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 June 30, 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_____
As of July 27, 2004, a total of 8,109,153 shares of Common Stock, $.75 par
value, were outstanding.
COMPUDYNE CORPORATION AND SUBSIDIARIES
INDEX
PAGE NO.
Part I. Financial Information
Item 1. Financial Statements - Unaudited
Consolidated Balance Sheets - June 30, 2004
and December 31, 2003 3
Consolidated Statements of Operations -
Three Months and Six Months Ended
June 30, 2004 and 2003 4
Consolidated Statement of Changes in
Shareholders' Equity - Six Months Ended
June 30, 2004 5
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2004 and 2003 6
Notes to Consolidated Financial Statements 7-15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16-28
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 29
Item 4. Controls and Procedures 30
Part II. Other Information 31
Signature 32
2
ITEM 1. FINANCIAL STATEMENTS
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30, December 31,
ASSETS 2004 2003
------------ ------------
(in thousands)
Current Assets
Cash and cash equivalents $ 3,729 $ 1,869
Marketable securities 20,312 --
Accounts receivable, net 40,150 41,780
Contract costs in excess of billings 15,447 17,568
Inventories 6,174 6,704
Deferred tax assets 1,509 1,371
Prepaid expenses and other 2,784 2,322
------------ ------------
Total Current Assets 90,105 71,614
Property, plant and equipment, net 9,227 10,079
Goodwill 21,280 21,280
Other intangible assets, net 9,585 9,785
Other 779 904
------------ ------------
Total Assets $ 130,976 $ 113,662
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities $ 17,238 $ 21,078
Billings in excess of contract costs incurred 10,369 13,551
Deferred revenue 4,482 6,036
Current portion of notes payable 440 2,103
------------ ------------
Total Current Liabilities 32,529 42,768
Notes payable 3,705 15,555
Convertible subordinated notes payable 39,025 --
Deferred tax liabilities 1,654 1,592
Other 575 820
------------ ------------
Total Liabilities 77,488 60,735
Commitments and Contingencies
Shareholders' Equity
Preferred stock, 2,000,000 shares authorized and unissued -- --
Common stock, par value $.75 per share: 50,000,000 and
15,000,000 shares authorized at June 30, 2004 and
December 31, 2003, respectively; 8,704,030 and 8,567,680
shares issued at June 30, 2004 and
December 31, 2003, respectively 6,527 6,426
Additional paid-in-capital 43,544 42,755
Retained earnings 7,709 7,926
Accumulated other comprehensive income (loss) (205) (93)
Treasury stock, at cost; 594,877 shares at
June 30, 2004 and December 31, 2003 (4,087) (4,087)
------------ ------------
Total Shareholders' Equity 53,488 52,927
------------ ------------
Total Liabilities and Shareholders' Equity $ 130,976 $ 113,662
============ ============
The accompanying notes are an integral part of these financial statements.
3
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands, except per share data)
Revenues:
System sales $ 32,920 $ 42,696 $ 67,246 $ 84,976
Service and other 4,863 4,842 9,564 9,329
-------- -------- -------- --------
Total revenues 37,783 47,538 76,810 94,305
Cost of sales 26,636 35,751 55,465 70,735
-------- -------- -------- --------
Gross profit 11,147 11,787 21,345 23,570
Selling, general and administrative expenses 8,677 7,696 16,831 15,654
Research and development 1,874 2,032 3,629 3,913
-------- -------- -------- --------
Income from operations 596 2,059 885 4,003
-------- -------- -------- --------
Other expense (income)
Interest expense 845 334 1,594 713
Interest income (344) (1) (414) (10)
Other expense (income) (58) (1) 63 1
-------- -------- -------- --------
Total other expense 443 332 1,243 704
-------- -------- -------- --------
Income (loss) before income taxes 153 1,727 (358) 3,299
Income taxes expense (benefit) 63 690 (141) 1,320
-------- -------- -------- --------
Net income (loss) $ 90 $ 1,037 $ (217) $ 1,979
======== ======== ======== ========
EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per common share $ .01 $ .13 $ (.03) $ .25
======== ======== ======== ========
Weighted average number of common
shares outstanding 8,075 7,898 8,042 7,860
======== ======== ======== ========
Diluted earnings (loss) per common share $ .01 $ .13 $ (.03) $ .24
======== ======== ======== ========
Weighted average number of common
shares and equivalents 8,376 8,139 8,042 8,106
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
4
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 136 101 789 -- -- -- -- 890
Net loss -- -- -- (217) -- -- --
(217)
Other comprehensive income, net of tax:
Ineffectiveness of interest
rate swap agreement -- -- -- -- 93 -- -- 93
Unrealized gain (loss) on
available for sale
marketable securities -- -- -- -- (205) -- -- (205)
--------------------------------------------------------------------------------------
Balance at
June 30, 2004 8,704 $ 6,527 $ 43,544 $ 7,709 $ (205) 595 $ (4,087) $ 53,488
===== ======== ======== ======== ======== === ======== ========
The accompanying notes are an integral part of these financial statements.
5
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
June 30,
2004 2003
-------- --------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ (217) $ 1,979
Adjustments to reconcile net (loss) income to
net cash provided by operations:
Depreciation and amortization 1,367 1,376
(Gain) loss from disposal of property, plant and equipment (1) 1
Amortization of debt discount 83 --
Unrealized loss on interest rate swap 68 --
Amortization of discounts on marketable securities (122) --
Changes in assets and liabilities:
Accounts receivable 1,630 2,044
Contract costs in excess of billings 2,121 3,714
Inventories 530 764
Prepaid expenses and other current assets (462) (658)
Other assets 125 (79)
Accounts payable and accrued liabilities (3,908) 2,268
Billings in excess of contract costs incurred (3,182) 52
Deferred revenue (1,554) (2,019)
Other liabilities (90) (1)
-------- --------
Net cash flows (used in) provided by operating activities (3,612) 9,441
-------- --------
Cash flows from investing activities:
Purchase of marketable securities (31,195) --
Redemption of marketable securities 10,662 --
Additions to property, plant and equipment (315) (339)
Proceeds from sale of property, plant and equipment 1 9
Net payment for acquisition -- (71)
-------- --------
Net cash flows used in investing activities (20,847) (401)
-------- --------
Cash flows from financing activities:
Issuance of common stock 890 193
Warrants exercised -- 166
Purchase of treasury stock -- (166)
Repayment of bank notes and line of credit (13,513) (6,428)
Borrowings of convertible subordinated notes payable 38,942 --
-------- --------
Net cash provided by (used in) financing activities 26,319 (6,235)
-------- --------
Net change in cash and cash equivalents 1,860 2,805
Cash and cash equivalents at beginning of period 1,869 1,274
-------- --------
Cash and cash equivalents at end of period $ 3,729 $ 4,079
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 244 $ 587
Income tax, net of refunds $ 215 $ 1,220
The accompanying notes are an integral part of these financial statements.
6
COMPUDYNE CORPORATION AND SUBSIDIARIES
NOTES TO 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 and six month periods ended
June 30, 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 was
effective for the fiscal quarter ended June 30, 2004. The adoption of this
standard did not have a material effect on the financial position, results of
operations or cash flows of the Company.
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 the
Company.
7
Comprehensive Income:
The following table shows the components of comprehensive (loss) income, net of
income taxes, for the six months ended June 30, 2004 and 2003, in thousands.
For the Six Months
Ended June 30,
2004 2003
-------- -------
Net (loss) income $ (217) $ 1,979
Unrealized loss on available-for-sale securities (205) --
Ineffectiveness of interest rate swap agreement 93 --
Translation adjustment -- (7)
Loss on interest rate swap agreement -- 41
------- -------
Comprehensive (loss) income $ (329) $ 2,013
======= =======
Stock-based Compensation:
As of June 30, 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 June 30,
2004 2003
------ ----
(in thousands, except per share data)
Net income, as reported $ 90 $1,037
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards net of related tax effects (261) (281)
------ -------
Pro forma net (loss) income $(171) $ 756
====== =======
Earnings (loss) per share:
Basic - as reported $ .01 $ .13
Basic - pro forma $(.02) $ .10
Diluted - as reported $ .01 $ .13
Diluted - pro forma $(.02) $ .09
8
For the Six Months
Ended June 30,
2004 2003
------ ------
(in thousands, except per share data)
Net (loss) income, as reported $(217) $1,979
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards net of related tax effects (509) (579)
------ ------
Pro forma net (loss) income $(726) $1,400
====== ======
Earnings (loss) per share:
Basic - as reported $(.03) $ .25
Basic - pro forma $(.09) $ .18
Diluted - as reported $(.03) $ .24
Diluted - pro forma $(.09) $ .17
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 For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
----- ----- ----- -----
Expected life in years 5.5 6.7 5.5 6.9
Risk-free interest rate 3.3% 2.6% 3.2% 2.8%
Expected volatility 76.6% 79.6% 76.6% 80.0%
Reclassifications:
Certain prior period amounts have been reclassified to conform to the current
period's presentation. The effect of these reclassifications is not material to
the consolidated financial statements.
2. OPERATING SEGMENT INFORMATION
The following is the operating segment information for the three months ended
June 30, 2004 and 2003, in thousands.
Pre-tax
Revenues Gross Profit Income/(loss)
----------------- ----------------- ------------------
2004 2003 2004 2003 2004 2003
------- ------- ------- ------- ------- ------
Institutional Security
Systems $13,954 $25,692 $ 2,244 $ 3,240 $ (84) $ 835
Attack Protection 6,741 6,533 1,082 1,380 (456) (52)
Federal Security Systems 4,371 4,261 611 603 214 296
Public Safety and Justice 12,717 11,052 7,210 6,564 960 482
CompuDyne Corporate -- -- -- -- (481) 166
------- ------- ------- ------- ------- -------
$37,783 $47,538 $11,147 $11,787 $ 153 $ 1,727
======= ======= ======= ======= ======= =======
9
The following is the operating segment information for the six months ended June
30, 2004 and 2003, in thousands.
Pre-tax
Revenues Gross Profit Income/(loss)
------------------- ------------------- --------------------
2004 2003 2004 2003 2004 2003
-------- -------- -------- -------- -------- --------
Institutional Security
Systems $ 30,011 $ 49,140 $ 4,749 $ 6,517 $ 123 $ 1,572
Attack Protection 13,694 14,876 2,001 3,355 (1,135) 510
Federal Security Systems 7,946 7,750 1,101 1,125 414 503
Public Safety and Justice 25,159 22,539 13,494 12,573 1,395 550
CompuDyne Corporate -- -- -- -- (1,155) 164
------ ------ ------ ------ ----- ---
$ 76,810 $ 94,305 $ 21,345 $ 23,570 $ (358) $ 3,299
======== ======== ======== ======== ======== ========
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 651,200 and
814,520 shares for the three month periods ended June 30, 2004 and 2003
respectively, were not dilutive and, therefore, were not included in the
computation of diluted earnings per common share. Additionally, the 2,897,768
shares issuable upon conversion of the 6.25% Convertible Subordinated Notes due
January 15, 2011 (the "2011 Notes") are excluded as the effect is antidilutive.
Stock options and warrants to purchase 651,200 and 1,044,020 shares for the six
month periods ended June 30, 2004 and 2003 respectively, were not dilutive and,
therefore, were not included in the computation of diluted earnings per common
share. Additionally, the 2,897,768 shares issuable upon conversion of the 2011
Notes are excluded as the effect is antidilutive.
The computations of the Company's basic and diluted earnings (loss) per share
amounts for the three and six months ended June 30, 2004 and 2003 were as
follows, in thousands, except per share data:
Three Months Ended Six Months Ended
Ended June 30, Ended June 30,
2004 2003 2004 2003
------------ ---------- ----------- ---------
Net income (loss) $ 90 $ 1,037 $ (217) $ 1,979
============ ========== =========== =========
Weighted average common shares outstanding 8,075 7,898 8,042 7,860
Effect of dilutive stock options and warrants 301 241 - 246
------------ ---------- ----------- ---------
Diluted weighted average common shares outstanding 8,376 8,139 8,042 8,106
============ ========== =========== =========
Net income (loss) per common share
Basic $ .01 $ .13 $ (.03) $ .25
Diluted $ .01 $ .13 $ (.03) $ .24
The 2011 Notes contain contingent participation rights. The participation rights
are contingent upon the ability, based on the undistributed earnings for the
period, of the Company to declare and distribute dividends per share equal to or
in excess of the per share fair value of the Company's common stock. The Company
does not believe this contingency was met for the three and six months ended
June 30, 2004. Accordingly, no undistributed earnings have been allocated to the
2011 Notes. At each reporting period, the Company will assess whether the
contingency criteria have been met and consequently if undistributed earnings
should be allocated to participating securities.
10
4. INVENTORIES
Inventories consist of the following, in thousands:
June 30, December 31,
2004 2003
-------- -------------
Raw materials $3,943 $3,745
Work in progress 1,601 2,310
Finished goods 630 649
--- ---
$6,174 $6,704
====== ======
5. GOODWILL
The Company reviews the carrying value of goodwill annually during the fourth
quarter of the year 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 of $21.3 million at both June 30, 2004 and December 31, 2003.
Goodwill consisted of $19.8 million for the Public Safety and Justice segment,
$0.8 million for the Institutional Security Systems segment and $0.7 million for
Attack Protection segment as of June 30, 2004 and December 31, 2003.
6. INTANGIBLE ASSETS
Intangible assets include the trade name, customer relationships and backlog
from the acquisition of Tiburon, Inc. in 2002. Other intangibles include trade
names, Department of State Certifications, Underwriters Laboratories, Inc.
listings, and patents related to the acquisition of Norment and Norshield in
1998. Except trade names, which have indefinite lives, the intangible assets are
being amortized using the straight-line method.
Intangible assets consist of the following, in thousands:
June 30, December 31, Amortizable
2004 2003 Lives
-------- ------------- -----------
(in years)
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
-------- --------
10,933 10,933
Less: accumulated amortization (1,348) (1,148)
$ 9,585 $ 9,785
======== ========
11
Amortization expense for the Company's intangible assets for the three and six
month periods ended June 30, 2004 was $87 thousand and $200 thousand,
respectively. The following schedule lists the expected amortization expense for
each of the years ending December 31, in thousands:
Year Expense
---- --------
2004 (remaining) $ 150
2005 270
2006 225
2007 225
2008 225
--------
Total $ 1,095
========
7. 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 June
30, 2004, the Company had a product warranty accrual in the amount of $454
thousand.
Product Warranty Liabilities
----------------------------
(In Thousands)
--------------
Beginning balance at January 1, 2004 $ 517
Plus accruals for product warranties 126
Changes in pre-existing warranties (1)
Less payments (188)
----
Ending balance at June 30, 2004 $ 454
=======
8. 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 June 30,
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 June 30, 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 June 30, 2004 are summarized, in thousands, as follows:
Gross Unrealized
----------------
Cost Gains Losses Fair Value
--------- --------- ----------- -----------
Collateralized mortgage obligations
(CMO's) consisting of securities
issued by Fannie Mae,
Freddie Mac, and Ginnie Mae $ 20,655 $ - $ 343 $ 20,312
12
The cost and estimated fair value of current debt securities at June 30, 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 20,655 20,312
------ ------
Total debt securities $ 20,655 $ 20,312
============ ===========
9. NOTES PAYABLE AND LINE OF CREDIT
June 30, December 31,
2004 2003
--------- ------------
(in thousands)
Industrial revenue bond, interest payable quarterly at a variable rate of 1.14%
to 1.38% (1.21% at June 30, 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% (1.18% at June 30, 2004) principal payable in yearly installments of
$300,000. The bond is fully collateralized by a $2.6 million letter of credit
and a bond guarantee agreement 2,605 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, repaid in full in January 2004 -- 1,663
--------- -------
Total notes payable and line of credit 44,395 17,658
Less convertible subordinated notes discount 1,225 --
--------- -------
Subtotal 43,170 17,658
Less amount due within one year 440 2,103
--------- -------
$42,730 $15,555
========= =======
13
Maturities of notes payable are as follows, in thousands:
Year Ending December 31, Amount
------------------------ ---------------
2004 (remaining) $ 140
2005 440
2006 440
2007 440
2008 440
Thereafter 42,495
--------------
$ 44,395
==============
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 2011 Note. 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 2011 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 2011 Notes are subordinated to all other liabilities of the Company. The
carrying value is listed below, in thousands.
Face value $ 40,250
Underwriters discounts, net 1,225
----------
$ 39,025
==========
The 2011 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 per share, 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 stock
cash dividends in excess of a stated threshold.
The 2011 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 2011 Notes, occurs. If such an event does occur,
the Company can redeem the 2011 Notes at face value plus a premium. If a change
in control event occurs and the Company does not elect to redeem the 2011 Notes,
the holders can require the Company to repurchase the 2011 Notes at face value
plus accrued interest. After January 15, 2009, the Company can redeem the 2011
Notes at a premium of two percent of the face value.
The Company incurred $452 thousand of debt issuance costs for the 2011 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 2011 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 2011 Notes. Interest expense
recorded for the total of the deferred financing costs and debt discount on the
2011 Notes totaled $63 thousand and $119 thousand for the three month and six
months ended June 30, 2004, respectively.
During January 2004, the Company repaid substantially all of its outstanding
bank borrowings from the proceeds of the issuance of the 2011 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
provides for 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 June 30, 2004 $5.4 million was committed
principally to letters of credit securing the Industrial Revenue Bonds.
14
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 June 30, 2004 and June 30, 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 a range of 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 under letters of credit. If
borrowings exceed $10.0 million for thirty consecutive days, commitment fees
equal to a range of 0.20% to 0.35% 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 six months ended June 30, 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 and six
months ended June 30, 2004 was a gain of $58 thousand and $87 thousand,
respectively, resulting in a remaining liability for the investment of $68
thousand. Future changes in the value of the interest rate swap will be
recognized in earnings.
10. COMMITMENTS AND CONTINGENCIES.
The Company's Public Safety and Justice segment settled certain litigation with
one of its customers on June 30, 2004. As a result of the settlement agreement,
the Company refunded $350 thousand to this customer in exchange for the return
of the hardware and other products previously delivered to this customer. The
Company recorded the excess of the accrued liability related to this dispute as
a reduction of cost of sales of $292 thousand, which is included in the results
of operations for the three and six months ended June 30, 2004.
11. SUBSEQUENT EVENTS.
The Company entered into a new lease for its corporate headquarters on July 1,
2004. The lease has a term of five years and total future minimum rental
payments under the lease are $528 thousand.
On July 6, 2004 the Company granted 75,000 stock options to an employee of the
Company. These options were granted at a strike price equal to the fair value of
the common stock on the date of grant, are subject to vesting provisions, and
have a term of five years.
15
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 were originally
incorporated in 1952. 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 and 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 234 systems installed at 63 facilities
including 58 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 wedge 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.
16
The Public Safety and Justice segment consists of two subsidiaries known to the
industry as 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 560
systems supporting approximately 255 active customers, Tiburon is a leader in
public safety and justice solutions.
MANAGEMENT OUTLOOK
We find ourselves in very challenging times. 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. During the second quarter of 2004 we
saw our backlog increase for the first time since the fourth quarter of 2002.
Although this increase was a relatively modest $5.2 million, or 4.0% of March
31, 2004 backlog, we view the fact that the backlog stopped declining and in
fact started to increase as a very important milestone and an early indicator
that the difficult economic environment we have been operating under during the
past 18 months has stabilized.
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
June 30, 2004 $ 62,765 $ 17,761 $ 6,296 $ 50,065 $ 136,887
Historically, approximately over 75% of our revenues were generated from sources
where the ultimate customer is a state or local government unit. During the last
few years due to 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 cancel many
infrastructure projects until such time as their economic fortunes rebound.
Until the economy has improved and thus the 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. As
noted above, our slightly increased backlog at June 30, 2004 preliminarily
indicates to us that the markets we serve are stabilizing and we are hopeful
that our future backlogs will reflect this trend.
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 12.5% 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 define 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.
17
Six Months Ended June 30, 2004
-------------------------------
(in Thousands) One-time Revenue % Recurring Revenue % Total
--------------- ---- ----------------- ---- ---------
Institutional Security Systems $ 27,472 35.8 $ 2,539 3.3 $ 30,011
Attack Protection 13,694 17.8 - - 13,694
Federal Security Systems 7,946 10.3 - - 7,946
Public Safety and Justice 18,134 23.6 7,025 9.2 25,159
------ ---- ----- --- ------
Total $ 67,246 87.5 $ 9,564 12.5 $ 76,810
============= ==== =========== ==== =========
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 two to
five years, we intend to modify our business model to rely less upon one-time
sources of revenue and more on recurring sources of revenue. In this regard, we
recently hired a Chief Operating Officer (COO). The COO position is a new
position within CompuDyne. Our new COO, Mr. Maurice Boukelif, brings extensive
manufacturing and operational experience to us. Relying on his expertise, we are
hopeful we will be able to make this business model shift in the next few years.
Our third key focus area is acquisitions. With the January 2004 completion of
the 2011 Notes offering, we have significant resources with which to fund
acquisitions. We are particularly interested in three areas.
The first is a business 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. Our assessment is that the
demands of our nation's first responders will grow in the foreseeable future.
Furthermore, this business is characterized by strong recurring revenues which
as discussed above is one of our key business drivers.
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 if we address and implement successfully the above three areas
of focus it will significantly enhance our future growth opportunities and will
provide for more predictable financial results.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
Revenues. The Company had revenues of $37.8 million and $47.5 million for three
months ended June 30, 2004 and 2003, respectively. This was a decrease of $9.8
million or 20.5%.
Revenues from the Institutional Security Systems segment were $14.0 million in
the three months ended June 30, 2004 a decrease from $25.7 million for the same
period of 2003. This was a decrease of $11.7 million or 45.7%. 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. The principal reason
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 2004 and the second quarter of 2004 than in 2003 and the second
quarter of 2003. At June 30, 2004, the backlog for the Institutional Security
System's segment was $62.8 million which was a $10.6 million increase over the
previous quarter. 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 half of 2004, the
types of projects that the Company solicits, namely large-scale medium to
maximum security installations, declined in 2003 and the first half 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.
18
Revenues from the Attack Protection segment was $6.7 million in the three months
ended June 30, 2004, an increase from $6.5 million for the same period of 2003.
This was an increase of $0.2 million or 3.2%. The Company purchased an existing
75,000 square foot factory for the Attack Protection segment on 20 acres of land
in close proximity to its existing factory in Montgomery, Alabama. 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 half 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 three months ended June 30 of 2004 compared to the three months ended June
30, 2003 the Norshield line experienced a 20.6% decline in revenues, whereas the
Fiber SenSys line experienced a 109.1% 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 number of embassy projects bid in a single
calendar year for this segment. As of June 30, 2004, the Company was awarded
five of these embassy projects, for a total CompuDyne contract value of $11.2
million, lost two embassy projects and the eighth has yet to be awarded. All
indications are that this increased level of new embassy construction will
continue for at least the next several years. We expect bidding on an additional
16 embassies during the second half of this year.
Revenues from the Federal Security Systems segment was $4.4 million in the three
months ended June 30, 2004, an increase from $4.3 million for the same period of
2003. This was an increase of $0.1 million or 2.6%. 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 June 30, 2004 was $6.3
million and at December 31, 2003 was $8.3 million.
Revenues from the Public Safety and Justice segment was $12.7 million in the
three months ended June 30, 2004, an increase from $11.1 million for the same
period of 2003. This was an increase of $1.7 million or 15.1%. This increase was
a result of this segment shipping more hardware to its software clients than it
did during the three months ended June 30, 2003.
Expenses. Cost of goods sold of $26.7 million in the three months ended June 30,
2004 were down $9.1 million or 25.5% from $35.8 million during the same period
of 2003. This decrease was a result of a decreased costs of goods sold of $10.7
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 29.4% in the three months ended June 30,
2004 as compared to 24.8% in 2003.
Cost of goods sold in the Institutional Security Systems segment of $11.7
million in the three months ended June 30, 2004 were down $10.7 million or 47.8%
from $22.4 million during the same period of 2003. This decrease was more than
the related sales decrease of this segment of 45.7% resulting in an increase in
the gross profit percentage to 16.1% from 12.6% in the three months ended June
30, 2003. During 2002, the West Coast operations of the Institutional Security
Systems segment identified that the costs to complete its projects was expected
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, resulting in a higher cost of goods sold
in 2003 as a result of these charges in estimate to complete.
19
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
Second Quarter of 2004 80,000
-----------
Total West Coast Margin Reductions $ 5,041,000
===========
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 cost 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. As of June
30, 2004, we believe that additional cost overruns to complete these projects
will be minimal, and as of June 30, 2004 we have accrued for any known probable
losses.
Cost of goods sold in the Attack Protection segment of $5.7 million in the three
months ended June 30, 2004 was up $0.5 million or 9.8% from $5.2 million during
the same period of 2003. This increase was more than the related sales increase
of this segment of 3.2%, resulting in a 5.1% decrease in the gross profit
percentage to 16.1% from 21.1% in the three months ended June 30, 2003. We are
actively working to better utilize the 75,000 square foot factory the Company
purchased in Montgomery, Alabama. The Airteq manufacturing operation in Oregon
was relocated and consolidated into this facility. 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 this plant in Alabama. In addition, we
identified a quality problem with the windows and doors being installed on one
active and current project. As a result of this identified problem, we were
forced to take remedial action in the field to repair this defect. During the
June 30, 2004 quarter we were forced to increase our estimated cost to complete
this project by $0.5 million thus causing this project to become a negative
margin project. The entire estimated loss on this project was recorded in the
June 30, 2004 quarter. As this project is brought to completion, it will be
without any margin.
Cost of goods sold in the Federal Security Systems segment of $3.8 million in
the three months ended June 30, 2004 were up $0.1 million or 2.8% from $3.7
million during the same period of 2003. This increase was more than the related
sales increase of this segment of 2.6% resulting in an 0.2% decrease in the
gross profit percentage to 14.0% from 14.2% in the three months ended June 30,
2003. Substantially all of the projects awarded in this segment are discrete
projects.
Cost of goods sold in the Public Safety and Justice segment of $5.5 million in
the three months ended June 30, 2004 were up $1.0 million or 22.7% from $4.5
million during the same period of 2003. This increase was more than the related
sales increase of this segment of 15.1% resulting in an 2.7% decrease in the
gross profit percentage to 56.7% from 59.4% in the three months ended June 30,
2003. A substantial portion of this segments sales increase represents hardware
sales whereby we buy and procure hardware for our clients. Hardware sales
inherently have a significantly lower margin than our software sales. In
addition, during the fourth quarter of 2003 our Public Safety and Justice
segment received a complaint alleging that we breached our contract to provide a
public safety software system to a customer. As a result we recorded a $1.7
million pre-tax charge. During the second quarter of 2004 this matter was
settled resulting in a reduction by the segment of $0.3 million of the accrued
charges, which was reflected as a reduction of its cost of sales.
20
Selling, general and administrative expenses was $8.7 million for the three
months ended June 30, 2004, an increase of $1.0 million or 12.4% from $7.7
million for the same period of 2003. Much of this increase is related to
additional costs incurred by the Company related to legal fees incurred in
connection with responding to the complaint filed by the Public Safety and
Justice segment customer, expenses incurred in connection with evaluating
potential acquisitions, recruiting fees incurred to fill the recently hired COO
position and other senior management positions and to comply with new
requirements mandated by the Sarbanes-Oxley Act and the SEC.
Research and Development expenses were $1.9 million for the three months ended
June 30, 2004, a decrease of $0.2 million or 7.8% from $2.0 million for the same
period of 2003. 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. During the second quarter of 2004, certain of the segment's research and
development resources were diverted to work on revenue producing projects, which
resulted in a decline in our research and development expenses.
The following table compares the weighted average of the Company's three month
period ended June 30, 2004 and June 30, 2003 interest bearing borrowings and the
related rates charged thereon.
Monthly Weighted Average Monthly Weighted Average
Second Quarter 2004 Second Quarter 2003
Amount Rate Amount Rate
---------- ------- -------- ---------
(in Thousands) (in Thousands)
Bank borrowings $ -- -- $16,497 3.7%
Industrial revenue bonds $ 4,145 3.5% $ 4,585 4.2%
Subordinated borrowings $40,250 6.3% -- --
Swap hedge agreement $ 3,382 4.6% $ 6,088 4.1%
In addition the Company recorded
the following interest expense:
Amortization and write-off
of deferred financing charges $ 145 $ 51
Taxes on Income. The effective tax rate was approximately 40% during both the
three month periods ended June 30, 2004 and June 30, 2003.
Net Income. The Company reported net income of $0.1 million and $1.0 million in
the second quarters of 2004 and 2003, respectively. Diluted earnings per share
decreased to $.01 in the second quarter of 2004 from $.13 in the second quarter
of 2003. The weighted average number of common shares outstanding and
equivalents increased in the second quarter of 2004 as compared to the second
quarter of 2003 to 8.4 million from 8.1 million in 2003.
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Revenues. The Company had revenues of $76.8 million and $94.3 million for the
six months ended June 30, 2004 and June 30, 2003, respectively. This was a
decrease of $17.5 million or 18.6%.
Revenues from the Institutional Security Systems segment were $30.0 million in
the six months ended June 30, 2004, a decrease from $49.1 million for the same
period of 2003. This was a decrease of $19.1 million or 38.9%. 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. The principal reason
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 six months of 2004 as compared to the first six months of
2003. At June 30, 2004, the backlog for the Institutional Security System's
segment was $62.8 million which was a $5.5 million increase over the December
31, 2003 backlog amount. 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 half of 2004, the
types of projects that the Company solicits, namely large-scale medium to
maximum security installations, declined in 2003 and the first half 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.
21
Revenues from the Attack Protection segment was $13.7 million in the six months
ended June 30, 2004, a decrease from $14.9 million for the same period of 2003.
This was a decrease of $1.2 million or 7.9%. The Company purchased an existing
75,000 square foot factory for the Attack Protection segment on 20 acres of land
in close proximity to its existing factory in Montgomery, Alabama. 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 half 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 six months ended June 30, 2004 compared to June 30, 2003 the Norshield line
experienced a 25.6% decline in revenues, whereas the Fiber SenSys line
experienced a 81.8% increase in revenues. 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 2003 has appeared to
stabilize. 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
number of embassy projects bid in a single calendar year for this segment. As of
June 30, 2004, the Company was awarded five of these embassy projects, for a
total CompuDyne contract value of $11.2 million, lost two embassy projects and
the eighth has yet to be awarded. All indications are that this increased level
of new embassy construction will continue for at least the next several years.
We expect bidding on additional 16 embassies during the second half of 2004.
Revenues from the Federal Security Systems segment was $7.9 million in the six
months ended June 30, 2004, an increase from $7.8 million for the same period of
2003. This was an increase of $0.1 million or 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 June 30, 2004 was $6.3 million.
Revenues from the Public Safety and Justice segment was $25.2 million in the six
months ended June 30, 2004 an increase from $22.5 million for the same period of
2003. This was an increase of $2.6 million or 11.6%. This increase was a result
of this segment shipping more hardware to its software clients than it did
during the six month period ended June 30, 2003.
Expenses. Cost of goods sold of $55.5 million in the six months ended June 30,
2004 were down $15.3 million or 21.6% from $70.7 million during the same period
of 2003. This decrease was a result of decreased costs of goods sold of $17.4
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 27.7% for the six months ended June 30,
2004 as compared to 25.0% in 2003.
Cost of goods sold in the Institutional Security Systems segment of $25.3
million for the six months ended June 30, 2004 were down $17.4 million or 40.7%
from $42.6 million during the same period of 2003. This decrease was more than
the related sales decrease of this segment of 38.9% resulting in a 2.6% decrease
in the gross profit percentage to 15.8% from 13.3% in the six months ended June
30, 2003. During 2002, the West Coast operations of the Institutional Security
Systems segment identified that the costs to complete its 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 resulting in a higher cost of goods sold
in 2003 as a result of the charges in estimate to complete.
22
These increases were identified and recorded in the cost to complete
calculations in the following periods.
Second Six Months of 2002 $ 2,400,000
First Six Months of 2003 1,525,000
Second Six Months of 2003 860,000
First Six Months of 2004 256,000
---------------
Total West Coast Margin Reductions $ 5,041,000
===============
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. As of June
30, 2004 we believe that additional cost overruns to complete these projects
will be minimal, and as of June 30, 2004 we have accrued for any known probable
losses.
Cost of goods sold in the Attack Protection segment of $11.7 million for the six
months ended June 30, 2004 increased $0.2 million or 1.5% from $11.5 million
during the same period of 2003. This increase occurred in spite of a sales
decrease of this segment of 7.9%, resulting in a 7.9% decrease in the gross
profit percentage to 14.6% from 22.6% during the six months ended June 30, 2003.
We are actively working to better utilize the 75,000 square foot factory the
Company purchased in Montgomery, Alabama. The Airteq manufacturing operation in
Oregon was relocated and consolidated into this facility. 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 this plant in
Alabama. In addition we identified a quality problem with the windows and doors
being installed on one active and current project. As a result of this
identified problem, we were forced to take remedial action in the field to
repair this defect. During the first six months of June 30, 2004 we were forced
to increase our estimated cost to complete this project by $0.9 thousand thus
causing this project to become a negative margin project. The entire loss on
this project was recorded in the June 30, 2004 quarter. As this project is
brought to completion, it will be without any margin.
Cost of goods sold in the Federal Security Systems segment of $6.8 million in
the six months ended June 30, 2004 increased $0.2 million or 3.3% from $6.6
million during the same period of 2003. This increase was more than the related
sales increase of this segment of 2.5%, resulting in an 0.7% decrease in the
gross profit percentage to 13.9% from 14.5% in the six months ended June 30,
2003. Substantially all of the projects awarded in this segment are discrete
projects.
Cost of goods sold in the Public Safety and Justice segment of $11.7 million for
the six months ended June 30, 2004 were up $1.7 million or 17.0% from $10.0
million during the same period of 2003. This increase was more than the related
sales increase of this segment of 11.6%, resulting in a 2.1% decrease in the
gross profit percentage to 53.6% from 55.8% in the six months ended June 30,
2003. During the fourth quarter of 2003 our Public Safety and Justice segment
received a complaint alleging that we breached our contract to provide a public
safety software system to a customer. As a result we recorded a $1.7 million
pre-tax charge. During the second quarter of 2004 this matter was settled
resulting in a recovery by the segment of $0.3 million of the accrued charge,
which was reflected as a reduction of its cost of sales.
Selling, general and administrative expenses was $16.8 million for the six
months ended June 30, 2004, an increase of $1.2 million or 7.5% from $15.7
million for the same period of 2003. Much of this increase is related to
additional costs incurred by the Company related to legal fees incurred in
connection with responding to the complaint filed by the Public Safety and
Justice segment customer, expenses incurred in connection with evaluating
potential acquisitions, recruiting fees incurred to fill the recently hired COO
position and other senior management positions and to comply with new
requirements mandated by the Sarbanes-Oxley Act and the SEC.
23
Research and Development expenses was $3.6 million for the six months ended June
30, 2004, a decrease of $0.3 million or 7.3% from $3.9 million for the same
period of 2003. 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. During the first six months of 2004 certain of the Public
Safety and Justice research and development resources were diverted to work on
revenue producing projects, which resulted in a decline in our research and
development expenses.
The following table compares the weighted average of the Company's six month
period ended June 30, 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 $ 1,233 2.1% $ 18,205 3.9%
Industrial revenue bonds $ 4,295 3.4% $ 4,883 3.7%
Subordinated borrowings $ 40,250 6.3% - -
Swap hedge agreement $ 3,721 4.5% $ 6,426 4.0%
In addition the Company recorded
the following interest expense:
Amortization and write-off
of deferred financing charges $ 273 $ 101
Taxes on Income. The effective tax rate was approximately 40% during both the
six month periods ended June 30, 2004 and 2003.
Net Income. The Company reported net (loss) income of ($0.2) million and $2.0
million in the first six months of 2004 and 2003, respectively. Diluted earnings
per share decreased to a loss of ($.03) in the first six months of 2004 from
$.24 in the first six months of 2003. The weighted average number of common
shares outstanding and equivalents decreased to 8.0 million in 2004 from 8.1
million in 2003. This decrease in the weighted average number of shares was
caused by the Company excluding anti-dilutive common stock equivalents caused by
the Company being in a loss position.
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 June 30, 2004, the Company had working capital of $57.6 million compared
with $28.8 million as of December 31, 2003. The most significant changes in
working capital were due to the cash proceeds from the 2011 Notes financing and
the commensurate pay down of the Company's debt, with the balance invested in
available-for-sale marketable securities.
Net cash used by operating activities was $3.6 million in the first six months
of 2004 versus $9.4 million provided by operating activities in the first six
months of 2003.
Net cash used for investing activities was $20.8 million in the first six months
of 2004 compared to net cash used of $401 thousand in the first six months of
2003. In the first six months of 2004, a net cost of $20.5 million of marketable
securities were purchased.
24
Net cash provided by financing activities amounted to $26.3 million in the first
six months of 2004 compared with a net cash use of $6.2 million in the first six
months of 2003. $13.5 million of our bank borrowings were repaid from the
proceeds of the issuance of the 2011 Notes.
The following table summarizes the long term debt of the Company as of June 30,
2004 and the payments due by period, in thousands.
Long-term Debt
--------------
December 31:
2004 $ 140
2005 440
2006 440
2007 440
2008 440
Thereafter 42,495
-------------
Totals $ 44,395
=============
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 2011 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 2011 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 June 30, 2004 amounted to
approximately $44.4 million. The 2011 Notes accounted for $40.2 million of these
borrowings. The remaining amount of $4.1 million resulted from borrowings at
variable rates and consisted of two industrial revenue bonds outstanding in the
amounts of $1.5 million and $2.6 million. The interest rate charged to the
Company at June 30, 2004 for its industrial revenue bonds was 1.21% and 1.18%
respectively. The variable interest rate for these borrowings fluctuated between
1.01% and 1.38% during the first six 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 letters of credit, which amounted to $5.4 million at
June 30, 2004, the Company has no other material off balance sheet liabilities.
The Company had $19.6 million of unused availability under its lines of credit
at June 30, 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 2011 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, and 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. 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.
25
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 2011 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 2011 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 $136.9 million at June 30, 2004. This was
a decrease of 1.8% 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:
June 30, December, 31,
2004 2003
------------ -------------
Institutional Security Systems $ 62,765 $ 57,258
Attack Protection 17,761 10,043
Federal Security Systems 6,296 8,326
Public Safety and Justice 50,065 63,727
----------- -----------
Totals $ 136,887 $ 139,354
=========== ===========
Included in the backlog of the Public Safety and Justice segment at June 30,
2004 and December 31, 2003 is $3.7 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.
26
Revenues for support and maintenance contracts are deferred and recognized
ratably over the life of the contract.
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 $30.9 million, net, at June 30, 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 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 tax bases will be more robust.
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 three 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
six months of 2004.
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 June 30, 2004 the notional amount of the swap agreement had
declined to $3.4 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 six months ended June 30, 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 June 30, 2004 was a
gain of $58 thousand, and the change in fair value of the interest rate swap for
the six months ended June 30, 2004 was a gain of $87 thousand, resulting in a
remaining liability for the investment of $68 thousand. Future changes in the
value of the interest rate swap will be recognized in earnings.
27
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 2011 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 2011 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 rate bank
notes payable. Subsequent to the pay-down of its bank notes payable the only
variable rate borrowings outstanding was approximately $4.4 million of
Industrial Revenue Bonds. Since these borrowings 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 was
effective for the fiscal quarter endied June 30, 2004. The adoption of this
standard did not have a material effect on the financial position, results of
operations or cash flows of the Company.
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 the
Company.
28
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 June 30, 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 June 30, 2004.
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 2011 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 $13.89 per share. The Company used a portion of the proceeds of this
note offering to pay down its variable bank notes payable. The pay down of its
variable borrowings reduced the Company's interest rate risk.
Financial Instruments by Expected Maturity Date
Notes Payable
Year Ending Variable Average Variable Fixed Average Fixed
December 31 Rate ($) Interest Rate Rate ($) Interest Rate
----------- ----------- ----------------- ----------------- --------------
2004 (remaining) $ 140,000 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 $ 4,145,000 2.6% $ 40,250,000 6.25%
Fair Value $ 4,145,000 2.6% $ 40,250,000 6.25%
Interest Rate Swaps
Year Ending Variable Average Average
December 31 Rate ($) Pay Rate Receive Rate
----------- ----------- --------- ------------
2004 (remaining) $ 1,352,940 4.9% 2.0%
2005 2,029,420 4.9% 3.0%
2006 - - -
2007 - - -
2008 - - -
Thereafter - - -
-----------
Total $ 3,382,360 4.9% 2.5%
Fair Value $ (67,599)
29
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 June 30, 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 change in the Company's internal control over
financial reporting during the six months ended June 30, 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.
30
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
During the fourth quarter of 2003 our Public Safety and Justice segment received
a complaint alleging that we breached our contract to provide a public safety
software system to a customer. As a result we recorded a $1.7 million pre-tax
charge. During the second quarter of 2004 this contract was settled resulting in
a recovery by the segment of $0.3 million of the accrued charge, which was
reflected as a reduction of its cost of sales.
Item 4 - Submission of Matters to a Vote of Security Holders
Proposal #2 - Amendment of the Corporation's Articles of Incorporation to
Increase the Number of Authorized Shares of the Corporation's Common Stock.
At the Annual Meeting of Shareholders on May 27, 2004, the shareholders approved
an amendment of the Corporation's Articles of Incorporation to increase the
number of authorized shares of the Corporation's capital stock from 17,000,000
to 52,000,000, 2,000,000 shares of preference stock, without par value, and
50,000,000 shares of common stock having a par value of $0.75 per share. The
votes were cast as follows:
For - 5,838,554 Against - 989,214 Abstain - 15,258
Proposal #3 - Amendment of the 1996 Stock Incentive Compensation Plan for
Employees.
At the Annual Meeting of Shareholders on May 27, 2004, the shareholders approved
the Amended and Restated 1996 Stock Incentive Compensation Plan for Employees
increasing the number of shares of common stock which may be issued or
transferred under the Employee Plan upon exercise of options or other rights
from 1,800,000 shares to 4,000,000 shares. The votes were cast as follows:
For - 2,408,146 Against - 1,223,411 Abstain - 36,306
Broker non-vote - 3,175,263
Proposal #4 - Amendment of the Corporation's Articles of Incorporation to Allow
the Board of Directors to Fill Vacancies on the Board Created by the Size of the
Board Being Increased.
At the Annual Meeting of Shareholders on May 27, 2004, the shareholders did not
approve an amendment of the Corporation's Articles of Incorporation to allow the
Board of Directors to fill vacancies on the Board created by the size of the
Board being increased. The votes were cast as follows:
For - 2,853,384 Against - 796,756 Abstain - 17,622
Broker non-vote - 3,175,264
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits -
3.1 Amendment to Articles of Incorporation of CompuDyne Corporation filed with
the Secretary of the State of Nevada on July 22, 2004, incorporated by
reference to Registrant's Proxy Statement dated April 29, 2004 for its 2004
Annual Meeting of Shareholders.
3.2 Amendment to By-laws as amended through June 30, 2004, filed herewith.
10.1 CompuDyne Corporation Amended and Restated 1996 Stock Incentive
Compensation Plan for Employees, herein incorporated by reference to
Registrant's Proxy Statement, dated April 29, 2004 for its 2004 Annual
Meeting of Shareholders.
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.
31
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: July 30, 2004 /s/ MARTIN ROENIGK
------------------------
Martin Roenigk
Chief Executive Officer
/s/ GEOFFREY F. FEIDELBERG
--------------------------
Geoffrey F. Feidelberg
Chief Financial Officer
32