNINGS (LOSS) PER
SHARE (Note 9) $ 0.48 $ 0.39 $ (0.12)
=========== ========== ==========
See notes to consolidated financial statements.
21
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
- --------------------------------------------------------------------------------
Additional Capital
---------------------------
Number Discount Total
of Common on Common Paid-in Retained Stockholders'
Shares Stock Stock Capital Earnings Equity
BALANCE, JANUARY 1, 1995 1,166,672 $35,000 $(11,161) $1,885,512 $ 474,952 $2,384,303
Common stock issued 4,370 131 - 12,727 - 12,858
Net loss - - - - (208,384) (208,384)
--------- ------- -------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1995 1,171,042 35,131 (11,161) 1,898,239 266,568 2,188,777
Common stock issued 36,532 1,096 - 129,677 - 130,773
Net income - - - - 722,081 722,081
--------- ------- -------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1996 1,207,574 36,227 (11,161) 2,027,916 988,649 3,041,631
Common stock issued from exercise of
options and for services provided 49,511 1,485 - 124,608 - 126,093
Tax effect of options exercised - - - 67,352 - 67,352
Three-for-two stock split (see Note 8) 603,800 18,114 - (18,114) - -
Issuance of common stock for acquisition
of Paragon, net of issuance costs 171,252 5,138 - 1,610,876 - 1,616,014
Net income - - - - 948,729 948,729
--------- ------- -------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997 2,032,137 $60,964 $(11,161) $3,812,638 $1,937,378 $5,799,819
========= ======= ======== ========== ========== ==========
See notes to consolidated financial statements.
22
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
- --------------------------------------------------------------------------------
1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 948,729 $ 722,081 $(208,384)
Adjustments to reconcile net incorne (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 300,232 235,431 212,470
(Gain) loss on sale of assets (15,357) - 1,821
Deferred taxes (68,560) (145,821) 18,000
Deferred rent (19,343) (13,489) (7,806)
Common stock issued for services 8,000 - 9,497
Change in assets and liabilities:
Accounts and contracts receivable (880,155) (52,217) 304,480
Income tax refund receivable - 215,693 (215,693)
Restricted cash (728,000) - -
Inventories (50,828) (424,627) (303,344)
Prepaid expenses and other assets (1,595) (197,660) (40,331)
Accounts payable 316,214 (208,727) 424,904
Accrued payroll 77,681 31,216 (4,728)
Accrued annual leave 33,873 15,578 (17,394)
Income taxes payable 728,000 - (45,000)
Other current liabilities (122,097) 209,846 (238,989)
----------- --------- ---------
Net cash provided by (used in) operating
activities 526,794 387,304 (110,497)
----------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (701,529) (219,119) (287,854)
Acquisition of Paragon, net of cash acquired (2,750,851) - -
Proceeds from sale of equipment 22,000 - -
----------- --------- ---------
Net cash used in investing activities (3,430,380) (219,119) (287,854)
----------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on note payable to bank 800,000 340,000 60,000
Payment on note payable to bank (500,000) (400,000) -
Proceeds from exercise of stock options 126,093 130,773 3,359
Repayments of long-term debt (46,426) (34,819) (23,212)
Borrowings of long-term debt 2,500,000 - 104,457
----------- --------- ---------
Net cash provided by financing activities 2,879,667 35,954 144,604
----------- --------- ---------
(Continued)
23
OPTELECOM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 (Continued)
- --------------------------------------------------------------------------------
1997 1996 1995
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (23,919) 204,139 (253,747)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 266,575 62,436 316,183
-------- -------- ---------
CASH AND CASH EQUIVALENTS,
END OF YEAR $242,656 $266,575 $ 62,436
======== ======== =========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid for interest $ 12,715 $ 24,731 $ 6,497
Cash paid for income taxes (net of refunds) $604,948 $276,477 $ 59,653
(Concluded)
See notes to consolidated financial statements.
24
OPTELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS - 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.
The Company is organized into four operating divisions: 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, the Paragon division (acquired in
December 1997), which designs and markets electronic products and
systems utilizing copper cabling, and the Raman Division, which
addresses technology development business opportunities. GPD is
composed of two operating groups, Electro/Optics (E/O) Technology and
Laser Illuminator Technology. These divisions were combined into one to
provide a natural grouping of similar operations and functions. The
principal markets for the Company's products and services are located
in California and several Southeastern and Southwestern regions of the
United States. Additionally, the Company generates a portion of its
revenues from several countries in Europe, including Paragon's
business, which is primarily in the U.K.
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
(see Note 2). 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 cost-plus-fixed-fee contracts are
recognized to the extent of costs incurred during the period plus a
proportionate amount of the fee earned. 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 and sales orders are recognized at the
time completed units are delivered.
25
Contract costs include all direct labor and material costs, all
indirect costs related to contract performance, such as indirect labor,
rent, depreciation and supplies, and selling, general and
administrative costs, such as officers' salaries and professional fees.
Provisions for estimated losses on uncompleted contracts and product
sales returns are made in the period in which such losses are
determined.
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 is
stated at cost and includes additions and major replacements and
betterments. 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.
INTANGIBLE ASSETS - The Company recorded intangible assets and goodwill
related to its December 1997 purchase transaction (see Note 2). The
purchase price allocation resulted in the recording of intangible
assets, primarily technology, trade names, customer lists, service and
supply contracts, distribution rights, and franchise agreements that
are being amortized on the straight-line method over their estimated
useful lives, which range from five to fifteen years. The Company
recorded goodwill for 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. If the
facts and circumstances indicate an asset is impaired, the asset will
be reduced to its estimated recoverable value.
RESEARCH AND DEVELOPMENT COSTS - Research and development costs are
expensed as incurred. The Company incurred research and development
costs of approximately $847,000, $518,000, and $539,000 for the years
ended December 31, 1997, 1996, and 1995, respectively.
EARNINGS PER SHARE - Effective December 31, 1997, the Company adopted
Statement of Financial Accounting Standards No. 128 (SFAS 128),
EARNINGS PER Share. Upon adoption of SFAS No. 128, the Company measures
basic and diluted earnings per share. Earnings per share for 1996 and
1995 has been restated to reflect the adoption of SFAS 128 and the
effects of a three-for-two stock split declared on November 11, 1997
(see Note 9).
INCOME TAXES - The Company recognizes income tax expense 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.
26
STOCK-BASED COMPENSATION - In 1996, the Company adopted 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 in
Note 10 pro forma disclosures of the effect on net income (loss) and
earnings (loss) 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 fiscal period. The
gains and losses that result from this process, and gains and losses on
intercompany transactions that are long-term in nature and that the
Company does not intend to repatriate, are shown in the cumulative
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.
CASH AND CASH EQUIVALENTS - For the purpose of presentation in the
statements of cash flows, cash and cash equivalents are defined as cash
and investments with original maturities of three months or less.
RESTRICTED CASH - The Company has deposited into escrow amounts that it
is obligated to pay to U.K. tax authorities resulting from its December
1997 purchase transaction (see Notes 2 and 13). Accordingly, such
amounts are classified as restricted cash.
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 December 31, 1997 and
1996, 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
year amounts to conform to current year presentation.
2. 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 the Company (see
Note 8). The acquisition was accounted for as a purchase, and the
purchase price was allocated on a preliminary basis to the net assets
acquired based upon the estimated fair value of such assets. Goodwill
recorded as a result of this
27
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.
The following supplemental unaudited pro forma information has been
prepared as though the acquisition had occurred at January 1, 1996.
1997 1996
Revenue $16,710,000 $12,355,000
----------- -----------
Net income $ 451,000 $ 294,000
=========== ===========
Per share:
Basic $ 0.25 $ 0.15
=========== ===========
Diluted $ 0.23 $ 0.14
=========== ===========
3. ACCOUNTS AND CONTRACTS RECEIVABLE
Accounts and contracts receivable at December 31, 1997 and 1996,
consisted of the following:
1997 1996
Billed $3,052,207 $1,324,564
Unbilled-net of cumulative progress billings of
$495,047 for 1997 and $283,746 for 1996 102,234 217,038
Less: Allowance for doubtful accounts (51,537) (78,176)
---------- ----------
$3,102,904 $1,463,426
========== ==========
Approximately 25%, 40%, and 26% of the Company's revenues in 1997,
1996, and 1995, 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 1993. 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.
28
4. INVENTORIES
Inventories at December 31, 1997 and 1996 consist of the following:
1997 1996
Production materials $ 591,768 $ 842,032
Work in process 455,648 397,123
Finished goods 798,141 342,062
Less: inventory allowance (92,684) (76,249)
---------- ----------
$1,752,873 $1,504,968
========== ==========
5. INTANGIBLE ASSETS
Intangible assets at December 31, 1997 consist of the following:
1997
Technology $ 750,000
Service and supply contracts 650,000
Distribution rights and franchise agreements 600,000
Customer lists 350,000
Trade names 275,000
----------
2,625,000
Less: Accumulated amortization (10,938)
----------
Total $2,614,062
==========
6. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1997 and 1996, consist of the
following:
1997 1996
Laboratory equipment $1,231,446 $ 1,113,530
Office equipment 1,070,367 695,490
Furniture and fixtures 90,756 26,366
Leasehold improvements 553,154 388,708
Motor vehicles 8,255 -
---------- -----------
2,953,978 2,224,094
Less accumulated depreciation and amortization (1,688,428) (1,445,041)
---------- -----------
Net property and equipment $1,265,550 $ 779,053
========== ===========
7. DEMAND NOTE PAYABLE TO BANK
The Company has a revolving credit agreement with a bank whereby it may
borrow up to $1,250,000 with interest at the bank's prime rate plus
1/4% (9% at December 31, 1997). The total amount of borrowings that may
be outstanding at any given time is
29
based upon a percentage of certain eligible receivables. Amounts under
the agreement are due in full on April 30, 1998 and $950,000 was
available under the credit agreement as of December 31, 1997. The
Company expects the credit agreement to be renewed for one year with
substantially similar terms.
8. NOTES PAYABLE
During 1995, Optelecom entered into a promissory note agreement of
$104,000 to finance the purchase of equipment, which serves as
collateral on the promissory note. At December 31, 1996, the
outstanding balance was $46,426, which was paid in full in March 1997.
In December 1997, Optelecom entered into a promissory note agreement to
finance the purchase of Paragon (see Note 2). The note is
collateralized by substantially all the assets and contracts of the
Company, and includes certain financial and other covenants. The
principal amount of the note is $2,500,000, which is payable in monthly
installments of $52,083 beginning in September 1998 and ending in
August 2002. Interest is payable monthly, beginning in January 1998, at
prime plus 1% (9.5% at December 31, 1997). The required principal
payments of the long-term debt are as follows:
1998 $ 208,000
1999 625,000
2000 625,000
2001 625,000
2002 417,000
Thereafter -
-----------
Total $ 2,500,000
===========
9. 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 remains at $0.03 per share
which 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 on a retroactive basis. At December 31,
1997, 338,538 shares were reserved for issuance under stock option
agreements and the employee stock bonus plan.
30
Reconciliations of the numerator and denominator for earnings per
common share and diluted earnings per common share are shown below.
1997 1996 1995
Basic Earnings Per Share:
Income available to common stockholders $ 948,729 $ 722,081 $ (208,384)
========== ========== ===========
Weighted average common and common
shares outstanding 1,845,399 1,774,880 1,755,590
========== ========== ===========
Basic Earnings (loss) per share $ 0.51 $ 0.41 $ (0.12)
========== ========== ===========
Diluted Earnings Per Share:
Income available to common stockholders $ 948,729 $ 722,081 $ (208,384)
========== ========== ===========
Weighted average common shares
shares outstanding 1,845,399 1,774,880 1,755,590
========== ========== ===========
Adjustment for exercise of options using year
end price when dilutive 143,763 53,460 --
========== ========== ===========
Diluted shares 1,989,631 1,828,340 1,755,570
========== ========== ===========
Diluted earnings (loss) per share $ 0.48 $ 0.39 $ (0.12)
========== ========== ===========
10. 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 1991 Plan superseded and
replaced the Incentive Stock Option Plan and the Non-Qualified Stock
Option Plan that the Company had in operation prior to the adoption of
the 1991 Plan. Options outstanding in prior years for the previous
plans are included in the 1991 Plan information as presented below.
The exercise price of each option may not be less than 100% of the fair
market value of the stock on the date of grant for incentive stock
options or 85% of such fair market value for nonqualified stock
options, as determined by the Board. Options issued prior to April 1,
1996 are exercisable in whole or in part any time after one year from
the date of grant. As amended in May 1996, options issued after April
1, 1996 are exercisable after one year from the date of grant and in
equal increments over four years. Options issued prior to April 1, 1996
expire three years after the date of grant and, in most cases, upon
termination of employment. Options issued after April 1, 1996, 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.
31
A summary of stock option activity during the years ended December 31,
1997, 1996, and 1995 (as adjusted for the three-for-two stock split) is
as follows:
1997 1996 1995
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
--------- -------- --------- -------- --------- --------
Outstanding, January 1 205,460 $2.78 93,750 $1.76 61,875 $2.24
Granted 126,427 8.36 151,085 3.11 41,250 1.93
Exercised 22,125 2.16 25,500 2.12 - -
Canceled 750 2.08 13,875 2.92 9,375 2.99
------- ----- ------- ----- ------ -----
Outstanding, December 31 309,012 $5.11 205,460 $2.78 93,750 $1.76
======= ===== ======= ===== ====== =====
Exercisable options 163,021 $3.10 58,875 $1.43 52,500 $2.24
======= ===== ======= ===== ====== =====
The following table summarizes information about stock options
outstanding at December 31, 1997:
Options Outstanding Options Exercisable
---------------------------------- -----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Total Life in Exercise Total Exercise
Outstanding Years Price Exercisable Price
----------- -------- -------- ----------- --------
61,500 0.9 $ 1.90 61,500 $1.90
103,500 3.5 2.68 82,125 2.56
68,585 4.1 6.72 4,396 7.25
59,002 4.7 9.14 15,000 9.75
16,425 4.8 11.24 - -
------- -------
309,012 163,021
======= =======
On December 19, 1988, the Board of Directors approved the Directors
Stock Option Plan (1988 Directors Plan) under which each nonemployee
director who attends a Board of Directors meeting is, at his election,
granted an option to purchase 500 shares of common stock in lieu of
receiving a certain dollar value of common stock. The options have an
exercise price equivalent to the market value of the stock on the date
of such Board meeting. The options were exercisable upon grant and
expire three years thereafter. This plan was terminated as of December
31, 1992, and all options granted under this plan either expired or
were exercised in 1995.
32
A summary of stock option activity during the year ended December 31,
1995 (as adjusted for the three-for-two stock split) is as follows:
1995
--------------------
Weighted
Average
Number Exercise
of Shares Price
--------- --------
Outstanding, January 1 4,495 $1.94
Granted - -
Exercised 1,998 1.38
Canceled 2,497 2.36
------ -----
Outstanding, December 31 - $ -
====== =====
On December 7, 1992, the Board of Directors approved the 1993
Directors' Stock Option Plan (1993 Directors' Plan), which replaces the
1988 Directors' Plan. Under this plan, each nonemployee 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. In February 1995, the
Board of Directors terminated this plan effective December 31, 1995,
and accordingly, no more options will be granted under this plan.
A summary of stock option activity during the years ended December 31,
1997, 1996, and 1995 (as adjusted for the three-for-two stock split) is
as follows:
1997 1996 1995
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
--------- -------- --------- -------- --------- --------
Outstanding, January 1 14,175 $2.28 41,175 $2.59 26,325 $2.98
Granted - - - - 14,850 2.29
Exercised 12,150 2.34 24,300 2.63 - -
Canceled - - 2,700 3.81 - -
------ ----- ------- ----- ------ -----
Outstanding, December 31 2,025 1.92 14,175 2.28 41,175 2.59
====== ===== ======= ===== ====== =====
Exercisable options 2,025 1.92 14,175 2.28 41,175 2.59
====== ===== ======= ===== ====== =====
33
The following table summarizes information about stock options
outstanding at December 31, 1997:
Options Outstanding Options Exercisable
---------------------------------- -----------------------
Weighted
Average Weighted
Remaining Weighted Average
Total Life in Average Total Exercise
Outstanding Years Price Exercisable Price
----------- -------- -------- ----------- --------
2,025 1.0 $1.92 2,025 $1.92
===== =====
In February 1996, the Board of Directors approved the 1996 Directors'
Stock Option Plan (1996 Directors' Plan), which replaces the 1993
Directors' Plan. Under this plan, each nonemployee 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,
1997 and 1996 (as adjusted for the three-for-two stock split), is as
follows:
1997 1996
-------------------- --------------------
Weighted Weighted
Average Average
Number Exercise Number Exercise
of Shares Price of Shares Price
--------- -------- --------- --------
Outstanding, January 1 24,000 $3.49 - $ -
Granted 32,250 8.59 24,000 3.49
Exercised 11,250 3.25 - -
Canceled - - - -
------ ----- ------ -----
Outstanding, December 31 45,000 $7.16 24,000 $3.49
====== ===== ====== =====
Exercisable options 45,000 $7.16 24,000 $3.49
====== ===== ====== =====
34
The following table summarizes information about stock options
outstanding at December 31, 1997:
Options Outstanding Options Exercisable
---------------------------------- ------------------------
Weighted
Average Weighted
Remaining Weighted Average
Total Life In Average Total Exercise
Outstanding Years Price Exercisable Price
----------- ---------- --------- ----------- -----------
9,750 3.7 $3.02 9,750 $3.02
1,500 3.8 4.42 1,500 4.42
13,500 4.1 6.48 13,500 6.48
9,000 4.5 8.75 9,000 8.75
11,250 4.9 10.65 11,250 10.65
------ ------
45,000 45,000
====== ======
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 is 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 will expire three years after
the date of grant. On the date of adoption, 5,000 options were granted
to the participant under the plan. This plan terminated on December 31,
1996, and accordingly, no more options will be granted under this plan.
A summary of stock option activity during the years ended December 31,
1997, 1996, and 1995 (as adjusted for the three-for-two stock split),
is as follows:
1997 1996 1995
------------------------- ------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
----------- ------------ ----------- --------- ---------- --------
Outstanding, January 1 5,000 $ 2.59 7,500 $ 2.89 5,000 $ 3.29
Granted - - 2,500 1.92 2,500 2.09
Exercised 2,500 1.92 2,500 2.09 - -
Canceled 2,500 3.25 2,500 3.33 - -
----- ------- ----- ------- ----- -------
Outstanding, December 31 - - 5,000 2.59 7,500 2.89
===== ======= ===== ======= ===== =======
Exercisable options - $ - 5,000 $ 2.59 7,500 $ 2.89
===== ======= ===== ======= ===== =======
In July 1991, the Board of Directors approved a special arrangement for
the granting of a total of 30,000 stock options to the Company's
president (President's Plan). Under the arrangement, the president
receives 10,000 options each year at the market price on the date of
grant. The options expire four years from the date of grant. All
outstanding options under this plan were canceled in 1996.
35
A summary of stock option activity during the years ended December 31,
1996 and 1995 is as follows:
1996 1995
------------------------- -------------------------
Weighted Weighted
Average Average
Number Exercise Number Exercise
of Shares Price of Shares Price
--------- --------- --------- --------
Outstanding, January 1 30,000 $ 2.50 30,000 $ 2.50
Granted - - - -
Exercised - - - -
Canceled 30,000 2.50 - -
------ ------- ------ -------
Outstanding, December 31 - - 30,000 2.50
====== ======= ====== =======
Exercisable options - $ - 20,000 $ 2.50
====== ======= ====== =======
In 1996, the Company 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.
If compensation cost for the Company's 1997, 1996, and 1995 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 earnings (loss) per share for the
years ended December 31, 1997, 1996, and 1995, would be as follows:
1997 1996 1995
Net income (loss) $ 948,729 $722,081 $(208,384)
As reported $ 708,932 $538,647 $(256,467)
Pro forma
Basic earnings (loss) per share
As reported $ 0.51 $ 0.41 $ (0.12)
Pro forma 0.38 $ 0.30 $ (0.15)
The weighted average fair value at date of grant for options granted
during 1997, 1996 and 1995 was $4.27, $4.66 and $2.52 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:
Expected dividend yield 0% 0% 0%
Expected stock price volatility 300% 244% 300%
Risk-free interest rate 6.12% 6.37% 5.10%
Expected option term 5 years 3 and 4 years 1 year
36
11. INCOME TAXES
The components of the provision (benefit) for income taxes for the
years ended December 31, 1997, 1996, and 1995 are summarized as
follows:
1997 1996 1995
Current $487,050 $ 455,957 $(251,756)
Deferred (68,560) 4,179 18,000
Change in valuation allowance - (150,000) -
-------- --------- ---------
$418,490 $ 310,136 $(233,756)
======== ========= =========
The Company's foreign taxable income was immaterial. 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 1995 tax provision included the benefit of the carryback
of the net loss to the prior year. 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,
1997, 1996, and 1995 are summarized as follows:
1997 1996 1995
Federal income tax (benefit) at statutory rates 34% 34% (34)%
Increase (reduction) of taxes:
State taxes, net of federal benefit 3.5 4 (7)
Valuation allowance related to net deferred tax assets - (15) (8)
Other (7) 7 (4)
---- ---- ----
Effective income tax rate 30.5% 30% (53)%
==== ==== ====
37
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, 1997 and 1996, are as
follows:
1997 1996
Deferred liabilities:
Amortization $(11,188) $ -
State taxes (10,666) (11,886)
Retainage receivable on long-term contracts (790) (24,945)
-------- --------
Gross deferred tax liabilities (22,644) (36,831)
-------- --------
Deferred tax assets:
Excess book depreciation 16,796 17,482
Capitalized overhead and inventory
obsolescence reserve 109,126 40,410
Accrued vacation 42,921 38,592
Deferral of rent expense 68,182 77,742
Warranty reserve - 8,426
-------- --------
Gross deferred tax assets 237,025 182,652
-------- --------
Net deferred tax assets $214,381 $145,821
======== ========
The Company assumed certain income tax liabilities upon the acquisition
of Paragon (see Note 13).
12. EMPLOYEE BENEFIT PLANS
The Company has a noncontributory Profit-Sharing Retirement Plan
covering substantially all employees. Vesting occurs over a period of
six 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 1997, 1996, and 1995 was $152,722, $113,329, and $-0-,
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 $83,203, $62,827, and $60,163 in 1997,
1996, and 1995, 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 1997,
1,000 shares were issued under the Plan and no shares were issued in
1996 and 1995. In the aggregate, 3,300 shares have been issued under
the Plan.
38
13. COMMITMENTS AND CONTINGENCIES
OPERATING LEASE - During 1992, the Company entered into a 10-year
noncancelable 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.
As of December 31, 1997, future net minimum rental payments required
under operating leases that have initial or remaining noncancelable
terms in excess of one year are as follows:
Year Ended December 31,
1998 $ 283,000
1999 272,000
2000 262,000
2001 228,000
2002 154,000
----------
$1,199,000
==========
Rental expense was approximately $242,000, $222,000, and $217,000 in
1997, 1996, and 1995, respectively.
EMPLOYMENT AGREEMENTS - The Company has an employment agreement with an
officer. In the event of his death while employed, the officer's salary
is to be paid to his beneficiaries for one year. Through December 31,
1995, the officer earned a bonus of 2,500 shares of common stock for
each twelve-month period of the term of employment (which began January
1, 1984), but no such stock shall be issued directly to him until
January 2, 1999. A total of 30,000 shares have been issued in trust
through December 31, 1997. All of the shares earned through December
31, 1995, are to be transferred to the officer in the future.
PARAGON ACQUISITION - In conjunction with the acquisition described in
Note 2, the Company entered into employment agreements with Paragon key
executives. Such agreements provide for minimum salary levels as well
as incentive bonuses that are payable if specified management goals are
attained. The agreements expire in December 2000, and the aggregate
commitment for future salaries as of December 31, 1997, excluding
bonuses, was approximately $1,100,000.
At the acquisition date, 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.
39
At the acquisition date, Paragon had a factoring agreement with a
financing company. Under the agreement, the financing company purchases
Paragon's accounts receivable at a discount and provides Paragon with
operating funds. Paragon incurs a liability until the purchased
accounts receivable are fully collected by the financing company. At
December 31, 1997, the Company had a liability of $363,000 to the
financing company. In February 1998, the Company terminated the
factoring agreement and settled all outstanding liabilities.
LEGAL PROCEEDINGS - The Company is involved in certain 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.
14. SEGMENT INFORMATION
Segment information by major business segment is presented below:
Year Ended December 31, 1997
----------------------------
Government Products Division
Electro/ Laser
Communication Optics Illuminator
Products Technology Technology
Division Group Group Paragon Raman Total
------------- ----------- ------------ ---------- ---------- ----------
Revenues $9,734,088 $688,690 $1,684,260 $ 164,019 $ - $12,271,057
Operating income (loss) $ 615,963 $ 18,296 $ 924,174 $ (13,581) $(136,459) $ 1,408,393
Identifiable assets $9,885,518 $109,943 $ 257,170 $1,165,543 $ - $11,418,174
Corporate assets - - - - - 791,567
---------- -------- ---------- ---------- --------- -----------
Total assets $9,885,518 $109,943 $ 257,170 $1,165,543 $ - $12,209,741
========== ======== ========== ========== ========= ===========
Gross additions to
property and
equipment:
Identifiable $ 592,150 $ 29,152 $ 7,605 $ - $ - $ 628,907
Corporate - - - - - 72,622
---------- -------- ---------- ---------- --------- -----------
Total $ 592,150 $ 29,152 $ 7,605 $ - $ - $ 701,529
========== ======== ========== ========== ========= ===========
Depreciation and
amortization:
Identifiable $ 299,623 $ - $ - $ 609 $ - $ 300,232
Corporate - - - - - -
---------- -------- ---------- ---------- --------- -----------
Total $ 299,623 $ - $ - $ 609 $ - $ 300,232
========== ======== ========== ========== ========= ===========
40
Year Ended December 31, 1996
______________________________
Government Products Division
Electro/ Laser
Communication Optics Illuminator
Products Technology Technology
Division Group Group Paragon Raman Total
------------- ----------- ------------ ---------- ---------- ----------
Revenues $6,453,686 $592,981 $ 1,863,596 $ - $ - $ 8,910,263
Operating income (loss) $ 60,664 $(31,903) $ 1,046,577 $ - $ - $ 1,075,338
Identifiable assets $3,186,605 $262,915 $ 247,363 $ - $ - $ 3,696,883
Corporate assets - - - - - 769,580
---------- -------- ----------- --------- --------- -----------
Total assets $3,186,605 $262,915 $ 247,363 $ - $ - $ 4,466,463
========== ======== =========== ========= ========= ===========
Gross additions to
property and
equipment:
Identifiable $ 219,119 $ - $ - $ - $ - $ 219,119
Corporate - - - - - -
---------- -------- ----------- --------- --------- -----------
Total $ 219,119 $ - $ - $ - $ - $ 219,119
========== ======== =========== ========= ========= ===========
Depreciation and
amortization:
Identifiable $ 235,431 $ - $ - $ - $ - $ 235,431
Corporate - - - - - -
---------- -------- ----------- --------- --------- -----------
Total $ 235,431 $ - $ - $ - $ - $ 235,431
========== ======== =========== ========= ========= ===========
Year Ended December 31, 1995
_______________________________
Government Products Division
Electro/ Laser
Communication Optics Illuminator
Products Technology Technology
Division Group Group Paragon Raman Total
------------- ----------- ------------ ---------- ---------- ----------
Revenues $5,319,556 $ 395,284 $715,296 $ - $ - $6,430,136
Operating income (loss) $ (470,866) $(263,930) $307,369 $ (427,427)
Identifiable assets $3,117,177 $ 101,103 $ 68,635 $3,286,915
Corporate assets - - - - - 387,089
---------- -------- ----------- --------- --------- -----------
Total assets $3,117,177 $ 101,103 $ 68,635 $ - $ - $3,674,004
========== ======== =========== ========= ========= ===========
Gross additions to
property and
equipment:
Identifiable $ 287,854 $ - $ - $ - $ - $ 287,854
Corporate
---------- -------- ----------- --------- --------- -----------
Total $ 287,854 $ - $ - $ - $ - $ 287,854
========== ======== =========== ========= ========= ===========
Depreciation and
amortization:
Identifiable $ 212,470 $ - $ - $ - $ - $ 212,470
Corporate
---------- -------- ----------- --------- --------- -----------
Total $ 212,470 $ - $ - $ - $ - $ 212,470
========== ======== =========== ========= ========= ===========
41
All of the revenues from the Electro Optics Technology and Laser
Illuminator divisions are from U.S. Government agencies and their prime
contractors.
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.
15. SIGNIFICANT CUSTOMERS AND FOREIGN EXPORTS
The Company's primary business activity is with the U.S. Government and
its prime contractors and commercial customers providing communications
products and services. In 1997, two commercial customers each accounted
for 10% and one customer accounted for 7% of sales. During 1996, the
Company made sales to three commercial customers that accounted for
approximately 21%, 8%, and 8% of sales, respectively. During 1995, the
Company made sales to two commercial customers that accounted for
approximately 10% and 9% of revenues, respectively. In 1997, 1996, and
1995, the Company had export sales to foreign customers totaling
approximately $2,130,000, $1,159,000 and $860,000, respectively.
Foreign operations and foreign sales resulting from the Paragon
acquisition (see Note 2) were immaterial to the Company's 1997
operations. At December 31, 1997, contract receivables from three
customers represented 16%, 12%, and 11%, respectively, of total
contract receivables outstanding. At December 31, 1996, contract
receivables from three customers represented 17%, 13%, and 4%,
respectively, of total accounts and contracts receivables outstanding.
16. RELATED PARTY TRANSACTIONS
At December 31, 1997, the Company had a $40,000 note receivable from a
former officer and board member. The note is noninterest-bearing and
is due in full on December 15, 1998.
17. NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, REPORTING COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, both of which
will be effective for the Company beginning January 1, 1998. SFAS No.
130 requires businesses to disclose comprehensive income and its
components in the financial statements. SFAS No. 131 redefines how
operating segments are determined and requires disclosure of certain
financial and descriptive information about the Company's operating
segments. The Company does not believe that adoption of SFAS 130 will
have a material impact on its financial position, and it has not yet
completed its analysis of which operating segments it will report on
upon adoption of SFAS No. 131.
* * * * * *
42
OPTELECOM, INC. SCHEDULE II
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1997, 1996, AND 1995
_______________________________________________________________________________
Balance Charged to Balance
at Beginning Costs and Other at End
Description of Period Expenses Changes Deductions of Period
- ----------- -------------- ------------ --------- ------------ ---------
Year Ended December 31, 1995
Reserves and allowances deducted
from assets/accounts:
Obsolescence reserve for
inventory $83,402 $105,722 $ - $ (92,119) $ 97,005
Allowance for uncollectible
contract costs 34,711 (34,711) - - -
Year Ended December 31, 1996
Reserves and allowances deducted
from assets/accounts:
Obsolescence reserve for
inventory $97,005 $ 92,494 $ - $(113,250) $ 76,249
Allowance for uncollectible
contract costs - 78,186 - - 78,186
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
contract costs 78,186 (15,000) - (11,649) 51,537
43
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 and Miscellaneous."
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 and Miscellaneous."
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, under the heading "Proposal 1."
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."
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, 1997 and 1996
Consolidated Statements of Operations for the Years Ended December 31, 1997,
1996, and 1995
44
Consolidated Statements of Stockholders' Equity for the Years Ended December 31,
1997, 1996, and 1995
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997,
1996, and 1995
Summary of Accounting Policies
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule II Valuation and Qualifying Accounts, Years Ended December 31,
1997 and 1996 (benefit)
Other schedules are omitted because they are not applicable or information
is shown elsewhere in the financial statements or notes thereto.
3. Exhibits
Item 3(i) Restated Certificate of Incorporation of Optelecom, Inc. as in
effect March 23, 1998.
Item 3(i)(1) Amended and Restated By-Laws of Optelecom, Inc. as in effect
March 23, 1998.
Item 11 - Statement Regarding Computations of Per Share Earnings
Item 12 -
Item 13 -
Item 21 - The significant subsidiaries of the Registrant, as defined in
Section 1-02(w) of regulations S-X are:
Paragon Audio Visual, Ltd. (Paragon), acquired by the Company on
December 12, 1997.
Item 23 -
4. Reports on Form 8-K
An 8-K was filed on December 23, 1997 reporting the acquisition of
Paragon. An 8-KA was filed on February 25, 1998 including the required
financial information on Paragon.
45
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: March 31, 1998 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: March 31, 1998 By /s/Alexander L. Karpinski
______________________________
Alexander L. Karpinski
DIRECTOR
Date: March 31, 1998 By /s/Calvin T. Mathews
______________________________
Calvin T. Mathews
DIRECTOR
Date: March 31, 1998 By /s/Gordon A. Smith
______________________________
Gordon A. Smith
DIRECTOR
Date: March 31, 1998 By /s/Robert S. Lalley
______________________________
Robert S. Lalley
CHIEF FINANCIAL OFFICER