UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from_________ to_________
Commission File Number 0-29798
CompuDyne Corporation
(Exact name of registrant as specified in its charter)
Nevada 23-1408659
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7249 National Drive, Hanover, Maryland 21076
(Address of principal executive offices)
Registrant's telephone number, including area code: (410) 712-0275
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 checkmark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act)
Yes X No
-- ---
1
As of May 6, 2004, a total of 8,073,126 shares of Common Stock, $.75 par value,
were outstanding.
2
COMPUDYNE CORPORATION AND SUBSIDIARIES
INDEX
Page No.
-------
Part I. Financial Information
Item 1. Financial Statements - Unaudited
Condensed Consolidated Balance Sheets - March 31, 2004
and December 31, 2003 3
Condensed Consolidated Statements of Operations -
Three Months Ended March 31, 2004 and 2003 4
Condensed Consolidated Statement of Changes in
Shareholders' Equity - Three Months Ended
March 31, 2004 5
Condensed Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2004 and 2003 6
Notes to Condensed Consolidated Financial Statements 7-13
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14-23
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 24
Item 4. Controls and Procedures 25
Part II. Other Information 26
Signature 27
3
ITEM 1. FINANCIAL STATEMENTS
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31, December 31,
ASSETS 2004 2003
---- ----
(in thousands)
Current Assets
Cash and cash equivalents $ 3,802 $ 1,869
Marketable securities 22,465 -
Accounts receivable, net 41,241 41,780
Contract costs in excess of billings 14,767 17,568
Inventories 5,874 6,704
Deferred tax assets 1,270 1,371
Prepaid expenses and other 1,859 2,322
----------- -----------
Total Current Assets 91,278 71,614
Property, plant and equipment, net 9,654 10,079
Goodwill 21,280 21,280
Other intangible assets, net 9,673 9,785
Other 754 904
----------- -----------
Total Assets $ 132,639 $ 113,662
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities $ 17,229 $ 21,078
Billings in excess of contract costs incurred 11,091 13,551
Deferred revenue 5,460 6,036
Current portion of notes payable 440 2,103
------------ -----------
Total Current Liabilities 34,220 42,768
Notes payable 4,005 15,555
Convertible subordinated notes payable 38,978 -
Deferred tax liabilities 1,654 1,592
Other 665 820
------------ ------------
Total Liabilities 79,522 60,735
Commitments and Contingencies
Shareholders' Equity
Preferred stock, 2,000,000 shares authorized and unissued - -
Common stock, par value $.75 per share: 15,000,000 shares
authorized; 8,614,309 and 8,567,680 shares issued at
March 31, 2004 and December 31, 2003, respectively 6,459 6,426
Additional paid-in-capital 42,974 42,755
Retained earnings 7,619 7,926
Accumulated other comprehensive gain(loss) 152 (93)
Treasury stock, at cost; 594,877 shares at
March 31, 2004 and December 31, 2003 (4,087) (4,087)
------------ ------------
Total Shareholders' Equity 53,117 52,927
----------- -----------
Total Liabilities and Shareholders' Equity $ 132,639 $ 113,662
========= =========
The accompanying notes are an integral part of these financial statements.
4
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended
March 31,
2004 2003
--------- ---------
(in thousands, except per share data)
Revenues:
System sales $ 34,326 $ 42,270
Service and other 4,701 4,497
------------ ------------
Total net sales 39,027 46,767
----------- -----------
Cost of sales:
System sales 27,414 33,605
Service and other 1,415 1,379
------------ ------------
Total cost of sales 28,829 34,984
----------- -----------
Gross profit 10,198 11,783
Operating expenses 8,162 7,987
Research and development 1,755 1,862
------------ -----------
Income from operations 281 1,934
------------- -----------
Other expense (income)
Interest expense 749 378
Interest income (78) (16)
Other expense 121 -
------------- -----------
Total other expense 792 362
------------- -----------
(Loss) income before income taxes (511) 1,572
Income taxes (benefit) (204) 630
------------- -----------
Net (loss) income $ (307) $ 942
============== ===========
(Loss) earnings per share:
Basic (loss) earnings per common share $ (.04) $ .12
============== ===========
Weighted average number of common
shares outstanding 8,009 7,822
============= ===========
Diluted (loss) earnings per common share $ (.04) $ .12
============= ===========
Weighted average number of common
shares and equivalents 8,009 8,073
============= ===========
The accompanying notes are an integral part of these financial statements.
5
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited)
(in thousands)
Accumulated
Additional Other
Common Stock Paid-in Retained Comprehensive Treasury Stock
Shares Amount Capital Earnings Income /(Loss) Shares Amount Total
------ ------- -------- -------- -------------- ---------- ------- ------
January 1, 2004 8,568 $6,426 $42,755 $7,926 $(93) 595 $(4,087) $52,927
Stock options exercised 46 33 219 - - - - 252
Subtotal 8,614 6,459 42,974 7,926 (93) 595 $(4,087) 53,179
Net loss - - - (307) - - - (307)
Other comprehensive
income, net of tax:
Ineffectiveness of interest
rate swap agreement - - - - 93 - - 93
Unrealized gain on
available for sale
marketable securities - - - - 152 - - 152
Balance at
March 31, 2004 8,614 $6,459 $42,974 $7,619 $152 595 $(4,087) $53,117
The accompanying notes are an integral part of these financial statements.
6
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended
March 31,
2004 2003
------ -------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ (307) $ 942
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization 704 751
Deferred tax (benefit) expense - (1)
(Gain) loss from disposal of property, plant and equipment (1) -
Amortization of debt discount 36 -
Unrealized loss on interest rate swap 126 -
Changes in assets and liabilities:
Accounts receivable 539 2,632
Contract costs in excess of billings 2,801 1,820
Inventories 830 880
Prepaid expenses and other current assets 463 493
Other assets 150 (2)
Accounts payable and accrued liabilities (3,975) 553
Billings in excess of contract costs incurred (2,460) (252)
Deferred revenue (576) (259)
------------- -------------
Net cash flows (used in) provided by operating activities (1,670) 7,557
------------- -------------
Cash flows from investing activities:
Purchase of marketable securities (22,212) -
Additions to property, plant and equipment (167) (128)
Proceeds from sale of property, plant and equipment 1 1
Net payment for acquisition - (55)
------------- --------------
Net cash flows used in investing activities (22,378) (182)
------------- --------------
Cash flows from financing activities:
Issuance of common stock 252 102
Repayment of bank notes and line of credit (13,213) (7,416)
Borrowings of convertible subordinated notes payable 38,942 -
------------- --------------
Net cash provided by (used in) financing activities 25,981 (7,314)
------------- --------------
Net change in cash and cash equivalents 1,933 61
Cash and cash equivalents at beginning of period 1,869 1,274
------------- --------------
Cash and cash equivalents at end of period $ 3,802 $ 1,335
============= ==============
Supplemental disclosures of cash flow information: Cash paid during the period
for:
Interest $ 135 $ 294
Income tax, net of refunds $ 187 $ 128
The accompanying notes are an integral part of these financial statements.
7
COMPUDYNE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT POLICIES
Basis of Presentation:
The accompanying unaudited consolidated financial statements of CompuDyne
Corporation and its subsidiaries (the "Company") have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission. The
consolidated balance sheet as of December 31, 2003 has been derived from the
Company's December 31, 2003 audited financial statements. Certain information
and note disclosures included in the annual financial statements, prepared in
accordance with accounting principles generally accepted in the United States of
America, have been condensed or omitted pursuant to those rules and regulations,
although the Company believes that the disclosures made are adequate to make the
information presented not misleading.
In the opinion of management, the accompanying unaudited consolidated financial
statements reflect all necessary adjustments and reclassifications (all of which
are of a normal, recurring nature) that are necessary for the fair presentation
of the periods presented. It is suggested that these consolidated unaudited
financial statements be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's annual report filed
with the Securities and Exchange Commission on Form 10-K for the year ended
December 31, 2003. Operating results for the three months ended March 31, 2004
and 2003 are not necessarily indicative of operating results for the entire
fiscal year.
New Accounting Pronouncements:
In March 2004 the Emerging Issues Task Force ("EITF") reached a final consensus
on EITF Issue No. 03-06, "Participating Securities and the Two-Class Method
under FAS 128, Earnings Per Share". Issue No. 03-06 addresses a number of
questions regarding the computation of earnings per share ("EPS") by companies
that have issued securities other than common stock that contractually entitle
the holder to participate in dividends and earnings of the company when, and if,
it declares dividends on its common stock. The issue also provides further
guidance in applying the two-class method of calculating EPS. It clarifies what
constitutes a participating security and how to apply the two-class method of
computing EPS once it is determined that a security is participating, including
how to allocate undistributed earnings to such a security. EITF 03-06 is
effective for the fiscal quarter ending June 30, 2004. We are currently
evaluating the impact of adopting EITF 03-06 on our consolidated financial
statements.
In January 2003 the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). In December 2003, FIN 46 was replaced by
FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities".
FIN 46(R) clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements", to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46(R)
requires an enterprise to consolidate a variable interest entity if that
enterprise will absorb a majority of the entity's expected losses, is entitled
to receive a majority of the entity's expected residual returns, or both. FIN
46(R) is effective for entities being evaluated under FIN 46(R) for
consolidation no later than the end of the first reporting period that ends
after March 15, 2004. The adoption of this standard did not have a material
effect on the financial position, results of operations or cash flows of
CompuDyne.
8
Comprehensive Income:
The following table shows the components of comprehensive (loss) income, net of
income taxes, for the three months ended March 31, 2004 and 2003, in thousands.
For the Three Months
Ended March 31,
2004 2003
--------- ---------
Net (loss) income $ (307) $ 942
Unrealized gain on available-for-sale securities 152 -
Ineffectiveness of interest rate swap agreement 93 -
Translation adjustment - (7)
Loss on interest rate swap agreement - 21
------- ---------
Comprehensive (loss) income $ (62) $ 956
========= =========
Stock-based Compensation:
As of March 31, 2004, the Company continues to account for its stock-based
compensation plans, which are described more fully in the Company's 2003 Annual
Report, using the intrinsic value method and in accordance with the recognition
and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued
to Employees," and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted had an exercise price
equal to fair market value of the underlying common stock on the date of grant.
The following table illustrates, in accordance with the provisions of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure," the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
For the Three Months
Ended March 31,
2004 2003
---------- --------------
(in thousands, except per share data)
Net (loss) income, as reported $ (307) $ 942
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards net of related tax effects (249) (363)
-------------- -------------
Pro forma net (loss) income $ (556) $ 579
============= ============
(Loss) earnings per share:
Basic - as reported $ (.04) $ .12
Basic - pro forma $ (.07) $ .07
Diluted - as reported $ (.04) $ .12
Diluted - pro forma $ (.07) $ .07
The fair value of the Company's stock-based option awards to employees was
estimated using the Black-Scholes model assuming no expected dividends and the
following weighted-average assumptions:
For The Three Months Ended
March 31,
2004 2003
-------- ---------
Expected life in years 5.5 7.5
Risk-free interest rate 2.8% 3.9%
Expected volatility 76.6% 73.0%
Reclassifications:
Certain prior period amounts have been reclassified to conform to the current
period's presentation.
9
2. OPERATING SEGMENT INFORMATION
The following is the operating segment information for the three months ended
March 31, 2004 and 2003, in thousands.
Pre-tax
Revenues Gross Profit Income/(Loss)
-------- ------------ -------------
2004 2003 2004 2003 2004 2003
------- ------- ------- ------- ------- ----------
Institutional Security
Systems $ 16,057 $ 23,448 $ 2,505 $ 3,277 $ 207 $ 737
Attack Protection 6,953 8,343 919 1,975 (679) 562
Federal Security Systems 3,575 3,489 490 522 200 207
Public Safety and Justice 12,442 11,487 6,284 6,009 435 68
CompuDyne Corporate - - - - (674) (2)
----------- ----------- ------------ ---------- ---------- ----------
$ 39,027 $ 46,767 $ 10,198 $ 11,783 $ (511) $ 1,572
=========== =========== ============ =========== ========== ==========
3. EARNINGS PER SHARE
Earnings per share are presented in accordance with SFAS No. 128, "Earnings Per
Share." This Statement requires dual presentation of basic and diluted earnings
per share on the face of the statement of operations. Basic earnings per share
is computed using the weighted average number of shares outstanding during the
period and excludes any dilutive effects of options or warrants and convertible
securities. Diluted earnings per share is computed using the weighted average
number of common and common stock equivalent shares outstanding during the
period; common stock equivalent shares are excluded from the computation if
their effect is antidilutive. Stock options and warrants to purchase 1,361,427
and 1,037,656 shares for the three month periods ended March 31, 2004 and 2003
respectively, were not dilutive and, therefore, were not included in the
computation of diluted earnings per common share. Additionally, another
2,897,768 shares issuable upon conversion of our 6.25% Convertible Subordinated
Notes (the "2004 Notes") due January 15, 2011 are excluded as the effect is
antidilutive.
The computations of the Company's basic and diluted (loss) earnings per share
amounts for the three months ended March 31, 2004 and 2003 were as follows, in
thousands, except per share data:
2004 2003
---------- -------
Net (loss) income $ (307) $ 942
=========== ========
Weighted average common shares outstanding 8,009 7,822
Effect of dilutive stock options and warrants - 251
---------- --------
Diluted weighted average common shares outstanding 8,009 8,073
========== ========
Net (loss) income per common share
Basic $ (.04) $ .12
Diluted $ (.04) $ .12
10
4. INVENTORIES
Inventories consist of the following:
March 31, December 31,
2004 2003
-------- ----------
(in thousands)
Raw materials $ 3,803 $ 3,745
Work in progress 1,413 2,310
Finished goods 658 649
----------- ------------
$ 5,874 $ 6,704
============ =============
5. GOODWILL AND INTANGIBLE ASSETS
Intangible assets include the trade name, customer relationships and backlog
from the acquisition of Tiburon, Inc. in 2002. Other intangibles include
Department of State Certifications, Underwriters Laboratories, Inc. listings,
and patents related to the acquisition of Norment and Norshield in 1998. Except
for goodwill and trade names, which have indefinite lives, intangibles are being
amortized using the straight-line method.
Goodwill and intangible assets consist of the following:
March 31, December 31, Amortizable
2004 2003 Lives
------- -------- ------------------
(in thousands) (in years)
Goodwill $ 21,386 $ 21,386 Indefinite
Trade name 6,913 6,913 Indefinite
Customer relationships 2,500 2,500 14
Backlog 300 300 2
Other 1,220 1,220 2 - 20
-------------- -------------
32,319 32,319
Less: accumulated amortization (1,366) (1,254)
-------------- -------------
$ 30,953 $ 31,065
============== =============
Goodwill consisted of $19.8 million for the Public Safety and Justice segment,
$0.8 million for the Institutional Security Systems segment and $0.8 million for
Attack Protection segment as of March 31, 2004 and December 31, 2003.
Amortization expense for the three months ended March 31, 2004 was $112
thousand. The following schedule lists the expected amortization expense for
each of the years ending December 31, in thousands:
Year Expense
---- -------
2004 (remaining) $ 237
2005 270
2006 225
2007 225
2008 225
---------
Total $ 1,182
=========
11
6. PRODUCT WARRANTIES
Included in accounts payable and accrued liabilities are estimated expenses
related to warranties made at the time products are sold or services are
rendered. These accruals are established using historical information on the
nature, frequency, and average cost of warranty claims. The Company warrants
numerous products, the terms of which vary widely. In general, the Company
warrants its products against defect and specific non-performance. As of March
31, 2004, the Company had a product warranty accrual in the amount of $495
thousand.
Product Warranty Liabilities
----------------------------
(in thousands)
Beginning balance at January 1, 2004 $ 517
Plus accruals for product warranties 59
Changes in pre-existing warranties 1
Less payments (82)
---------
Ending balance at March 31, 2004 $ 495
=========
7. INVESTMENTS IN MARKETABLE SECURITITES
The Company's marketable securities are categorized as available-for-sale
securities, as defined by Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." At March 31,
2004 all of the Company's investments in marketable securities were classified
as available-for-sale, and as a result, were reported at fair value. Unrealized
gains and losses are reported as a component of accumulated other comprehensive
income in shareholders' equity. The amortized costs of debt securities is
adjusted for accretion of discounts from the date of purchase to maturity. The
accretion is included in interest income on the investments. As of March 31,
2004 the Company had no realized gains or losses and the cost for marketable
securities was determined using the specific identification method. The fair
values of marketable securities are estimated based on quoted market price for
these securities.
Marketable securities at March 31, 2004 are summarized, in thousands, as
follows:
Gross Unrealized
---------------------
Cost Gain Loss Fair Value
------ ------- ------- ---------------
Collateralized mortgage obligations
(CMO's) consisting of securities issued by
Fannie Mae, Freddie Mac,and Ginnie Mae $ 22,212 $ 253 $ - $ 22,465
The cost and estimated fair value of current debt securities at March 31, 2004,
by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because the issuers of the securities may have the right
to repay obligations without prepayment penalties. It is the Company's policy to
classify available-for-sale securities that are available for use in current
operations as a current asset.
Estimated
(in thousands) Costs Fair Value
------------ ----------
Due in one year or less $ - $ -
Due after one year and beyond 22,212 22,465
------------ ----------
Total debt securities $ 22,212 $ 22,465
=========== ==========
12
8. NOTES PAYABLE AND LINE OF CREDIT
March 31, December 31,
2004 2003
------------- -----------
(in thousands)
Industrial revenue bond, interest payable quarterly at a variable rate of 1.14%
to 1.38% (1.29% at March 31, 2004) principal payable in quarterly installments
of $35,000. The bond is fully collateralized
by a $1.6 million letter of credit and a bond guarantee agreement. $ 1,540 $ 1,540
Industrial revenue bond, interest payable quarterly at a variable rate of 1.01%
to 1.30% (1.14% at March 31, 2004) principal payable in yearly installments of
$300,000. The bond is fully collateralized
by a $2.9 million letter of credit and a bond guarantee agreement. 2,905 2,905
6.25% Convertible Subordinated Notes due January 15, 2011. The notes bear
interest at a rate of 6.25% per annum, payable semi-annually, and are
convertible into shares of common stock at a conversion price of $13.89 per
share. These notes
are subordinated to all other liabilities of the Company. 40,250 -
Line of credit with a Bank, interest range from LIBOR + 2.25% to Prime + 1.00%,
weighted average rate at December 31, 2003 was
3.89%, collateralized by virtually all of the Company's assets. - 11,550
Note payable to Bank, interest at LIBOR plus a fixed credit spread of 2.50%,
(3.62% at December 31, 2003) collateralized by virtually all of the Company's
assets, due in quarterly installments through
February 2005 - 1,663
------------- -----------
Total notes payable and line of credit 44,695 17,658
Less convertible subordinated notes discount 1,272 -
------------- -----------
Subtotal 43,423 17,658
Less amount due within one year 440 2,103
------------- -----------
$ 42,983 $ 15,555
============= ===========
Maturities of notes payable are as follows:
Year Ending December 31, Amount
------------------------ -----------
(in thousands)
2004 $ 440
2005 440
2006 440
2007 440
2008 440
Thereafter 42,495
-------------
$ 44,695
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 2004 Notes. The offering was for $35 million principal
amount plus an underwriter's over-allotment option of $5.25 million principal
amount, which was exercised in full. The 2004 Notes bear interest at a rate of
6.25% per annum, payable semi-annually, and are convertible into shares of
common stock at a conversion price of $13.89 per share, subject to adjustments.
These 2004 Notes are subordinated to all other liabilities of the Company. The
carrying value is listed below, in thousands.
13
Face value $ 40,250
Underwriters discounts, net 1,272
----------
$ 38,978
The 2004 Notes can be converted into the Company's common stock at the option of
the holder at any time at a conversion price of $13.89, subject to adjustments
for stock splits, stock dividends, the issuance of certain rights or warrants to
the existing holders of the Company's common stock and common cash dividends in
excess of a stated threshold.
The 2004 Notes are redeemable at the option of the Company after January 15,
2009, unless a change in control event, as defined in the indenture dated as of
January 15, 2004 between the Company and Wachovia Bank of Delaware, National
Association, relating to the 2004 Notes, occurs. If such an event does occur,
the Company can redeem the 2004 Notes at face value plus a premium. If a change
in control event occurs and the Company does not elect to redeem the 2004 Notes,
the holders can require the Company to repurchase The 2004 Notes at face value
plus accrued interest. After January 15, 2009, the Company can redeem the 2004
Notes at a premium of two percent of the face value.
The Company incurred $443 thousand of debt issue costs for the 2004 Notes. These
costs are recorded as non-current assets and are amortized on a straight line
basis to interest expense over the term of the 2004 Notes. In addition,
underwriters' discounts totaled $1.3 million and are amortized on the straight
line basis to interest expense over the term of the 2004 Notes. Interest expense
recorded for the total of the deferred financing costs and debt discount on the
2004 Notes totaled $49 thousand and $0 for the three months ended March 31, 2004
and 2003, respectively.
During January 2004, the Company repaid substantially all of its outstanding
bank borrowings from the proceeds of the issuance of the 2004 Notes. The Company
has decided not to repay any of its Industrial Revenue Bond ("IRB") borrowings
as it has determined that there were certain favorable tax treatments afforded
the Company when it entered into these IRB's which it would lose in the event
these borrowings were repaid prematurely.
At March 31, 2004, the Company signed an Amended and Restated Credit Agreement
for its $25.0 million secured working capital line of credit. The new agreement
allows borrowings against eligible accounts receivable and inventories. Of this
line of credit $10.0 million matures on March 1, 2007 and $15.0 million matures
on March 1, 2005. At March 31, 2004 $5.4 million was committed principally to
letters of credit securing the Industrial Revenue Bonds.
The bank borrowings contain various financial covenants, including among other
things, maintenance of fixed charge coverage ratios, interest coverage ratios,
maximum senior debt to earnings before interest, taxes, depreciation and
amortization ("EBITDA") ratios, maximum permitted capital expenditures, and a
restriction against paying dividends. The Company was in compliance with all
bank covenants at March 31, 2004 and 2003.
The interest rate on the line of credit is variable based on the performance of
the Company and ranges from LIBOR + 1.00% to Prime + 0.75%. The Company incurs
commitment fees equal to 0.20% to 0.35% on any unused balances, defined as the
difference between the total amount of its $10.0 million line of credit less
amounts borrowed, and outstanding letters of credit. If borrowings exceed $10.0
million for thirty consecutive days, commitment fees will also be incurred on
the $15.0 million line of credit.
In January 2004 the interest rate swap ceased to be a highly effective cash flow
hedge when the related debt was repaid. Consequently, the amounts previously
recorded in other comprehensive income as changes in fair value of the interest
rate swap were recognized in earnings for the three months ended March 31, 2004.
Upon determination of the hedge ineffectiveness the cumulative loss on the fair
value of the interest rate swap was $155 thousand, which was recognized in other
income. The change in fair value of the interest rate swap for the three months
ended March 31, 2004 was a gain of $29 thousand, resulting in a remaining
liability for the investment of $126 thousand. Future changes in the value of
the interest rate swap will be recognized in earnings.
14
ITEM 2
COMPUDYNE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
CompuDyne Corporation was reincorporated in Nevada in 1996. We believe that we
are a leading provider of products and services to the public security markets.
We operate in four distinct segments: Institutional Security Systems; Attack
Protection; Federal Security Systems; and Public Safety and Justice.
The Institutional Security Systems ("ISS") segment is headquartered in
Montgomery, Alabama operates under the trade name Norment Security Group
("Norment"). This segment provides physical and electronic security products and
services to the corrections industry (prisons and jails) and to the courthouse,
municipal and commercial markets. ISS serves as a contractor, responsible for
most installation work on larger projects. Installations involve hard-line
(steel security doors, frames, locking devices, etc.) and sophisticated
electronic security systems, including software, electronics, touch-screens,
closed circuit TV, perimeter alarm devices and other security monitoring
controls. ISS also developed a product called MaxWall. MaxWall is a modular
steel, concrete filled prefabricated jail cell. It allows for construction
projects to use considerably less space and can save the project owner
significant amounts of money. ISS, through its regional offices provides field
level design, installation and maintenance of both physical and electronic
security products.
Included in the Institutional Security Systems segment is the TrenTech line
which designs, manufactures and integrates electronic security systems. TrenTech
integrates generally available products and software as well as designing its
own proprietary systems. TrenTech has developed a sophisticated proprietary
video badging system, with approximately 225 systems installed at 61 facilities
including 55 military installations.
The Institutional Security Systems segment also manufactures a complete line of
locks and locking devices under the brand name Airteq. Airteq is an industry
leader in pneumatic and electro-mechanical sliding devices used in the
corrections industry.
The Attack Protection segment is one of the country's largest original equipment
manufacturers (OEM) of bullet, blast and attack resistant windows and doors
designed for high security applications such as embassies, courthouses, Federal
buildings, banks, corporate headquarters and other facilities that insist on
having the highest level of protection currently available. We believe we are a
premier provider of Level 8 security products, the highest rating level of
commercial security products. Our attack resistant windows and doors are
integrated and structurally secure products with specifically designed frames
and encasements that are integral parts of the structure in which they are
installed. Existing product installations number in the thousands and range from
the Middle East to the White House. Working under contracts from the United
States Department of State, the segment's largest customer, Attack Protection is
a significant supplier of bullet and blast resistant windows and doors to United
States embassies throughout the world. Attack Protection products are also sold
to drug stores, convenience stores, and banks to secure drive through
facilities. Other commercial applications include guard booths, tollbooths, cash
drawers and other similar items. Additionally, this segment designs and installs
both fixed and pop-up bollards and barrier security systems.
The Attack Protection segment also manufactures a sophisticated fiber optic
sensor system, known as Fiber SenSys, used to detect physical intrusion. This
application is designed to protect large perimeters including such applications
as Federal facilities, military deployments and bases, oil fields, airport
tarmacs, public utilities, nuclear reactors and water systems. In addition, it
has been installed to protect the perimeters of numerous private estates and
other similar properties.
The Federal Security Systems segment is known as Quanta Systems Corporation. Its
customer base includes the military, governmental agencies, and state and local
governmental units. Federal Security Systems provides turnkey system,
integration of public security and safety systems. This segment specializes in a
wide range of customized access control and badging, intrusion detection,
surveillance and assessment, communications, command and control, fire and life
safety, and asset tracking systems. Federal Security Systems provides central
station oversight and control of multiple and separate facilities as well as
security and public life safety systems and equipment. This segment designs and
manufactures advanced digital signal processing products used in reconnaissance
of foreign telecommunications signals designed for the United States Government
and its foreign allies.
15
The Public Safety and Justice segment consists of two subsidiaries known to the
industry as CorrLogic, Inc., ("CorrLogic") and Tiburon. We believe that
CorrLogic is a leading developer of inmate management and institutional medical
software systems. CorrLogic specializes in the development, implementation and
support of complex, integrated inmate management software systems, including
inmate medical management that improves the efficiency and accuracy of
correctional facility operations. CorrLogic's focus is entirely on information
solutions for the corrections industry.
During 2002, we expanded our offerings in the Public Safety and Justice sector
by completion of our acquisition of Tiburon. Tiburon provides a fully integrated
suite of products including computer-assisted dispatch, records management,
court and probation software systems for the law enforcement, fire and rescue,
corrections and justice environments. We believe that Tiburon is a worldwide
market leader in the development, implementation and support of public safety
and justice automation systems. In business since 1980, with more than 600
systems supporting approximately 275 active customers, Tiburon is a leader in
public safety and justice solutions.
Management Outlook
We find ourselves in a very challenging time. We now have three major areas of
emphasis: the first is increasing the amount of our backlog; the second is
migrating to a business model with a more predictable revenue stream; and the
third is finding attractive acquisition candidates to enhance our existing
businesses.
During 2003 and the first quarter of 2004, as depicted in the following chart,
we saw the amount of our backlog decline.
Institutional Federal Public
Security Attack Security Safety and
(in thousands) Systems Protection Systems Justice Total
------------------------------------------------------------------------------
December 31, 2002 $ 99,527 $ 18,478 $ 11,440 $ 74,867 $ 204,312
March 31, 2003 $ 91,602 $ 14,827 $ 11,667 $ 66,007 $ 184,103
June 30, 2003 $ 81,916 $ 16,552 $ 10,643 $ 72,621 $ 181,732
September 31, 2003 $ 68,780 $ 14,375 $ 11,528 $ 65,962 $ 160,645
December 31, 2003 $ 57,258 $ 10,043 $ 8,326 $ 63,727 $ 139,354
March 31, 2004 $ 52,147 $ 12,905 $ 9,269 $ 57,332 $ 131,653
Historically, approximately over 75% of our revenues are generated from sources
where the ultimate customer is a state or local government unit. During the last
few years during the general economic slowdown, state and local budgets, which
we are dependent on for our revenue sources, have come under intense pressure.
Most states are currently running in a deficit situation, as are many local
governments. This has caused many of them to delay and in some cases temporarily
cancel many infrastructure projects until such time as their economic fortunes
rebound. Until such time as the economy as a whole improves and thus tax bases
for our customers improve, we would anticipate our backlog levels continuing to
remain under pressure. To address this area of focus we are actively bidding on
jobs and keeping our offerings in front of our customers so that when the
current economic cycle turns around we will be well positioned to capitalize on
new opportunities.
Our second area of focus surrounds reengineering our business model so that it
contains a greater degree of recurring revenue. As indicated in the following
table, approximately 12.0% of our revenue is generated from recurring revenue
sources (primarily maintenance revenues), and the majority of these revenues
occur in our Public Safety and Justice segment. We define one-time revenue as
revenue derived from discrete projects, from which we do not expect to generate
incremental revenue upon the completion of the project. We defines recurring
revenue as sources of revenue from which we anticipate receiving revenue in the
current, as well as future periods, for example, annual renewable maintenance
contracts.
(in thousands) One-time Revenue % Recurring Revenue % Total
---------------- --- ----------------- -- -----------
Institutional Security Systems $ 14,905 38.2 $ 1,152 2.9 $ 16,057
Attack Protection 6,953 17.8 - - 6,953
Federal Security Systems 3,575 9.2 - - 3,575
Public Safety and Justice 8,893 22.8 3,549 9.1 12,442
------------- ---- ----------- ----- ----------
Total $ 34,326 88.0 $ 4,701 12.0 $ 39,027
------------- ---- ----------- ---- ---------
16
Since the majority of our revenues are one-time revenues and are non-recurring,
we must reinvent our book of business every day. This makes it very difficult
for us to project our future revenue stream and thus makes it very difficult for
us to project our earnings as well as our business outlook. Over the next 18 to
24 months, we intend to modify our business model to rely less upon one-time
sources of revenue and more on recurring sources of revenue.
Our third key focus area is acquisitions. With the January 2004 completion of
the 2004 Notes offering, we have significant resources with which to fund
acquisitions. We are particularly interested in three areas.
The first is businesses that would either prove additive or complementary to our
current offerings in the Public Safety and Justice segment. We envision this
segment as being a growth segment for our business. We can only envision the
demands of our nation's first responders growing in the foreseeable future.
Furthermore, this business is characterized by strong recurring revenues which
as discussed above is one of our key business drivers for CompuDyne.
Second, we are continually looking for companies that have attractive security
technology based products that we can leverage by offering the technology to our
existing customers and markets.
The third type of business we are interested in acquiring is a high-end
commercial security integrator. Our primary clientele are currently governmental
units. Throughout our other three segments, over the years we have developed
significant skills as it relates to security integration and applications. Our
offerings however are sold almost exclusively to various governmental units. We
believe that the purchase of the right high end commercial security integrator
would give us a market entree whereby we would be able to offer many of our
existing offerings into the private sector, a wholly new business arena for us,
and one that we believe is not served as well as the governmental arena to which
we have heretofore dedicated ourselves.
We believe that our ability to address and implement successfully the above
three areas of focus will significantly enhance our future growth opportunities
and will provide for more predictable financial results.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
Revenues. The Company had revenues of $39.0 million and $46.8 million for three
months ended March 31, 2004 and 2003, respectively. This was a decrease of $7.7
million or 16.6%.
Revenues from the Institutional Security Systems segment decreased from $23.4
million in 2003 to $16.1 million in 2004. This was a decrease of 31.5%. The
Institutional Security Systems segment is largely a construction driven
business. Much of its revenue is obtained by working on new and retrofit
construction projects in the corrections industry, as opposed to sources of
recurring revenue. As such, the decrease in revenue experienced by this segment
is largely attributable to its working on less projects than it did in the
previous year. One of the reasons was because its backlog had decreased from
$99.5 million at December 31, 2002 to $57.3 million at December 31, 2003 thus
resulting in less work available to be performed in the first quarter of 2004
than in the first quarter of 2003. At March 31, 2004, the backlog for the
Institutional Security System's segment further declined to $52.1 million. The
year 2003 was a slow bidding period for the Company. Although the gross amount
of construction spending in the corrections area remained relatively flat
between 2002, 2003 and the first quarter of 2004, the types of projects that the
Company solicits, namely large-scale medium to maximum security installations,
declined in 2003 and the first quarter of 2004. This situation was further
compounded by the general state and local governmental budget deficits which are
causing these governmental units to rethink and delay many of their pending
corrections projects.
17
Revenues from the Attack Protection segment decreased from $8.3 million in 2003
to $7.0 million in 2004. The Attack Protection segment was largely capacity
constrained during 2001. As a result, the Company purchased an existing 75,000
square foot factory on 20 acres of land in close proximity to its existing
factory in Montgomery, Alabama. This expansion provided the segment with the
necessary capacity to generate incremental revenue of approximately $10 million
per year. This capacity increase was largely driven by the Company's expectation
that the demands for its products, principally its bullet and blast resistant
windows and doors would accelerate significantly in the post September 11, 2001
world. Throughout 2002, 2003 and the first quarter of 2004 this anticipated
increase in demand did not materialize leaving the segment with significant
excess capacity. This segment is composed of two chief product offerings, namely
Norshield, which encompasses bullet and blast resistant windows and doors and
ancillary products, and Fiber SenSys, which encompasses its fiber optic
intrusion detection systems. During the first three months of 2004 compared to
2003 the Norshield line experienced a 29.4% decline in revenues, whereas the
Fiber SenSys line experienced a 55.8% increase in revenue. The Company continues
to see heightened interest for its Fiber SenSys products and expects sales for
these items to continue to experience sustainable growth. The slow-down in the
government building process experienced during 2002 and early 2003 has appeared
to stabilize. Now it appears that projects are being released for construction,
and thus the Attack Protection segment is experiencing increased bidding
activity for its products. During the fourth quarter of 2003 the Company
furnished bids to supply its products for eight new embassy projects. This was
the largest amount of embassy projects bid in a single calendar year for this
segment. As of March 31, 2004, the Company won one of the embassy bids, lost one
of the embassy bids and the remaining six (6) embassy bids have not yet been
awarded to subcontractors. In addition, all indications are that this increased
level of new embassy construction will continue for at least the next several
years.
Revenues from the Federal Security Systems segment increased from $3.5 million
for the first three months of 2003 to $3.6 million for the same period in 2004.
This was an increase of 2.5%. Substantially all of this segment's revenue is
backlog driven. The Federal Security Systems Segment ended 2002 with a backlog
level of $11.4 million. Backlog at December 31, 2003 was $8.3 million and at
March 31, 2004 was $9.3 million.
Revenues from the Public Safety and Justice segment increased $1.0 million or
8.3% from $11.5 million for the first three months of 2003 to $12.4 million for
the same period in 2004.
Expenses. Cost of goods sold decreased from $35.0 million during the first three
months of 2003 to $28.8 million in 2004. This decrease was a result of a
decreased costs of goods sold of $6.6 million at the Institutional Security
Systems segment, largely attributable to the decreased sales of this segment.
The smaller percentage decrease in sales as compared to the percentage decrease
in cost of goods sold resulted in an increased gross profit percentage of 26.1%
in the first three months of 2004 as compared to 25.2% in 2003.
Cost of goods sold in the Institutional Security Systems segment decreased from
$20.2 million in the first three months of 2003 to $13.6 million in 2004. This
was a decrease of $6.6 million or (32.8%). This decrease was more than the
related sales decrease of this segment of 31.5% resulting in an increase in the
gross profit percentage from 14.0% in 2003 to 15.6% in 2004. During 2002, the
West Coast operations of the Institutional Security Systems segment identified
that the costs to complete these projects was going to be significantly higher
than was previously projected. This was a result of significant cost overruns on
many of these projects. As the work on the projects progressed and as these
projects neared completion the Institutional Security Systems segment identified
additional cost overruns which would cause the costs to complete these projects
to increase.
18
These increases were identified and recorded in the cost to complete
calculations in the following periods.
Third and Fourth Quarters of 2002 $ 2,400,000
First Quarter of 2003 248,000
Second Quarter of 2003 1,277,000
Third Quarter of 2003 373,000
Fourth Quarter of 2003 487,000
First Quarter of 2004 176,000
-------------
Total West Coast Margin Reductions $ 4,961,000
As a result, as these projects are being brought to completion the revenue
generated by them is resulting in little margin or in some cases losses as the
additional cumulative costs overruns of $5.0 million were being identified and
realized. To address this situation, the Company implemented more centralized
controls and replaced certain personnel at its West Coast operations.
Cost of goods sold in the Attack Protection segment decreased from $6.4 million
for the first three months of 2003 to $6.0 million for the same period in 2004.
This was a decrease of $0.3 million or 5.2%. This decrease was smaller than the
related sales decrease of this segment of 16.7%, resulting in a decrease in the
gross profit percentage from 23.7% in 2003 to 13.2% in 2004. We are actively
working to better utilize the new capacity provided by the Company in 2002. One
of the actions we have taken was to relocate the AirTeq manufacturing operation
in Oregon and consolidate it into the facilities we have in Montgomery, Alabama.
This was done in an effort to enhance the utilization of our owned facilities in
Alabama and thus absorb some of our excess manufacturing capacity. Although not
a huge contributor, this did in fact result in further utilization of
approximately 12,000 square feet of previously unused manufacturing space in our
new plant in Alabama. This segment continues to experience a lack of business.
Cost of goods sold in the Federal Security Systems segment was relatively steady
at $3.0 million for the first three months of 2004 and 2003. The 4% increase in
cost of sales was slightly less than the related sales increase of this segment
of 2.5%. The Federal Security Systems segment gross profit percentage was 13.7%
and 15.0% for the first three months of 2004 and 2003 respectively.
Substantially all of the projects awarded in this segment are discrete projects.
Cost of goods sold in the Public Safety and Justice segment increased from $5.5
million for the first three months of 2003 to $6.2 million in 2004. This was an
increase of $0.7 million or 12.4%, slightly more than the related sales increase
of 8.3%.
Operating expenses increased from $8.0 million for the first three months of
2003 to $8.2 million in 2004. This was an increase of 2.2%.
Research and Development expenses decreased from $1.9 million in the first three
months of 2003 to $1.8 million in the first three months of 2004. Being a
technology driven enterprise, the Company's Public Safety and Justice segment is
required to continually update and enhance its software offerings thus causing
it to incur significant research and development costs.
19
The following table compares the weighted average of the Company's first three
months of 2004 and 2003 interest bearing borrowings and the related rates
charged thereon.
Monthly Weighted Monthly Weighted
Average - 2004 Average - 2003
Amount Rate Amount Rate
------ ---- ------ ----
(in thousands) (in thousands)
Bank borrowings $ 2,467 4.2% $ 19,909 4.1%
Industrial revenue bonds $ 4,445 3.4% $ 5,180 3.3%
Subordinated borrowings $ 40,250 6.3% - -
Swap hedge agreement $ 4,059 4.4% $ 6,765 3.9%
In addition the Company recorded
the following interest expense:
Amortization and write-off
of financing charges $ 128 $ 50
Taxes on Income. The effective tax rate was approximately 40% during both
the first three months of 2004 and 2003.
Net Income. The Company reported net (loss) income of ($0.3) million and $0.9
million in the first three months of 2004 and 2003, respectively. Diluted (loss)
earnings per share decreased to ($.04) in the first three months of 2004 from
$.12 in the first three months of 2003. The weighted average number of common
shares outstanding and equivalents increased from 8.0 million in 2003 to 8.4
million 2004.
Liquidity and Capital Resources
The Company funds its operations through cash flows generated from its
operations, bank and public financings, and the sale of its common stock. The
Company's liquidity requirements arise from cash necessary to carry its
inventories and billed and unbilled receivables, for capital expenditures, to
repurchase shares of its common stock under its share repurchase program, for
payments of principal and interest on outstanding indebtedness and for
acquisitions. The ultimate customers of the Company are primarily Federal, State
and local governmental units. In the event the funding of these governmental
units is reduced for any reason, including budgetary reductions due to economic
conditions, there is a risk that the demand for the Company's goods and services
would decrease which would reduce the availability of funds to the Company.
As of March 31, 2004, the Company had working capital of $57.1 million compared
with $28.8 million as of December 31, 2003. The most significant changes in
working capital were due to the cash proceeds of the 2004 Notes financing and
the purchase of $22.2 million available-for-sale marketable securities at cost.
Net cash used by operating activities was $1.7 million in the first three months
of 2004 versus $7.6 million provided by operating activities in the first three
months of 2003.
Net cash used for investing activities was $22.4 million in the first three
months of 2004 compared to net cash used of $182 thousand in the first three
months of 2003. In the first three months of 2004, $22.2 million of marketable
securities were purchased at cost.
Net cash provided by financing activities amounted to $26.0 million in the first
three months of 2004 compared with a use of $7.3 million in the first three
months of 2003. From the proceeds of the issuance of the 2004 Notes, $13.0
million of the bank borrowings were repaid.
20
The following table summarizes the long term debt of the Company as of March 31,
2004 and the payments due by period, in thousands.
Long-Term Debt
--------------
December 31:
2004 $ 440
2005 440
2006 440
2007 440
2008 440
Thereafter 42,495
-------------
Totals $ 44,695
=============
In addition, the Company enters into purchase obligations to procure equipment
and services, including subcontractor contracts, in the performance of the
day-to-day operations of its business. Substantially all of these obligations
are covered by our existing backlog and the revenues generated by these backlogs
are expected to be sufficient to meet any payment obligations resulting from
these purchase commitments.
On January 22, 2004, the Company completed the offering of the 2004 Notes. The
offering was for $35 million principal amount plus an underwriter's
over-allotment option of $5.25 million principal amount, which was exercised in
full. The 2004 Notes bear interest at the rate of 6.25% per annum, payable
semi-annually, and are convertible into shares of common stock at a conversion
price of $13.89 per share.
On March 31, 2004 the Company and its banks amended and restated its credit
agreement. Under the terms of the new agreement $10.0 million of the line of
credit matures on March 1, 2007 and $15.0 million of the line of credit matures
on March 1, 2005.
The Company's total outstanding borrowings at March 31, 2004 amounted to
approximately $43.4 million. The 2004 Notes accounted for $39.0 million of these
borrowings. The remaining amount of $4.4 million resulted from borrowings at
variable rates and consisted of two industrial revenue bonds outstanding in the
amounts of $1.5 million and $2.9 million. The interest rate charged to the
Company at March 31, 2004 was 1.29% and 1.14% respectively. The variable
interest rate for these borrowings fluctuated between 1.01% and 1.38% during the
first three months of 2004 based on weekly market conditions. These bonds are
fully collateralized by bank letters of credit issued under the Credit
Agreement. The Company's banks consider letters of credit as outstanding
borrowings when considering the amount of availability the Company has remaining
under its line of credit.
Other than the Company's $5.4 million of letters of credit, the Company has no
other material off balance sheet liabilities.
The Company had $19.6 million of unused availability under its line of credit at
March 31, 2004.
As a result of the variable nature of the interest rate on the Company's bank
borrowings, any increase in the amount of outstanding borrowings and/or
decreases in the Company's EBITDA (an increase in the "leverage ratio") will
result in the Company's interest rate increasing and thus the amount of interest
expense incurred also increasing.
The Company anticipates that cash generated from operations and borrowings under
the working capital line of credit and the cash generated from its recent
issuance of the 2004 Notes will enable the Company to meet its liquidity,
working capital and capital expenditure requirements during the next 12 months.
The Company, however, may require additional financing to pursue its strategy of
growth through acquisitions to meet its long-term liquidity, working capital and
capital expenditure requirements. If such financing is required, there are no
assurances that it will be available, or if available, that it can be obtained
on terms favorable to the Company. The Company presently has no binding
commitment or binding agreement with respect to any acquisition or strategic
investment. However, from time to time, the Company may be party to one or more
non-binding letters of intent regarding material acquisitions, which, if
consummated, may be paid for with cash or through the issuance of a significant
number of shares of the Company's common stock.
21
The current interest rate environment nationally is at historic lows. In light
of this favorable environment, the Company determined that it was in its best
interests to lock in a favorable fixed interest rate for a significant amount of
borrowings. These borrowings, which were made on a subordinated basis, were used
to pay off the Company's existing bank debt and will be available to fund the
Company's future growth opportunities and also will be available to fund any
acquisitions which the Company may wish to pursue. These funds will be
instrumental in the Company's growth through acquisition strategy. Unlike the
Company's existing bank debt availability, the 2004 Notes do not contain any
restrictive covenants or ratios. As a result of securing this borrowing, the
Company renegotiated its bank lines of credit. Although the Company currently
does not see the need to borrow under its bank lines, it intends to keep such
lines open and available to enhance its financial flexibility.
During January 2004, the Company repaid substantially all of its outstanding
bank borrowings from the proceeds of the issuance of its 2004 Notes. The Company
has decided not to repay any of its Industrial Revenue Bond ("IRB") borrowings
as it has determined that there were certain favorable tax treatments afforded
the Company when it entered into these IRB's which it would lose in the event
these borrowings were repaid prematurely.
Additional Considerations
Cost Containment
Due to current economic conditions, and in light of a very strong competitive
environment, the Company recognizes that its ability to increase the prices it
charges its customers is limited. As a result, in order to enhance its
profitability, the Company recognizes the need to continue to seek ways to
reduce its costs.
Total Backlog
CompuDyne's total backlog amounted to $131.7 million at March 31, 2004. This was
a decrease of 5.7% from the Company's December 31, 2003 backlog of $139.4
million. The break down of the Company's backlog by segment is as follows, in
thousands:
March 31, December, 31,
2004 2003
----------- ---------------
Institutional Security Systems $ 52,147 $ 57,258
Attack Protection 12,905 10,043
Federal Security Systems 9,269 8,326
Public Safety and Justice 57,332 63,727
------------ -------------
Totals $ 131,653 $ 139,354
============ =============
Included in the backlog of the Public Safety and Justice segment at March 31,
2004 and December 31, 2003 is $13.8 million and $12.0 million, respectively,
representing awards received by the segment, for which the customers have not
yet entered into signed contracts. These awards are expected to result in signed
contracts over the next twelve months.
Critical Accounting Policies
A complete description of the Company's significant accounting policies appears
in the Company's Annual Report to its stockholders and is incorporated by
reference in its Annual Report on Form 10-K for the year ended December 31,
2003.
Percentage of Completion Accounting and Revenue Recognition
Approximately 75% of the Company's revenues are derived from long term contracts
where revenue is recognized under the percentage of completion method of
accounting. The Company's software related contracts utilize labor hours
incurred to date on a project, divided by the total expected project hours to
determine the completion percentage. The Company's manufacturing and
construction contracts utilize costs incurred to date on a project, divided by
the total expected project costs to determine the completion percentage. Both of
these methods require considerable judgment and as such, the estimates derived
at any point in time could differ significantly from actual results. These
estimates effect many of the balance sheet and statement of operations accounts
including net sales, cost of goods sold, accounts receivable, contract costs in
excess of billings and billings in excess of contract costs incurred.
Revenues for support and maintenance contracts are deferred and recognized
ratably over the life of the contract.
22
Provisions for estimated losses on uncompleted contracts are recognized in the
period such losses are determined.
Goodwill and Intangible Assets
The Company reviews the carrying value of goodwill and unamortized intangible
assets annually during the fourth quarter of the year as of October 1 or
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable, utilizing a discounted cash flow model. Changes in estimates
of future cash flows caused by items such as unforeseen events or changes in
market conditions could negatively affect the reporting unit's fair value and
result in an impairment charge. The Company cannot predict the occurrence of
events that might adversely affect the reported value of goodwill and intangible
assets that totaled approximately $31.0 million, net at March 31, 2004.
Stock Compensation Policy
The Company accounts for its stock-based compensation using the intrinsic value
method and in accordance with the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. No stock-based employee compensation employee compensation cost
is reflected in net income, as all options granted had an exercise price equal
to the fair market value of the underlying common stock on the date of the
grant.
Economic Conditions and the After Effect of the September 11, 2001
Terrorist Attacks
Much of the work CompuDyne performs is for state and local governmental units.
These entities have been severely impacted by recent economic conditions and the
resultant contraction of the tax bases of these governmental units. This has
caused these governmental units to carefully evaluate their budgets and defer
expenses and projects where possible. Much of the work of the Company's Public
Safety and Justice and Institutional Security Systems segments is contracted
with these state and local governmental units. As a result, these segments have
seen delays in new work available to be bid and worked on. In addition, even
work that has been contracted for where possible is being deferred by the
customer into the future, presumably when the economy will experience more
robust times.
After the occurrence of the tragic events of the September 11, 2001 terrorist
attacks, there was a general perception that our Federal Security Systems and
Attack Protection segments would see a significant increase in order flow. To
the contrary, in the months subsequent to the terrorist attacks these segments
saw a slowing in new work opportunities as the various Federal agencies and
other customers that are the usual source of business for the Company slowed
their procurement processes waiting for definitive direction as to how to
proceed in the post September 11 world. Now further complicated by the military
action in Iraq, the Company's customers are reevaluating priorities and budgets
and are funding only their most pressing demands while also making key decisions
as to which projects can be deferred.
Over time the Company believes these units will start to see a significant
increase in business which has not as of yet begun.
As a result of the above factors, during the last two years the Company has
experienced a more challenging marketplace than it experienced in several years
prior to September 11, 2001.
Impact of Inflation
Inflation did not have a significant effect on our operations during the first
three months of 2004.
23
Market Risk
The Company is exposed to market risk related to changes in interest rates. The
Company entered into an interest rate swap agreement on June 26, 2001 in the
initial notional amount of $11.5 million. The notional amount of this swap
agreement declines by $676 thousand on a quarterly basis until it becomes $0 on
October 1, 2005. At March 31, 2004 the notional amount of the swap agreement had
declined to $4.0 million at a fixed rate of 4.9%. In January 2004 the interest
rate swap ceased to be a highly effective cash flow hedge when the related debt
was repaid. Consequently, the amounts previously recorded in other comprehensive
income as changes in fair value of the interest rate swap were recognized in
earnings for the three months ended March 31, 2004. Upon determination of the
hedge ineffectiveness the cumulative loss on the fair value of the interest rate
swap was $155 thousand, which was recognized in other income. The change in fair
value of the interest rate swap for the three months ended March 31, 2004 was a
gain of $29 thousand, resulting in a remaining liability for the investment of
$126 thousand. Future changes in the value of the interest rate swap will be
recognized in earnings.
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 2004 Notes. The offering was for $35 million principal
amount plus an underwriter's over-allotment option of $5.25 million principal
amount, which was exercised in full. The 2004 Notes bear interest at the rate of
6.25% per annum, payable semi-annually, and are convertible into shares of
common stock at a conversion price of $13.89 per share. The Company used a
portion of the proceeds of this note offering to pay down its variable bank
notes payable. Subsequent to the pay-down of its bank notes payable the only
variable rate borrowings outstanding are approximately $4.4 million of
Industrial Revenue Bonds. Since these lines bear interest at variable rates, and
in the event interest rates increase dramatically, the increase in interest
expense to the Company could be material to the results of operations of the
Company.
Recent Accounting Pronouncements
In March 2004 the Emerging Issues Task Force ("EITF") reached a final consensus
on EITF Issue No. 03-06, "Participating Securities and the Two-Class Method
under FAS 128, Earnings Per Share". Issue No. 03-06 addresses a number of
questions regarding the computation of earnings per share ("EPS") by companies
that have issued securities other than common stock that contractually entitle
the holder to participate in dividends and earnings of the company when, and if,
it declares dividends on its common stock. The issue also provides further
guidance in applying the two-class method of calculating EPS. It clarifies what
constitutes a participating security and how to apply the two-class method of
computing EPS once it is determined that a security is participating, including
how to allocate undistributed earnings to such a security. EITF 03-06 is
effective for the fiscal quarter ending June 30, 2004. We are currently
evaluating the impact of adopting EITF 03-06 on our consolidated financial
statements.
In January 2003 the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entitites" (FIN 46). In December 2003, FIN 46 was replaced by
FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities".
FIN 46(R) clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements", to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46(R)
requires an enterprise to consolidate a variable interest entity if that
enterprise will absorb a majority of the entity's expected losses, is entitled
to receive a majority of the entity's expected residual returns, or both. FIN
46(R) is effective for entities being evaluated under FIN 46(R) for
consolidation no later than the end of the first reporting period that ends
after March 15, 2004. The adoption of this standard did not have a material
effect on the financial position, results of operations or cash flows of
CompuDyne.
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ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
CompuDyne has fixed and variable rate notes payable. These on-balance sheet
financial instruments expose the Company to interest rate risk, with the primary
interest rate exposure resulting from changes in the bond market used to
determine the interest rate applicable to the borrowings under the Company's IRB
borrowings.
The information below summarizes our sensitivity to market risks associated with
fluctuations in interest rates as of March 31, 2004. To the extent that the
Company's financial instruments expose the Company to interest rate risk, they
are presented in the table below. The table presents principal cash flows and
related interest rates by year of maturity of the Company's notes payable with
variable rates of interest in effect at March 31, 2004.
It should be noted that on January 22, 2004, the Company completed an offering
of $40.25 million principal amount of 6.25% Convertible Subordinated Notes due
on January 15, 2011. The 2004 Notes bear interest at a rate of 6.25% per annum,
payable semi-monthly, and are convertible into shares of common stock at a
conversion price of $13.89 per share. The Company used a portion of the proceeds
of this note offering to pay down its variable bank notes payable. The pay down
of its variable borrowings reduced the Company's interest rate risk.
Financial Instruments by Expected Maturity Date
Notes Payable
Year Ending Variable Average Variable Fixed Average Fixed
December 31 Rate ($) Interest Rate Rate ($) Interest Rate
----------- ---------------- ------------------- ------------- ---------------- --
2004 $ 440,000 1.7% $ - -
2005 440,000 2.0% - -
2006 440,000 2.3% - -
2007 440,000 2.6% - -
2008 440,000 2.9% - -
Thereafter 2,245,000 2.9% 40,250,000 6.25%
-------------- -------------
Total $ 4,445,000 2.6% $ 40,250,000 6.25%
Fair Value $ 4,445,000 2.6% $ 40,250,000 6.25%
Interest Rate Swaps
Year Ending Variable Average Average
December 31 Rate ($) Pay Rate Receive Rate
----------- --------------- -------- -------------
2004 $ 2,029,410 4.9% 2.0%
2005 2,029,420 4.9% 3.0%
2006 - - -
2007 - - -
2008 - - -
Thereafter - - -
---------------
Total $ 4,058,830 4.9% 2.5%
Fair Value $ (125,598)
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ITEM 4
CONTROLS AND PROCEDURES
The Company's management conducted an evaluation, under the supervision and with
the participation of the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of March 31, 2004. Based on this
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that (i) the Company's disclosure controls and procedures are effective in
ensuring that information required to be disclosed in reports filed or submitted
to the SEC is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure and (ii) such information is recorded,
processed, summarized and reported within the time periods specified in the SEC
rules and forms.
In addition, the Company's management, including the Chief Executive Officer and
Chief Financial Officer, reviewed the Company's internal control over financial
reporting, and there was no changes in the Company's internal control over
financial reporting during the quarter ending March 31, 2004 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting. The Company continually strives to improve its
disclosure controls and procedures to enhance the quality of its financial
reporting.
26
PART II - OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits -
3.1 Amendment to By-laws to allow the Board of Directors to fill
vacancies created by the size of the board being increased, filed
herewith.
10.1 Amended and Restated Credit Agreement dated as of March 31, 2004
by and among CompuDyne Corporation and its subsidiaries, certain
participating lenders and PNC Bank, National Association, in its
capacity as agent for the lenders, filed herewith.
31.1 Certification by Mr. Martin Roenigk, Chief Executive Officer
pursuant to Rule 13a-14(a), filed herewith.
31.2 Certification by Mr. Geoffrey F. Feidelberg, Chief Financial
Officer pursuant to Rule 13a-14(a), filed herewith.
32.1 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act
of 2002, 18 U.S.C. Section 1350, for Mr. Martin Roenigk, Chief
Executive Officer, filed herewith.
32.2 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act
of 2002, 18 U.S.C. Section 1350, for Mr. Geoffrey F. Feidelberg,
Chief Financial Officer, filed herewith.
(b) Reports on Form 8-K
1) Current Reports on Form 8-K filed February 23, 2004 attaching
CompuDyne Corporation's press release concerning earnings during
the period ending December 31, 2003.
2) Current Reports on Form 8-K filed April 16, 2004 regarding
engagement of new independent auditors.
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SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
COMPUDYNE CORPORATION
Date: May 7, 2004 /s/ Martin Roenigk
------------------
Martin Roenigk
Chief Executive Officer
/s/ Geoffrey F. Feidelberg
--------------------------
Geoffrey F. Feidelberg
Chief Financial Officer
28