WASHINGTON, DC 20549

 

 

FORM 10-Q

 

Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

 

For Quarter Ended June 30, 2003
Commission File No.

 

 

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)

 

12920 CLOVERLEAF CENTER DRIVE, GERMANTOWN, MARYLAND 20874

(Address of principal executive offices) (Zip code)

 

 

Registrant’s telephone number, including area code: (301) 444-2200.

 

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 ý    No o

 

At August 8, 2003, the registrant had outstanding 3,104,774 shares of Common Stock, $.03 Par Value.

 

 

OPTELECOM, INC.

FORM 10-Q

 

TABLE OF CONTENTS

 

PART I.  FINANCIAL INFORMATION
	ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS
		Consolidated Balance Sheets as of June 30, 2003 (unaudited) and December 31, 2002
		Consolidated Statements of Operations for the Three Months Ended June 30, 2003 and 2002 (unaudited)
		Consolidated Statements of Operations for the Six Months Ended June 30, 2003 and 2002 (unaudited)
		Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002 (unaudited)
		Notes to Consolidated Financial Statements
	ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PART II.  OTHER INFORMATION

 

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OPTELECOM, INC.

CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2003 and DECEMBER 31, 2002

 

		2003			2002
		(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	507,957		$	46,012
Accounts and contracts receivable, net		2,159,162			3,164,721
Inventories, net		2,816,567			2,453,201
Prepaid expenses and other current assets		244,272			184,876
Total current assets		5,727,958			5,848,810
Property and equipment, net		1,156,316			522,983
Restricted certificate of deposit		129,368			129,368
Other assets		—			126,062
TOTAL ASSETS		$	7,013,642		$	6,627,223
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable		$	755,768		$	971,416
Accrued payroll		277,396			255,096
Commissions payable		199,800			369,197
Bank line-of-credit payable		—			576,079
Current portion of notes payable		67,500			—
Current portion of leases payable		—			1,006
Other current liabilities		672,109			786,596
Total current liabilities		1,972,573			2,959,390
Notes payable		112,500			—
Deferred rent liability		28,406			—
Total liabilities		2,113,479			2,959,390
STOCKHOLDERS’ EQUITY:
Common stock, $.03 par value - shares authorized, 15,000,000; issued and outstanding, 3,009,315 and 2,877,891 shares as of June 30, 2003 and December 31, 2002, respectively		90,279			86,336
Additional paid-in capital		10,531,065			10,152,729
Foreign currency translation		(13,257		)	41,538
Treasury stock, 162,672 shares, at cost		(1,265,047		)	(1,265,047		)
Accumulated deficit		(4,442,877		)	(5,347,723		)
Total stockholders’ equity		4,900,163			3,667,833
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	7,013,642		$	6,627,223

 

See notes to unaudited consolidated financial statements.

 

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OPTELECOM, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED JUNE 30,

(Unaudited)

 

		2003			2002
Revenues		$	4,176,293		$	3,327,857
Cost of goods sold		1,686,437			1,471,568
Gross profit		2,489,856			1,856,289
Operating expenses:
Engineering		324,966			299,228
Selling and marketing		661,231			596,757
General and administrative		959,704			708,852
Total operating expenses		1,945,901			1,604,837
Income from operations		543,955			251,452
Interest income (expense), net		909			(26,547		)
Income before income taxes		544,864			224,905
Provision for income taxes		8,540			—
Net income		$	536,324		$	224,905
Foreign currency translation		(91,724		)	(119,663		)
Comprehensive income		$	444,600		$	105,242
Basic earnings per share		$	0.18		$	0.08
Diluted earnings per share		$	0.17		$	0.08
Weighted average common shares outstanding — basic		2,978,943			2,842,577
Weighted average common shares outstanding — diluted		3,170,891			2,894,497

 

See notes to unaudited consolidated financial statements.

 

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OPTELECOM, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE SIX MONTHS ENDED JUNE 30,

(Unaudited)

 

		2003			2002
Revenues		$	7,664,679		$	6,634,048
Cost of goods sold		3,208,672			3,027,493
Gross profit		4,456,007			3,606,555
Operating expenses:
Engineering		626,971			525,628
Selling and marketing		1,174,385			1,174,999
General and administrative		1,734,855			1,422,479
Total operating expenses		3,536,211			3,123,106
Income from operations		919,796			483,449
Interest expense, net		(6,410		)	(54,316		)
Income before income taxes		913,386			429,133
Provision for income taxes		8,540			—
Net income		$	904,846		$	429,133
Foreign currency translation		(54,795		)	(91,409		)
Comprehensive income		$	850,051		$	337,724
Basic earnings per share		$	0.31		$	0.15
Diluted earnings per share		$	0.29		$	0.15
Weighted average common shares outstanding — basic		2,936,057			2,839,434
Weighted average common shares outstanding — diluted		3,112,977			2,893,821

 

See notes to unaudited consolidated financial statements.

 

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OPTELECOM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30,

(Unaudited)

 

 

		2003			2002
Cash Flows From Operating Activities:
Net income		$	904,846		$	429,133
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		151,223			201,384
Accounts receivable (benefit) / provision		(7,038		)	10,592
Inventory benefit		(5,150		)	(36,911		)
Loss on sale / disposal of fixed assets		—			7,080
Stock based compensation		—			3,047
Change in operating assets and liabilities:
Accounts and contracts receivable		1,012,596			547,273
Inventories		(358,216		)	146,503
Prepaid expenses and other current assets		(59,396		)	(11,428		)
Other assets		126,063			(25,979		)
Accounts payable		(215,648		)	(343,545		)
Other current liabilities and accrued payroll		(261,584		)	115,523
Deferred rent liability		28,406			(24,523		)
Net cash provided by operating activities		1,316,102			1,018,149
Cash Flows From Investing Activities:
Proceeds from sale of equipment		—			5,841
Capital expenditures		(784,556		)	(75,666		)
Net cash used in investing activities		(784,556		)	(69,825		)
Cash Flows From Financing Activities:
Borrowings on bank line-of-credit payable		2,020,551			5,872,575
Payments on bank line-of-credit payable		(2,596,630		)	(6,418,720		)
Borrowings on notes payable		180,000			—
Payments on notes payable and capital leases		(1,006		)	(391,294		)
Proceeds from issuance of common stock		34,500			17,334
Proceeds from exercise of stock options		347,779			5,897
Net cash used in financing activities		(14,806		)	(914,208		)
Effect of foreign currency translations		(54,795		)	(91,409		)
Net increase (decrease) in cash and cash equivalents		461,945			(57,293		)
Cash and cash equivalents - beginning of period		46,012			58,869
Cash and cash equivalents - end of period		$	507,957		$	1,576
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for interest		$	11,459		$	54,945
Cash paid during the period for income taxes		$	15,200		$	—

 

See notes to unaudited consolidated financial statements.

 

6

 

OPTELECOM, INC.

 

Notes to Consolidated Financial Statements (Unaudited)

 

1.               Basis of Presentation

 

The accompanying unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and note disclosures normally included in the annual financial statements, prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to those rules and regulations, although Optelecom, Inc. (the Company) believes that the disclosures made are adequate to make the information presented not misleading.

 

In the opinion of management, the unaudited accompanying financial statements reflect all necessary adjustments and reclassifications (all of which are of a normal, recurring nature) that are necessary for fair presentation for the periods presented.  It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest annual report to the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2002.

 

2.               Line of Credit

 

The Company has a revolving credit agreement with a bank whereby it may borrow up to $2,500,000.  This agreement consists of two separate facilities as follows:

 

The first facility is a demand working capital line of credit which will enable the Company to borrow up to the lesser of $2,000,000 or the borrowing base.  The borrowing base shall equal the sum of 90% of eligible government billed accounts receivable, 80% of the eligible commercial billed accounts receivable and 20% of eligible related inventory capped at $500,000.  In addition, a sublimit was established for the issuance of a standby letter of credit for collateral rent support related to the Company’s new office lease.

 

The second facility is a $500,000 transaction specific revolving demand export line of credit for short-term financing.  The amount available will be the lesser of $500,000 or the borrowing base.  The borrowing base shall equal the sum of 75% of the eligible export-related inventory and 90% of the eligible export-related accounts receivable.  This facility is guaranteed 90% by the Export-Import Bank of the United States (“Ex-Im Bank”) under Ex-Im Bank’s Working Capital Guarantee Program.

 

Both facilities carry interest at the rate of PRIME plus 1.25%, floating.  Optelecom is required to comply with certain financial ratios including maintaining a minimum current ratio, a maximum debt to worth ratio, a maximum funded debt to EBITDA ratio and a minimum tangible net worth ratio.  The Company was in compliance with all of these covenants at June 30, 2003.

 

3.               Note Payable

 

The Company took delivery of major capital equipment for its manufacturing operations in March 2003 and incurred a promissory note with the vendor.  The note principal is $180,000 and is payable in semi-annual installments of $22,500 beginning June 2003 through December 2006, with interest payable at the rate of 4.40%.

 

4.               Accounts and Contracts Receivable

 

Accounts and contracts receivable consisted of the following:

 

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		June 30, 2003			December 31, 2002
Accounts and contracts receivable		$	2,308,563		$	3,321,160
Less:  Allowance for doubtful accounts		(149,401		)	(156,439		)
Total		$	2,159,162		$	3,164,721

 

5.               Inventory

 

Inventories consisted of the following:

 

		June 30, 2003			December 31, 2002
Production materials		$	1,710,990		$	1,367,886
Work in process		272,846			210,637
Finished goods		1,131,577			1,178,674
Allowance for obsolescence		(298,846		)	(303,996		)
Net		$	2,816,567		$	2,453,201

 

6.               Property and Equipment

 

Property and equipment are recorded at historical cost and are reported net of accumulated depreciation and amortization.  Depreciation of property and equipment is provided under the straight-line method over the estimated useful lives of the assets, generally five to ten years, not to exceed the lease term for leasehold improvements.  Accumulated depreciation and amortization was $2,846,967 and $3,381,970 at June 30, 2003 and December 31, 2002, respectively.

 

7.               Income Taxes

 

The Company has established a full valuation allowance against the deferred tax assets in accordance with FASB No. 109.  Based upon the level of current taxable income and projections for future taxable income over the periods in which the temporary differences are anticipated to reverse, management believes that it is more likely than not that the Company will realize the benefits of these deductible differences net of the valuation allowance at December 31, 2003.  However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.

 

8.               Earnings Per Share

 

Basic earnings per share is computed using the weighted average number of common shares outstanding.  Diluted earnings per share is computed using the weighted average number of shares outstanding and the treasury stock computation method for stock options and warrants, provided they are not antidilutive.  The following is a reconciliation of the basic and diluted earnings per share.

 

8

 

 

9.               Stock-based Compensation

 

The Company recognizes expense for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost is recognized for the excess of the estimated fair value of the stock at the grant date over the exercise price, if any. The Company accounts for equity instruments issued to non-employees in accordance with EITF 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods, or Services.

 

In accordance with Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, the effect on net income and net income per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation is as follows:

 

9

 

 

These pro forma amounts are not necessarily indicative of future effects of applying the fair value-based method due to, among other things, the vesting period of the stock options and the fair value of the additional stock options issued in future years.

 

10.         Business Unit Information

 

Beginning in 2003, Optelecom restructured its operations from three business segments into two segments: the Communication Products Division (CPD) and the Electro-Optics Division (EOD).  The CPD develops, manufactures, and sells optical fiber-based data communication equipment to both commercial and government clients.  In addition, the CPD now includes the previously-reported Copper Products Division (Paragon) which had been focused on the delivery and distribution of video systems over Category5 (CAT5) copper cabling as the transmission medium.  The EOD is focused on Interferometric Fiber Optic Gyro coils and engineering contract services for development of electro-optic devices and sub-systems for defense applications.  These divisions reflect the manner in which management analyzes internal reportable information and indicates Optelecom’s strategic business units’ financial results reported before income taxes.  The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Prior year information has been presented to reflect the new segments.  Optelecom does not allocate income taxes or interest expense to segments.

 

10

 

 

Optelecom is engaged primarily in the development, manufacture, and sale of integrated multi-media products for communicating video, audio, and other data over both copper wire and optical network systems.  Revenues represent shipments and services provided to third parties. Contract costs and operating expenses directly traceable to individual segments were deducted from revenues to arrive at income from operations.  Identifiable assets by segment are those assets that are used in the Company’s operations in each segment.

 

11.         New Accounting Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” which clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” relating to consolidation of certain entities.  FIN 46 will require identification of our participation in variable interest

 

11

 

entities (“VIEs”), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a stand-alone basis, or whose equity holders lack certain characteristics of a controlling financial interest.  For entities identified as VIEs, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIEs, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns.  FIN 46 also sets forth certain disclosure requirements regarding interests in VIEs that are deemed significant, even if consolidation is not required.  As we do not maintain any VIEs, the adoption of FIN 46, effective July 1, 2003 for entities acquired before February 1, 2003, will not have a material impact on our consolidated financial position, results of operations or cash flows.

 

12

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Except for the historical financial information contained herein, the following discussion and analysis may contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Such statements include declarations regarding the intent, belief or current expectations of the Company and its management.  Prospective investors are cautioned that any such forward looking statements are not guarantees of future performance and involve a number of risks and uncertainties; actual results could differ materially from those indicated by such forward looking statements.

 

The following discussion should be read in conjunction with the Financial Statements and Notes thereto.

 

OVERVIEW

 

Optelecom offers integrated multi-media products for communicating video, audio, and other data over both copper wire and optical network systems.  Optelecom has two business segments: the Communication Products Division (CPD) and the Electro-Optics Division (EOD).  The primary focus of the CPD is the design, manufacture and sale of optical fiber-based data communication equipment to commercial and Government clients as well as the delivery and distribution of video systems over Category5 (CAT5) copper cabling as the transmission medium.  This Division is now managing the processes previously reported under the Optical Products Unit and the Copper Products Unit.  The EOD develops and manufactures innovative optical devices under contract, primarily to government and defense industry customers.

 

The CPD addresses business opportunities in the worldwide optical communication equipment marketplace, specializing in optical fiber transmission technologies.  The majority of its current and future revenues are derived from several niche markets that leverage the advantages of fiber optic telecommunications to address their transmission requirements.  Presently, the vertical markets served include communications systems for highway traffic monitoring, advanced air traffic control video monitor displays, security surveillance and control systems, and manufacturing process and control communications.  Verticals that offer future sources of revenue include video teleconferencing, healthcare, and broadcasting market opportunities.  The CPD also includes the operations of the previously-named Copper Products Unit which addresses worldwide markets in financial market data information and business television services.  The products include multi-media applications utilizing unshielded twisted-pair copper or “structured” Category 5 (CAT5) cabling for in-house computer data networking applications.

 

In the EOD, emphasis has been placed on fabrication of precision-wound coils of optical fiber used as the sensing elements of fiber optic gyroscopes.  During the past decade, Optelecom has received U.S. Government contracts to investigate advanced manufacturing technology related to gyro coil winding. Optelecom currently pursues this tradition of business development and continues to seek out technology development opportunities with potential for production follow-on. The EOD also produces precision wound coils for applications ranging from optical fiber dispensers used in remote vehicle control systems to precision optical fiber coils for communications systems.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002

 

REVENUES

 

Consolidated revenues for the three months ended June 30, 2003 were $4,176,293 compared to $3,327,857 for the same period of 2002, representing an increase of $848,436 or 25% when compared to the prior year.

 

Revenues for the Communication Products Division for the second quarter of 2003 were $3,747,300 as compared to $3,050,548 for the same period in 2002.  This increase of $696,752 or 23% is attributable to new U.S. Department of Defense and ITS projects and the continued expansion of our customer base facilitated by

 

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growth in the number of Optelecom integrators.

 

The Electro-Optics Division reported revenues of $428,993 for the second quarter of 2003 as compared to $277,309 for the same period in 2002.  This 55% increase of $151,684 is primarily attributable to a significant increase in coil winding revenues.

 

GROSS PROFIT

 

Consolidated gross profit was $2,489,856, or 60% for the three months ended June 30, 2003 as compared to $1,856,289, or 56% for the second quarter of 2002.  The Communication Products Division’s gross profit was $2,259,064 for the second quarter of 2003 compared to $1,760,968 in the second quarter of 2002.  The increase of $498,096 or 28% was due to higher sales, the shift from analog to digital products, cost reductions and selective price increases.  The gross profit of the Electro-Optic Division increased from $95,321 in the second quarter of 2002 to $230,792 in the second quarter of 2003 primarily as a result of the increase in coil winding revenues in 2003.

 

ENGINEERING COSTS

 

Engineering costs for the second quarter of 2003 were $324,966 compared to $299,228 in the same period in  2002.  The increase of $25,738 or 9% is due to higher engineering personnel and laboratory expenses.

 

SELLING AND MARKETING

 

Selling and marketing costs were $661,231 for the second quarter of 2003 compared to $596,757 for the same period in 2002.  This increase of $64,474 or 11% was primarily a result of higher sales commissions and demo equipment expenditures.

 

GENERAL AND ADMINISTRATIVE

 

General and administrative costs were $959,704 for the second quarter of 2003 compared to $708,852 for the same period in 2002.  This increase of $250,852 or 35% is primarily attributable to increases in employee costs and facility expenses related to the relocation of the U.S. operations.

 

OTHER INCOME (EXPENSE)

 

Other income (expense) consisted of net interest income of $909 for the quarter ended June 30, 2003.  This income was generated as a result of accumulated cash reserves.  Other income (expense) for prior year quarter consisted of interest expense of $26,547.  The reduction of interest expense from the prior year to the current year is due to the payoff of the Company’s bank line of credit in the first quarter of 2003.

 

 

SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002

 

REVENUES

 

Consolidated revenues for the six months ended June 30, 2003 were $7,664,679 compared to $6,634,048 for the same period of 2002, representing an increase of $1,030,631 or 16% when compared to the prior year.

 

Revenues for the Communication Products Division for the first six months of 2003 were $6,502,825 as compared to $6,081,613 for the same period in 2002.  This increase of $421,212 or 7% is attributable to new U.S. Department of Defense and ITS projects and the continued expansion of our customer base facilitated by growth in the number of Optelecom integrators.

 

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The Electro-Optics Division reported revenues of $1,161,854 for the first six months of 2003 as compared to $552,435 for the same period in 2002.  This 110% increase of $609,419 is primarily attributable to the delivery of product associated with a major contract that occurred during the first quarter of 2003 and a significant increase in coil winding revenues.

 

GROSS PROFIT

 

Consolidated gross profit was $4,456,007, or 58% for the six months ended June 30, 2003 as compared to $3,606,555, or 54% for the six months ended June 30, 2002.  The Communication Products Division’s gross profit was $3,743,522 for the six months ended June 30, 2003 compared to $3,397,932 for the first six months of 2002. The increase of $345,590 or 10% was due to higher sales, the shift from analog to digital products, cost reductions and selective price increases.  The gross profit of the Electro-Optic Division increased from $208,623 for the first six months of 2002 to $712,486 for the six months ended June 30, 2003 primarily as a result of the delivery of product associated with a major contract that occurred during the first quarter of 2003.

 

ENGINEERING COSTS

 

Engineering costs for the six months ended June 30, 2003 were $626,971 compared to $525,628 for the same period in  2002.  The increase of $101,343 or 19% is due to higher engineering personnel and laboratory expenses.

 

SELLING AND MARKETING

 

Selling and marketing costs were $1,174,385 for the six months ended June 30, 2003 compared to $1,174,999 for the same period in 2002.  This decrease of $614 was primarily a result of slightly higher sales commissions in 2003 offset by lower demo equipment expenditures in 2003.

 

GENERAL AND ADMINISTRATIVE

 

General and administrative costs were $1,734,855 for the six months ended June 30, 2003 compared to $1,422,479 for the same period in 2002.  This increase of $312,376 or 22% is primarily attributable to increases in employee costs and facility expenses related to the relocation of the U.S. operations.

 

OTHER INCOME (EXPENSE)

 

Other income (expense) consisted of net interest expense of $6,410 for the six months ended June 30, 2003. Other income (expense) for prior year consisted of interest expense of $54,316.  The reduction of interest expense from the prior year to the current year is due to the payoff of the Company’s bank line of credit in the first quarter of 2003.

 

 

FINANCIAL CONDITION AND LIQUIDITY

 

Stockholders’ equity increased from $3,667,833 at December 31, 2002 to $4,900,163 at June 30, 2003.  The increase is primarily attributable to net earnings of $904,846 as well as an increase in common stock and paid-in-capital due to the exercise of stock options and warrants, and the purchase of shares pursuant to the employee stock purchase plan.

 

Other key components of Optelecom’s financial condition include accounts receivable, inventory, fixed assets, accounts payable and debt. The Company’s current ratio has increased to 2.90 at June 30, 2003 compared to 1.98 at December 31, 2002.  This increase is primarily attributed to the decrease in the Company’s borrowings under the bank line of credit and a reduction in accounts payable.

 

Accounts receivable, net decreased from $3,164,721 at December 31, 2002 to $2,159,162 at June 30, 2003 due to lower sales in the second quarter of 2003 as compared to the fourth quarter of 2002.  Inventories increased

 

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from $2,453,201 at December 31, 2002 to $2,816,567 as of June 30, 2003 primarily due to management’s decision to increase stocking levels of higher volume products in an effort to increase its penetration of the security and surveillance market.

 

The Company’s current liabilities decreased from $2,959,390 at December 31, 2002 to $1,972,573 at June 30, 2003 primarily as a result of a decrease of $576,079 in the bank line-of-credit payable.  As of March 31, 2003, the line of credit had been completely paid down.  Additionally, accounts payable decreased $215,648 from 2002 to 2003 and other current liabilities were reduced by $114,487.

 

Cash provided by operating activities was $1,316,102 during the first six months of 2003 compared to $1,018,149 in the same period of 2002.  After adding back non-cash adjustments such as depreciation and amortization to reconcile the net income to net cash used by operating activities, the net cash provided was $1,043,881 for the first six months of 2003 as compared to $614,325 in the first six months of 2002.  Working capital provided by operating activities was $272,221 for the six months ended June 30, 2003.  The working capital provided was due primarily to a decrease of $1,012,596 in accounts receivable which was partially offset by an increase in inventory of $358,216 and a decreases in accounts payable of $215,648.

 

Cash used in investing activities during the six months ended June 30, 2003 was $784,556 compared to $69,825 in 2002.  The Company increased its level of capital asset acquisitions during the first six months of 2003 to improve its manufacturing capabilities through manufacturing equipment and facility expansion.

 

Cash used in financing activities during the first six months of 2003 was $14,806 compared to $914,208 in 2002. The Company’s net bank line-of-credit payable was reduced by $576,079 as compared to a net decrease of $546,145 in the same period of 2002.  The Company incurred $180,000 of bank note indebtedness as a result of its capital acquisitions during the first quarter of 2003.  During 2002 the Company paid down its notes payable by $391,294.  Proceeds from the issuance of stock and the exercise of stock options and warrants increased from $23,231 for the first six months of 2002 to $382,279 in 2003.

 

Optelecom has the ability, provided there are sufficient accounts receivable and inventory, to borrow up to $2.5 million under our two-tiered bank line-of-credit.  The borrowings, if any, are secured by the assets of the Company.

 

Optelecom’s future working capital needs will be financed by our operating cash flow and continued use of the line-of-credit. In the event that operating cash flows become insufficient to meet funding needs, the Company may be required to scale back or eliminate product research and development and overhead costs. Additionally, the Company would look to increase its line of credit and/or pursue equity financing. The Company’s strategy will focus on identifying new products that meet the demands of our core markets, expanding our distribution channels and implementing processes which will increase manufacturing efficiencies. Management fully understands the costs required to execute this strategy and will pursue these initiatives in a timely and fiscally prudent manner.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

We are subject to market risk associated with changes in foreign currency exchange rates and interest rates.  Our foreign currency exchange rate risk comes primarily from our operations in Europe.  The net impact of foreign exchange activities on earnings was immaterial for the six-month period ended June 30, 2003 and 2002, respectively, however, we will continue to assess the impact, if any, as we continue to implement the distribution of our products in Europe through our direct infrastructure.  Interest rate exposure is primarily limited to the company’s cash balances.  We do not actively manage the risk of interest rate fluctuations; however, such risk is mitigated by the relatively short-term (less than twelve months) nature of certain investments.  We do not consider the present rate of inflation to have a significant impact on our business.

 

Item 4.  Controls and Procedures

 

As of June 30, 2003, the principal executive officer and principal financial officer evaluated controls and procedures related to its reporting and disclosure obligations, as well as its internal controls.  These officers have

 

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concluded that the disclosure controls and procedures are sufficient to provide that (a) material information relating to the Company, including its consolidated subsidiaries, is made known to these officers by other employees of the Company and its consolidated subsidiaries, particularly material information related to the period for which this periodic report is being prepared; and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms promulgated by the Securities and Exchange Commission.

 

There have been no significant changes in internal controls or in other factors that could significantly affect these internal controls subsequent to the date of the evaluation.

 

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PART II - OTHER INFORMATION

 

ITEM 1 - LEGAL PROCEEDINGS

 

From time to time, the Company is involved in legal proceedings and litigation arising in the ordinary course of business.  As of the date of this report, except as described above, the Company is not a party to any litigation or other legal proceeding that, in the opinion of management, could have a material adverse effect on the Company’s business, financial condition or results of operations.

 

ITEM 2 - CHANGES IN SECURITIES

 

None.

 

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

 

None

 

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None

 

ITEM 5 - OTHER INFORMATION

 

None

 

ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

 

The Company filed a Form 8-K on March 27, 2003 as a result of changes in the Company’s Board of Directors.  For details please see the 8-K.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

		OPTELECOM, INC.
Date:	August 14, 2003	/s/  Edmund Ludwig
		Edmund Ludwig,
		Director, President and Chief Executive Officer
Date:	August 14, 2003	/s/  James Armstrong
		James Armstrong,
		Director, Chief Financial Officer

 

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