UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-29798
CompuDyne Corporation
(Exact name of registrant as specified in its charter)
Nevada 23-1408659
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2530 Riva Road, Annapolis, Maryland 21401
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 224-4415
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock $.75
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes [X] NO [ ]
As of March 25, 2005, a total of 8,123,479 shares of Common Stock, $.75 par
value, were outstanding. The aggregate market value of Common Stock held by
non-affiliates of the Registrant, based upon the average of the bid and asked
prices on the Nasdaq National Market on June 30, 2004 was approximately $73.8
million. (see ITEM 5).
Documents incorporated by reference: Portions of the Proxy Statement relating to
the 2005 Annual Meeting of Shareholders are incorporated in Part III.
1
PART I
ITEM 1. BUSINESS
CompuDyne Corporation was reincorporated in Nevada in 1996. We believe
that we are a leading provider of products and services to the public security
markets. We operate in four distinct segments: Institutional Security Systems;
Attack Protection; Federal Security Systems; and Public Safety and Justice.
Revenues from external clients, gross profit, pre-tax income and total
assets for each segment for the last three years are discussed in footnote 20 to
the consolidated financial statements.
Four Business Segments
- ----------------------
Institutional Security Systems
The Institutional Security Systems ("ISS") segment is headquartered in
Montgomery, Alabama and operates under the trade name Norment Security Group
("Norment"). The clients this segment serves consist primarily of state and
local governmental units. 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, through a network of regional
offices, provides field level design, installation and maintenance of both
physical and electronic security products.
Key products and services of the Institutional Security Systems segment include:
o MaxWall: a modular steel, concrete-filled, prefabricated jail cell.
o Airteq: a complete line of pneumatic and electro-mechanical operating
devices, locks and hardware.
o Integrated Security Systems: integrated central control and monitoring
products for locking, paging, audio, closed circuit television
cameras, nurse call and duress signals.
Attack Protection
The Attack Protection segment is one of the country's largest
manufacturers of bullet, blast and attack resistant windows and doors. The
ultimate clients this segment serves consist primarily of units of the Federal
Government. These products are designed for high security applications such as
embassies, courthouses and Federal buildings. We also provide our products and
services to banks, corporate headquarters and other facilities requiring the
highest level of protection currently available. We believe that we are a
premier provider of Underwriters Laboratory ballistic standard UL-752 Level 8
security windows and doors, the highest rating level of commercial ballistic
security windows and doors. Additionally, this segment designs and installs both
fixed and pop-up bollards and barrier security systems.
Key products of the Attack Protection segment include:
o Bullet and Blast Protection: integrated and structurally secure
bullet, blast and attack resistant windows and doors.
o Vehicle Intrusion Barriers: fixed, removable, semi-automatic and
automatic vehicle bollards and wedge barrier security systems.
o Fiber SenSys: a sophisticated fiber optic monitoring system used to
detect physical intrusion.
o SecurLAN: integrated security management system designed to detect
intrusion attempts aimed at secure and classified communications
networks.
Federal Security Systems
The Federal Security Systems segment consists of our subsidiary, Quanta
Systems Corporation. Our Federal Security Systems segment provides turnkey
design, production, installation, and integration of public security and safety
systems. The ultimate clients this segment serves consist primarily of units of
the Federal Government. This segment is a security systems integrator,
specializing in a wide range of customized systems, including:
2
o Access Control and Biometric
o Asset Tracking
o Badging and Identification
o Barriers and Turnstiles
o Command, Control, and Communications
o Computer Aided Dispatch (CAD)/ Records Management
o Electronic Article Surveillance
o Fencing, Lighting, Uninterrupted Power
o Fire/Life Safety
o Information Technology
o Intrusion Detection (Exterior, Interior, and Duress)
o Fiber Optic Network
o Perimeter Security
o Smart Card
o Surveillance and Assessment
Our Federal Security Systems segment provides central station oversight
and control of multiple and separate facilities as well as security and public
life safety systems and equipment.
Key products and services of the Federal Security Systems segment include:
o Regionalization Systems: Command and control centers that consolidate
the operation and management of 911 emergency services (fire, rescue,
and police), radio frequency communications, intrusion detection
systems, access control systems, and video surveillance systems for
multitudes of buildings at diverse geographical locations. This system
centralizes monitoring and dispatch functions, maximizing utility and
efficiency of all resources.
o Waterside Sentry Systems: Multi-functional security systems designed
to detect, alert, monitor, track, and record water-based and shoreline
attack threats.
o Flightline Sentry Systems: An integration of surveillance, intrusion
detection, access control, and other electro/mechanical systems in a
comprehensive, "layered" approach to security, which begins inside
operations centers and extends beyond base perimeters, providing
protection against both overt and covert acts of aggression.
o Signals Intelligence+ (SigInt) Systems: Signal gathering and analysis
products and systems used for field-based collections and monitoring,
providing the U.S. intelligence community and U.S. allies with real
time intelligence for strategic and tactical decision making.
Public Safety and Justice
The Public Safety and Justice ("PS&J") segment consists of CorrLogic,
Inc., Tiburon, Inc. and the recently acquired businesses known as 90 Degrees,
Inc. ("90 Degrees") and Copperfire Software Solutions, Inc. ("Copperfire"). The
clients this segment serves consist primarily of state and local governmental
units. This segment provides a fully integrated suite of products including
computer-assisted dispatch, records management and court and probation software
systems for the law enforcement, fire and rescue, corrections and justice
environments. We believe that we are a worldwide market leader in the
development, implementation and support of public safety and justice automation
systems. Tiburon, acquired by us in 2002, has been in business since 1980.
Key products and services of the Public Safety and Justice segment include:
o Dispatch Systems: computer-assisted dispatch systems designed for
first responders such as police, fire and emergency medical personnel
that feature peer-to-peer technology that is less vulnerable to server
and database failures.
3
o Records Management Systems: integrated software modules to automate
today's law enforcement and fire protection agencies, from initial
incident entry to final disposition and related state reporting.
o Mobile Computing Systems: solutions that provide instant access to
computer assisted dispatch and records management systems by law
enforcement and emergency personnel in the field.
o Inmate Management Systems: development, implementation and support of
complex, integrated inmate management software systems.
Substantially all of the Company's research and development expenditures occur
in the PS&J segment. The PS&J segment incurred $7.1 million, $7.1 million and
$4.8 million of research and development expenses in the years ended December
31, 2004, 2003 and 2002, respectively. The 2002 expenses include the expenses
incurred from the acquisition of Tiburon, which occurred on May 2, 2002.
The Market
- ----------
The market opportunity for jail and prison security systems is related to new
facility construction, existing facility upgrades, and the trend towards
outsourcing government services. We believe approximately $3.0-3.5 billion is
spent annually on correctional facility construction, of which typically 10% to
15% relates to security hardware and security electronics, the markets which we
currently serve. Our new MaxWall product has the potential to enable us to serve
the jail cell construction portion of this market, which constitutes an
additional 12% to 15% of the overall market. Other larger security markets we
serve include state and local government facilities, federal government
facilities and large commercial installations.
In all four segments of our business, we face considerable competition from
large and small companies. We compete primarily on a price basis with our
competitors. While we are one of the largest suppliers of physical and
electronic security to the corrections industry, we have one significant
competitor and many small competitors.
Most of our business occurs on a bid or request for proposal basis. Because of
the bid and request for proposal process, we do not generally have access to the
underlying assumptions that resulted in our competitors' bids and therefore,
other than price, we cannot determine why our bid was successful or unsuccessful
for particular contracts. Much of the Federal Security Systems work is on a cost
recoverable basis and is subject to audit by the Defense Contract Audit Agency.
The Public Safety and Justice segment competes in a market where we believe
annual sales are approximately $1 billion. Most of the competitors in this
market are smaller than us, however there are several large competitors
including divisions of Motorola, Intergraph and Northrop Grumman.
Business Strategy
- -----------------
We continually strive to position the Company to meet the expanding requirements
of the public security market. We believe that we have market-leading positions
in key areas of high-end security systems integration, security electronics,
advanced security technology products and first responder support software. We
are a single supplier resource for the most difficult and complex public
security and first responder requirements. In order to enhance our position in
the public security market, our current strategy is to:
Pursue our existing business through internal growth. We believe that we
have market-leading positions in many product and service categories,
which provide us a leverageable and ready-made growth platform.
Expand our client base to encompass high-end commercial clients. Our
products are now being marketed to banks, corporate headquarters,
private estates and other facilities.
Migrate our Institutional Security capabilities to other markets. Many
of our products and technologies, and the applications of those products
and technologies, were designed to keep offenders confined to certain
areas and to keep inmates from "breaking out." These same products and
technologies can be adapted to keep people from "breaking in." We are
currently working towards adapting our products to this new market.
Make selective acquisitions to complement and enhance our current
technological capabilities and market access. Our acquisitions of
Norment and Tiburon greatly expanded our product offerings and
solidified our position within the Institutional Security Systems and
Public Safety and Justice segments. We believe other acquisition
opportunities exist which if successfully consummated could further
enhance our current product and service offerings.
4
Develop strategic alliances with large defense contractors and teaming
agreements with other integrators, which may put us in a position to
participate in large blanket procurement projects from the Department of
Homeland Security in response to homeland security requirements.
Improve our cost structure, quality, and client and employee
satisfaction, and re-engineer our business model to generate a greater
degree of recurring revenue.
Corporate Information
- ---------------------
We were reincorporated in Nevada in 1996 and our predecessor corporation was
incorporated in Pennsylvania in 1952. Our principal executive offices are
located at 2530 Riva Road, Annapolis, Maryland 21401. Our telephone number is
(410) 224-4415.
General Information
- -------------------
The Company purchases most of the parts and raw materials used in its products
from various suppliers. The primary raw materials used in the manufacturing of
its products are electronic components and steel or aluminum sheets, stampings
and castings. These materials are generally available from a number of different
suppliers. While the bulk of such raw material is purchased from relatively few
sources of supply, the Company believes that alternative sources are readily
available.
There is no significant seasonality in CompuDyne's business. The Company's
construction related business, ISS, has historically been a very cyclical
business in line with the cycle of prison construction in the United States.
See the Management Outlook located in Item 7 for a discussion of backlogs.
At December 31, 2004, the Company had 726 permanent employees. Of the permanent
employees, 58 are subject to collective bargaining agreements. The Institutional
Security Systems Segment regularly hires union personnel on a temporary basis
for field projects. These personnel are subject to various collective bargaining
agreements depending on their skills and locale. At December 31, 2004, there
were no temporary employees covered under collective bargaining agreements.
The ultimate clients through which substantially all of the sales of the Company
are generated are the Federal government or state and local governments in the
United States of America.
Cautionary Statement Regarding Forward-Looking Information
- ----------------------------------------------------------
Certain statements made in this Form 10-K with regard to the Company's
expectations as to future revenues, expenses, financial position and industry
conditions, the Company's ability to secure new contracts, its goals for future
operations, implementation of business strategy and other future events
constitute "forward-looking statements" within the meaning of the federal
securities laws. When used in this Form 10-K, words such as "anticipate,"
"believe," "estimate," "expect," "intend" and similar expressions, as they
relate to management, identify forward-looking statements. Although the Company
makes such statements based on current information and assumptions it believes
to be reasonable, there can be no assurance that actual results will not differ
materially from those expressed or implied by such forward-looking statements.
Actual results could differ materially from those contemplated by the
forward-looking statements as a result of certain important factors, including
but not limited to, demand for the Company's products, competitive factors and
pricing pressures, changes in legal and regulatory requirements, government
budget problems, the ability to successfully grow the Company by completing
acquisitions, the ability to remain in compliance with its bank covenants,
delays in government procurement processes, ability to obtain bid, payment and
performance bonds on various of the Company's projects, technological change or
difficulties, the ability to refinance debt when it becomes due, product
development risks, commercialization difficulties, adverse results in
litigation, the level of product returns, the amount of remedial work needed to
be performed, and general economic conditions.
Available Information
- ---------------------
Our website is located at www.CompuDyne.com. The Company posts all of its SEC
filings (including its annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and all amendments to these reports) on the
Company website as soon as reasonably practicable after electronically filing or
otherwise furnishing such material to the SEC.
5
ITEM 2. PROPERTIES
The Company's principal executive offices are in Annapolis, Maryland. The
Company leases approximately 4,358 square feet of office space.
At December 31, 2004 the Institutional Security Systems segment leased primary
facilities for engineering, assembly and administration including: Alabama -
43,571 square feet, California - 15,795 square feet, Maryland - 9,500 square
feet, Arizona - 8,369 square feet and North Carolina - 5,775 square feet.
At December 31, 2004 the Attack Protection segment owned primary facilities for
engineering, manufacturing and administration in Alabama - 211,703 square feet.
These facilities are encumbered by Industrial Revenue Bonds. The Attack
Protection segment also leases 30,327 square feet of office/warehouse space in
Oregon.
At December 31, 2004 the Federal Security Systems segment leased primary
facilities for engineering, assembly and administration in Maryland - 18,090
square feet.
At December 31, 2004 the Public Safety and Justice segment leased primary
facilities for engineering and administration including California - 37,945
square feet, Colorado - 10,432 square feet, Texas - 7,711 square feet, Maryland
- - 5,728 square feet, Oregon - 5,669 square feet, Utah - 5,422 square feet,
Washington - 4,000 square feet, and Wisconsin - 1,902 square feet.
The Company leases only those properties necessary to conduct its business and
does not invest in real estate or interests in real estate on a speculative
basis. The Company believes that its current properties are suitable and
adequate for its current operations. As its operations grow, however, additional
space may be required to service contracts in other areas.
ITEM 3. LEGAL PROCEEDINGS
The Company is party to certain legal actions and inquiries for environmental
and other matters resulting from the normal course of business. Some of our
businesses, especially Institutional Security Systems, involve working as a
subcontractor to a prime contractor. From time to time we make claims against
the prime contractor, or the prime contractor makes claims against us. At any
point in time we are engaged in a number of claim disputes with prime
contractors, some of which may have a significant negative outcome. Although the
total amount of liability with respect to these matters can not be ascertained,
the Company believes that any resulting liability should not have a material
effect on its financial position, results of future operations or cash flows.
In addition to claims with prime contractors, we may also make claims against
customers and customers may make claims against us.
The Company has learned that the National Association of Securities Dealers
("NASD") is seeking sanctions against certain purchasers of the Company's common
stock in its 2001 PIPE transaction. In addition, the Company has learned that
the placement agent for this transaction is also being investigated by the SEC
and the NASD. The Company is investigating these matters and is evaluating its
options for recovery.
Over the past several years, we have been named in lawsuits involving asbestos
related personal injury and death claims in which CompuDyne Corporation,
individually and as an alleged successor, is a defendant. We have been named as
a defendant in cases related to claims for asbestos exposure allegedly due to
asbestos contained in certain of its predecessor's products. We have advised our
insurers of each of these cases, and the insurers are providing a defense
pursuant to agreement with us, subject to reservation of rights by the insurers.
The insurers have advised that claims in such litigation for punitive damages,
exemplary damages, malicious and willful and wanton behavior and intentional
conduct are not covered. One of the carriers has given notice that asbestos
related claims are excluded from certain of these policies. The insurers have
additional coverage defenses, which are reserved, including that claims may fall
outside of a particular policy period of coverage. Litigation costs to date have
not been significant and we have not paid any settlements from our own funds.
The Company cannot ascertain the total amount of potential liability with
respect to these matters, but does not believe that any such liability should
have a material effect on its financial position, future operations or future
cash flows.
6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
CompuDyne Common Stock is quoted on the Nasdaq National Market, under the symbol
"CDCY". There were 1,893 common shareholders of record as of March 25, 2005.
The following table sets forth the high and low sales for CompuDyne Common Stock
as quoted on the Nasdaq National Market.
2004 2003
---- ----
Quarter Ended High Low High Low
- ------------- --------------------- --------------------
March 31 $ 13.19 $ 8.56 $ 7.49 $ 4.80
June 30 $ 17.46 $ 8.55 $10.20 $ 6.75
September 30 $ 11.61 $ 7.06 $10.78 $ 7.37
December 31 $ 8.50 $ 6.10 $10.62 $ 7.50
The Company did not pay any dividends on its common stock during the years ended
December 31, 2004 and 2003, and its Board of Directors has no intention of
declaring a dividend in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following is a consolidated summary of operations of CompuDyne and its
subsidiaries for the years ended December 31, 2004, 2003, 2002, 2001 and 2000.
The information in the table below is based upon the audited consolidated
financial statements of CompuDyne and its subsidiaries for the years indicated
appearing elsewhere in this annual report or in prior annual reports on Form
10-K filed by the Company with the SEC, and should be read in conjunction
therewith and the notes thereto.
(In thousands except per share data): For the years ended December 31
-----------------------------------------------------------------------
2004 2003 2002(a) 2001 2000(b)
-------- -------- -------- -------- --------
Net sales $142,782 $193,263 $155,556 $127,394 $130,611
======== ======== ======== ======== ========
Gross profit $ 37,678 $ 46,396 $ 34,816 $ 25,280 $ 25,502
Selling, general and administrative expenses 36,219 32,305 25,785 17,378 17,792
Research and development 7,755 7,374 4,916 220
70
Impairment of goodwill and other intangibles
1,826 - - - -
-------- -------- -------- -------- --------
Operating (loss) income $ (8,122) $ 6,717 $ 4,115 $ 7,832 $ 7,490
======== ======== ======== ======== ========
Interest expense, net of interest income $ 2,289 $ 1,051 $ 1,394 $ 2,540 $ 1,934
======== ======== ======== ======== ========
Net (loss) income $ (8,198) $ 3,408 $ 1,814 $ 4,092 $ 4,139
======== ======== ======== ======== ========
(Loss) earnings per share (c):
Basic: (Loss) earnings per common share $ (1.01) $ .43 $ .24 $ .75 $ .78
======== ======= ======= ======= =======
Weighted average number of common
shares outstanding 8,136 7,895 7,456 5,424 5,339
======== ======= ======= ======= =======
Diluted
(Loss) earnings per common share $ (1.01) $ .42 $ .23 $ .67 $ .69
======== ======= ======= ======= =======
Weighted average number of common
shares and equivalents 8,136 8,158 7,940 6,110 6,028
======== ======= ======= ======= =======
Total assets $132,891 $115,732 $120,804 $ 74,485 $ 59,382
======== ======== ======== ======== ========
Long-term debt $ 43,123 $ 17,658 $ 27,510 $ 15,162 $ 20,217
======== ======== ======== ======== ========
Total shareholders' equity $ 45,831 $ 52,927 $ 49,204 $ 32,637 $ 13,796
======== ======== ======== ======== ========
Reclassifications - Certain prior year amounts have been reclassified to conform
with the current year's presentation.
Notes:
(a) Includes operations of Tiburon, Inc. from May 2, 2002, the date of
purchase.
(b) Includes operations of Fiber SenSys Inc. from October 31, 2000, the
date of purchase.
(c) No dividends have been paid on the Company's Common Stock during the
above periods.
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
Overview of CompuDyne Corporation
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 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 238 systems installed at 67 facilities,
including 62 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 manufacturers 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 that we are a premier provider of
Underwriters Laboratory ballistic standard UL-752 Level 8 security windows and
doors, the highest rating level of commercial ballistic security windows and
doors. 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 prime contractors who have direct
contracts with the United States Department of State, the segment's largest
client, 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.
9
The Public Safety and Justice segment consists of CorrLogic Inc., Tiburon, Inc.
and the recently acquired assets of 90 Degrees and Copperfire. 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 systems that improve the efficiency and accuracy of
correctional facility operations. CorrLogic's focus is entirely on information
solutions for the corrections industry.
During 2002 CompuDyne expanded its offerings in the Public Safety and Justice
sector by completing its acquisition of Tiburon, Inc. 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. The Company believes Tiburon
is a worldwide market leader in the development, implementation and support of
public safety and justice automation systems. In business since 1980, with more
than 600 systems supporting approximately 275 active clients, Tiburon is a
leader in public safety and justice solutions.
During the third and fourth quarters of 2004, we expanded our offerings in the
Public Safety and Justice sector by completing our acquisition of the assets of
90 Degrees and Copperfire, respectively. 90 Degrees provides a web-based fire
records management system, which is being integrated into our current PS&J
product offerings. 90 Degrees' enterprise-wide records management solutions
assist fire and EMS agencies in managing responses to emergency situations. We
anticipate that as we integrate 90 Degrees' product offerings into our PS&J
product offerings, the open web-based technology from 90 Degrees will advance
our current fire and rescue product offerings. Copperfire provides customized
report writing and forms generation software designed specifically for public
safety and justice agencies. The software automates an agency's current business
practices, turning hard copy forms into digital images, to create a paperless
report writing system. We believe that integration of Copperfire's products will
enhance our total offerings in PS&J.
Management Outlook
We continue to find ourselves in very challenging times. We have four major
areas of focus:
o The first is increasing the amount of our backlog.
o The second is migrating to a business model with a more predictable
revenue stream.
o The third is finding attractive acquisition candidates to enhance our
existing business.
o The fourth is to improve our cost structure, quality, and customer and
employee satisfaction.
We are continuing to experience a decline in our overall backlog. Our backlog is
a key indicator of what our future revenues will look like. Our backlog peaked
at December 31, 2002, at which time it exceeded $204 million. Since then it has
continued to decline and although it saw a slight increase at the ends of the
second and third quarters in 2004, it slipped to approximately $127 million at
December 31, 2004 as shown in the following table:
Institutional Federal Public
Security Attack Security Safety and Backlog
(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
September 30, 2004 $ 59,524 $ 19,351 $ 9,018 $ 50,215 $138,108
December 31, 2004 $ 49,324 $ 20,803 $ 8,299 $ 48,434 $126,860
Historically, approximately 90% of our revenues were generated from sources
where the ultimate client is a federal, 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 improves for several quarters and until
state and local budgets 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 clients so
that when or if the current government budget cycle turns around, we will be
well positioned to capitalize on new opportunities.
10
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 13.7% of our 2004 revenue was generated from recurring
revenue sources (primarily maintenance revenues), and the majority of these
revenues occurred 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.
Year Ended December 31, 2004
----------------------------
(in thousands) One-time Revenue % Recurring Revenue % Total
---------------- ----- ----------------- ---- --------
Institutional Security Systems $ 48,859 34.2 $ 5,093 3.6 $ 53,952
Attack Protection 25,161 17.6 - - 25,161
Federal Security Systems 14,293 10.0 - - 14,293
Public Safety and Justice 34,895 24.5 14,481 10.1 49,376
-------- ---- -------- ---- --------
Total $123,208 86.3 $ 19,574 13.7 $142,782
======== ==== ======== ==== ========
Since the majority of our revenues are one-time revenues and are non-recurring,
we must reinvent our book of business on a continual basis. 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 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, in July 2004 we hired a Chief Operating Officer (COO). The COO position
is a newly created position within CompuDyne. Our new COO, Mr. Maurice Boukelif,
brings extensive manufacturing and operational experience to us. Under his
leadership, we are hopeful we will be able to transform this business model in
the next few years.
Our third key focus area is acquisitions. With the January 2004 completion of
the 6.25% Convertible Subordinated Notes due January 15, 2011, (the "2011
Notes") offering, we have resources available with which to fund acquisitions.
We are particularly interested in three areas.
o The first is a business that would either prove additive or
complementary to our current offerings in the Public Safety and
Justice segment. Although this segment has seen a decline in its
backlog over the prior two years, we anticipate this segment will be
one of the first to see a recovery. 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.
o 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 clients and markets.
o 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 all our segments other than
Public Safety and Justice (which is involved in a different market),
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.
Our fourth focus area is to improve our cost structure, quality, and client and
employee satisfaction. Our Institutional Security business segment is undergoing
a significant organizational and expense restructuring, including a partial
consolidation of regional office efforts and an increased focus on centralized
performance of the most complicated security projects. This initiative begins by
ensuring our organization is properly aligned with our clients' needs. Many
changes have been made and initial results indicate that our cost, our quality,
our clients and our employees are responding favorably to the changes
implemented thus far. We have much room for improvement as we move toward a more
client centric organization. The organization re-alignment is critical to
strengthening our future as it allows us to deploy the Six Sigma methodology
across all our business segments more efficiently. The Six Sigma methodology
focuses on defect elimination, which will have a direct impact on our cost,
quality, and client satisfaction.
11
We believe that if we address and implement successfully the above four areas of
focus, we will significantly enhance our future growth opportunities and will
provide for more predictable financial results.
During the third and fourth quarters of 2004, we expanded our offerings in the
Public Safety and Justice sector by completion of our acquisition of the assets
of 90 Degrees and Copperfire respectively. 90 Degrees provides a web-based fire
records management system, which is being integrated into our current PS&J
product offerings. 90 Degrees' enterprise-wide records management solutions
assist fire and EMS agencies in managing responses to emergency situations. We
anticipate that as we integrate 90 Degrees' product offerings into our PS&J
product offerings, the open web-based technology from 90 Degrees will advance
our current fire and rescue product offerings. Copperfire provides customized
report writing and forms generation software designed specifically for public
safety and justice agencies. The software automates an agency's current business
practices, turning hard copy forms into digital images, to create a paperless
report writing system. We believe that integration of Copperfire's products will
enhance our total offerings in Public Safety and Justice.
Results of Operations
YEARS ENDED DECEMBER 31, 2004 AND 2003
Revenues. The Company had revenues of $142.8 million and $193.3 million for the
years ended December 31, 2004 and December 31, 2003, respectively, representing
a decrease of $50.5 million or 26.1%. As discussed below, most of this decline
occurred in our ISS segment due to delayed projects at the state and local
levels, largely caused by significant budget deficits many governmental units
are currently experiencing.
Revenues from the Institutional Security Systems segment were $54.0 million in
the year ended December 31, 2004, a decrease from $98.7 million for the same
period of 2003 representing a decrease of $44.7 million or 45.3%. 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 our working on less projects than we did in the
previous year. The principal reason for the decline was that 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 year ended
December 31, 2004 as compared to the year ended December 31, 2003. Backlog at
December 31, 2004 had declined further to $49.3 million. The years 2003 and 2004
have been slow bidding periods for the Company. Although the gross amount of
construction spending in the corrections area remained relatively flat between
2002, 2003 and 2004, the types of projects that the Company solicits, namely
large-scale medium to maximum security installations, declined in 2003 and 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.
Revenues from the Attack Protection segment were $25.2 million in the year ended
December 31, 2004, a decrease from $28.4 million for the same period of 2003
representing a decrease of $3.2 million or 11.3%. In 2002 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 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 fiber optic intrusion detection systems. For the year
ended December 31, 2004 the Norshield line experienced a 22.7% decline in
revenues as compared to the year ended December 31, 2003, whereas the Fiber
SenSys line experienced a 40.5% increase in revenues for the comparable period.
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 appears to have stabilized. It appears that projects are being released for
construction, and thus the Attack Protection segment is experiencing increased
bidding activity for its products. During 2003 the Company furnished bids to
supply its products for eight new embassy projects. At the time, this was the
largest number of embassy projects bid in a single calendar year for this
segment. Through December 31, 2004, the Company was awarded four of these
embassy projects, for a total CompuDyne contract value of $7.0 million, and lost
the remaining four embassy projects. During 2004, we bid on fifteen new embassy
projects. Through March 2005 the Company was awarded six of these embassy
projects for a total contract value of $8.6 million, and lost seven embassy
projects to competitors, with two projects still awaiting award. In 2005,
preliminary indications show eighteen embassy projects will be available for
bid. It appears to us that this increased level of new embassy construction will
continue for the next several years.
12
Revenues from the Federal Security Systems segment were $14.3 million in the
year ended December 31, 2004, a decrease from $16.4 million for the same period
of 2003 representing a decrease of $2.1 million or 13.1%. A significant portion
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 December 31, 2004 was also $8.3 million.
Revenues from the Public Safety and Justice segment were $49.4 million in the
year ended December 31, 2004, a decrease from $49.8 million for the same period
of 2003 representing a decrease of $0.4 million or 0.8%. In 2003, the Company
recognized approximately $5.5 million of revenue related to hardware supplied
under a contract with one of its customers. Minimal margin was earned on this
hardware. Although PS&J ships certain hardware components to clients on an
occasional basis, shipments of this magnitude of hardware, done to accommodate
our client, is an unusual and non-routine event. In addition, it should be noted
that although we made two acquisitions in this segment in 2004 (90 Degrees and
Copperfire), these acquisitions had little impact on Public Safety and Justice's
revenues due to their relatively small size and due to their occurring in the
later part of the year.
Expenses. Cost of goods sold of $105.1 million in the year ended December 31,
2004 were down $41.8 million or 28.4% from $146.9 million during the same period
of 2003. This decrease was a result of decreased costs of goods sold of $36.9
million at the Institutional Security Systems segment, largely attributable to
the decreased sales of this segment. The smaller percentage decrease in sales as
compared to the percentage decrease in cost of goods sold resulted in an
increased gross profit percentage of 26.4% for the year ended December 31, 2004
as compared to 24.0% in 2003.
Cost of goods sold in the Institutional Security Systems segment of $47.5
million for the year ended December 31, 2004 were down $36.9 million or 43.7%
from $84.4 million during the same period of 2003. This decrease was less than
the related sales decrease of this segment of 45.3%, resulting in a 2.5%
decrease in the gross profit percentage to 11.9% from 14.4% in the year ended
December 31, 2003. Starting in 2002 and continuing through 2004, Institutional
Security Systems' senior management identified managerial problems at its West
Coast operations and determined that numerous problems existed there including
that the costs to complete its projects were 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, the
Institutional Security Systems segment identified additional cost overruns which
would cause the costs to complete these projects to increase as a result of the
changes in the estimates to complete. Although the problem projects identified
in 2002 are substantially all complete, the problems in the ISS West Coast
operations continued into 2003 and 2004. We realized that the management changes
made in 2002 did not adequately address the root problems identified, and as a
result, projects started after 2002 continued to experience cost overruns due to
a lack of appropriate oversight. Staff and management changes in ISS are
ongoing. We have revised our estimates to complete these project and believe
that all future costs on these projects have been adequately considered through
December 31, 2004.
The West Coast problems, including project overruns, resulted in losses recorded
in the following periods:
(in thousands)
Second Half of 2002 $ 2,698
First Half of 2003 1,674
Third Quarter of 2003 541
Fourth Quarter of 2003 1,872
First Quarter of 2004 1,271
Second Quarter of 2004 1,139
Third Quarter of 2004 1,516
Fourth Quarter of 2004 2,166
-------
Total West Coast Losses $12,877
=======
To address this situation, the Company is implementing more centralized
controls, replaced certain personnel at its West Coast operations and its
Alabama headquarters, and hired a Chief Operating Officer.
Cost of goods sold in the Attack Protection segment of $23.6 million for the
year ended December 31, 2004 increased $0.9 million or 4.1% from $22.7 million
during the same period of 2003. This increase occurred in spite of a sales
decrease of this segment of 11.3%, resulting in a 13.9% decrease in the gross
profit percentage to 6.2% from 20.1% during the year ended December 31, 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 in the latter part of 2003 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 the primary contributor, this did result in further utilization of
approximately 12,000 square feet of previously unused manufacturing space in
this plant in Alabama. In addition, we identified, in late 2003, a quality
problem with the windows and doors being installed on a project ultimately
completed in the fourth quarter of 2004. As a result of this identified problem,
we took remedial action in the field to repair this defect. During the year
ended December 31, 2004 we increased our estimated cost to complete this project
by $2.0 million thus causing this project to become a negative margin project.
Cumulative write-downs on this project amount to $2.3 million.
13
Cost of goods sold in the Federal Security Systems segment of $12.3 million in
the year ended December 31, 2004 decreased $1.6 million or 11.3% from $13.8
million during the same period of 2003. This decrease was less than the related
sales decrease of this segment of 13.1%, resulting in a 1.8% decrease in the
gross profit percentage to 14.1% from 15.9% in the year ended December 31, 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 $21.7 million for
the year ended December 31, 2004 was down $4.2 million or 16.2% from $25.9
million during 2003. This decrease was more than the related sales decrease of
this segment of 0.8%, resulting in an 8.0% increase in the gross profit
percentage to 56.0% from 48.0% in the year ended December 31, 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 client. As a result, we recorded a $1.6 million pre-tax
charge, of which $600 thousand was recorded as a reduction of revenue and $1.0
million was recorded as a charge to cost of sales. During the second quarter of
2004 this matter was settled, resulting in a reversal of $0.3 million of the
accrued charge, which was reflected as a reduction of cost of sales. The net of
this activity contributed $1.9 million of the $3.8 million gross profit
improvement in 2004 compared to 2003.
Selling, general and administrative expenses were $36.2 million for the year
ended December 31, 2004, an increase of $3.9 million or 12.1% from $32.3 million
for the same period of 2003. Much of this increase is related to additional
costs incurred by the Company related to legal fees in connection with
responding to and settling the complaint filed by a Public Safety and Justice
segment client, expenses incurred in connection with evaluating potential
acquisitions, recruiting fees incurred to fill the recently hired COO position
and other senior management positions and expenses related to compliance with
new requirements mandated by the Sarbanes-Oxley Act and the SEC.
During the fourth quarter of 2004 the Company concluded that the continuing
decline in the backlog in its ISS segment constituted a triggering event which
caused the Company to conclude it was necessary to reassess and ultimately write
off goodwill in the amount of $0.7 million and certain other intangibles in the
amount of $1.1 million. Those amounts appear as a separate line item in the 2004
statement of operations.
In conjunction with the acquisition of the assets of 90 Degrees and Copperfire
and in compliance with Statement of Financial Accounting Standards No. 141 (SFAS
141) Business Combinations, the Company preliminarily determined the fair value
of the following identifiable assets and assigned the indicated lives for the
purposes of amortization and depreciation.
Amount
(in thousands) Life (in years)
-------------- ---------------
Software $2,800 5
Employment Contracts 120 1-3
--------
$2,920
========
The amortization of the above assets resulted in the Company recording
amortization expense related to these assets of $178 thousand in 2004, which is
included in operating expenses.
Research and development expenses were $7.8 million for the year ended December
31, 2004, an increase of $0.4 million or 5.1% from $7.4 million for the same
period of 2003. Being a technology-driven enterprise, the Company's Public
Safety and Justice segment continually updates and enhances its software
offerings, thus incurring significant research and development costs.
Interest expense increased to $3.3 million for the year ended December 31, 2004
from $1.4 million for the year ended December 31, 2003 due to an increase in
borrowings and overall higher interest rates. The following table compares the
weighted average of the Company's years ended December 31, 2004 and December 31,
2003 interest bearing borrowings and the related rates charged thereon.
14
Monthly Weighted Monthly Weighted
Average - 2004 Average - 2003
Amount Rate Amount Rate
------ ---- ------ ----
(in thousands) (in thousands)
Bank borrowings $ 617 4.2% $16,208 3.6%
Industrial revenue bonds $ 4,162 3.1% $ 4,675 3.7%
Subordinated borrowings $40,250 6.3% - -
Swap hedge agreement $ 3,721 3.6% $ 6,103 4.0%
In addition the Company recorded the following non-cash interest expense:
Amortization and write-off
of deferred financing charges $ 600 $ 250
Taxes on Income. The effective tax benefit was approximately 21% for the year
ended December 31, 2004 and the effective tax rate was approximately 41% for the
year ended December 31, 2003. The difference in rates is largely attributable to
the losses experienced in 2004 and the related valuation allowance established
for substantially all of the Company's net deferred tax assets as of December
31, 2004.
Net (Loss) Income. The Company reported net (loss) income of ($8.2) million and
$3.4 million in the years ended December 31, 2004 and 2003, respectively. The
reason for the loss in 2004 was the significant decline in revenues. While the
Company was able to significantly reduce its cost of goods sold, its selling,
general and administrative expenses increased while its revenues significantly
decreased, contributing to the loss. Diluted earnings per share decreased to a
loss of ($1.01) in the year ended December 31, 2004 from a profit of $.42 in the
year ended December 31, 2003. The weighted average number of common shares
outstanding and equivalents used in computing EPS was 8.1 million in 2004 and
8.2 million in 2003.
YEARS ENDED DECEMBER 31, 2003 AND 2002
Revenues. The Company had revenues of $193.3 million and $155.6 million for the
years ended December 31, 2003 and 2002, respectively. This was an increase of
$37.7 million or 24.2%.
Revenues from the Institutional Security Systems segment increased from $84.2
million in 2002 to $98.7 million in 2003. This was an increase of 17.2%. 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 increase in revenue experienced by this segment
is largely attributable to its ability to work on more projects than it did in
the previous year. One of the reasons it was able to do this was because its
backlog had grown from $92.3 million at December 31, 2001 to $99.5 million at
December 31, 2002 thus providing it with the ability to engage in more work in
2003 than it did in 2002. At December 31, 2003, the backlog for the
Institutional Security System's segment declined to $57.3 million. The year 2003
was a slow bidding period for the Company. Although the gross amount of
construction spending in the corrections area remained relatively flat between
2002 and 2003, the types of projects that the Company solicits, namely
large-scale medium to maximum security installations, declined in 2003. 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.
Revenues from the Attack Protection segment were flat at $28.4 million during
both 2003 and 2002. The Attack Protection segment was largely capacity
constrained during 2001. As a result, the Company purchased an existing 75,000
square foot factory on 20 acres of land in close proximity to its existing
factory in Montgomery, Alabama. This expansion provided the segment with the
necessary capacity to generate incremental revenue of approximately $10 million
per year. This capacity increase was largely driven by the Company's expectation
that the demands for its products, principally its bullet and blast resistant
windows and doors would accelerate significantly in the post September 11, 2001
world. Throughout 2002 and 2003 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
the bullet and blast resistant windows and doors and ancillary products, and
Fiber SenSys, which encompasses its fiber optic intrusion detection systems.
During 2003 the Norshield line experienced a 0.9% decline in revenues, whereas
the Fiber SenSys line experienced a 4.7% 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. In addition, all indications are that this increased level of new
embassy construction will continue for at least the next few years.
15
Revenues from the Federal Security Systems segment increased from $13.4 million
in 2002 to $16.4 million in 2003. This was an increase of 22.9%. A significant
portion of this segment's revenue is backlog driven. Its backlog is therefore a
precursor to future revenues. The Federal Security Systems segment's failure to
have any meaningful backlog at December 31, 2001 resulted in substantially all
of its 2002 revenue being driven by contract awards it received during 2002.
This inherently caused the segment's revenue to be low during that period. The
Federal Security Systems Segment ended 2002 with a significantly improved
backlog level of $11.4 million. As such it entered 2003 with a much greater book
of business from which to generate its increased revenue during 2003. Backlog at
December 31, 2003 was $8.3 million.
Revenues from the Public Safety and Justice segment increased $20.2 million from
$29.7 million during 2002 to $49.8 million in 2003. On May 2, 2002 the Company
completed its acquisition of Tiburon, Inc. Previously, the Company controlled
approximately 20% of Tiburon and recorded its investment in Tiburon under the
equity method of accounting. Subsequent to May 2, 2002, Tiburon became a wholly
owned subsidiary of the Company at which time its operating results were
consolidated with those of the Company. Tiburon's revenues for 2003 amounted to
$45.4 million as compared to $24.9 million for the eight-month period Tiburon
was owned by CompuDyne in 2002.
Expenses. Cost of goods sold increased from $120.7 million during 2002 to $146.9
million in 2003. This increase was largely a result of the acquisition of
Tiburon on May 2, 2002, which added $11.8 million of cost of goods sold to the
results of the Company, as well as increased costs of goods sold of $11.7
million at the Institutional Security Systems segment, all largely attributable
to the increased sales levels attained by these segments.
The smaller percentage increase in cost of goods sold as compared to the
percentage increase in sales resulted in an increased gross profit percentage of
24.0% in 2003 as compared to 22.4% in 2002.
Cost of goods sold in the Institutional Security Systems segment increased from
$72.8 million in 2002 to $84.5 million in 2003. This was an increase of $11.7
million or 16.0%. This increase was less than the related sales increase of this
segment of 17.2% resulting in an increase in the gross profit percentage from
13.5% in 2002 to 14.4% in 2003. During 2002, the West Coast operations of the
Institutional Security Systems segment experienced significant cost overruns on
many of its projects. These cost overruns were incurred and recorded during the
third and fourth quarters of 2002 and amounted to approximately $2.4 million. As
a result, as these projects were brought to completion in 2003, the revenues
generated by them resulted in little margin or in some cases losses. The Company
recorded approximately $1.9 million of additional write-downs on West Coast
projects that were either completed or neared completion in 2003. These were the
primary reasons for the depressed gross profit percentage by Institutional
Security Systems. To address this situation, in 2002 the Company implemented
more centralized controls and replaced certain personnel at its West Coast
operations.
Cost of goods sold in the Attack Protection segment decreased from $23.7 million
in 2002 to $22.7 million in 2003. This was a decrease of $1.0 million or 4.5%.
This decrease was smaller than the related sales increase of this segment of
0.1%, resulting in an increase in the gross profit percentage from 16.3% in 2002
to 20.1% in 2003. Although the results of this segment improved in 2003, they
are still significantly below what is expected of this segment. We are actively
working to better utilize the new capacity provided by the Company in 2002. One
of the actions we have taken was to relocate the AirTeq manufacturing operation
in Oregon and consolidate it into the facilities we have in Montgomery, Alabama.
This was done in an effort to enhance the utilization of our owned facilities in
Alabama and thus use some of our excess manufacturing capacity. Although not a
huge contributor, this did in fact result in further utilization of
approximately 12,000 square feet of previously unused manufacturing space in our
new plant in Alabama.
Cost of goods sold in the Federal Security Systems segment increased from $11.0
million in 2002 to $13.8 million in 2003. This was an increase of $2.8 million
or 25.7%. This increase was slightly less than the related sales increase for
this segment of 22.9%. The Federal Security Systems segment gross profit
percentage was 17.7% and 15.9% in 2002 and 2003 respectively. Substantially all
of the projects awarded in this segment are discrete projects.
Cost of goods sold in the Public Safety and Justice segment increased from $13.2
million in 2002 to $25.9 million in 2003. This was an increase of $12.7 million.
Substantially all of this increase was a result of the Company's May 2, 2002
acquisition of Tiburon. In addition, in 2003 the Company recognized
approximately $5.5 million of revenue related to hardware supplied under a
contract with one of its clients. This hardware was furnished at minimal gross
profit of approximately 6.7%, which caused the entire margin for this segment to
be reduced. This segment recorded a $1.6 million charge for a contract in
litigation. This charge was recorded by reducing previously recorded revenues by
approximately $600 thousand and increasing cost of goods sold by $1.0 million.
16
Operating expenses increased from $25.8 million in 2002 to $32.3 million in
2003. This was an increase of $6.5 million. Much of the change in operating
expenses was a result of the Company's May 2, 2002 acquisition of Tiburon.
Included in operating expenses in 2003 is $362 thousand related to the closure
and relocation of its ISS Midwest regional office and its Airteq manufacturing
group.
In conjunction with the acquisition on May 2, 2002, of Tiburon, Inc. and in
compliance with Statement of Financial Accounting Standards No. 141 (SFAS 141)
"Business Combinations," the Company determined the fair value of the following
identifiable assets and assigned the indicated lives thereto for purposes of
amortization and depreciation.
Amount Life
------------ ----------
(in thousands) (in years)
Trade name $ 5,340 Indefinite
Customer relationships $ 2,500 14
Software $ 3,000 5
Backlog $ 300 2
Other $ 135 3
The amortization of the above intangibles resulted in the Company recording
amortization expense related to these intangibles of $973 thousand and $649
thousand in 2003 and 2002, respectively, which is included in operating
expenses.
Research and Development expenses increased from $4.9 million in 2002 to $7.4
million in 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. The increase in 2003 over 2002 is largely a reflection of the May 2002
acquisition of Tiburon by the Company.
Interest expense remained relatively constant at $1.4 million in both 2003 and
2002.
Monthly Weighted Monthly Weighted
Average - 2003 Average - 2002
Amount Rate Amount Rate
------ ---- ------ ----
(in thousands) (in thousands)
Bank borrowings $ 16,208 3.6% $ 17,983 3.8%
Industrial revenue bonds $ 4,675 3.7% $ 4.387 2.6%
Subordinated borrowings $ - - $ 1,310 4.9%
In addition the Company recorded the
following non-cash interest expense:
Amortization and write-off
of financing charges $ 250 $ 145
Taxes on Income. The effective tax rate in 2003 was 40.8% as compared to 36.1%
in 2002. The primary reason for this change in effective tax rates is due to a
change in the mix in the states in which the Company's earnings occurred.
Net Income. The Company reported net income of $3.4 million and $1.8 million in
2003 and 2002, respectively. Diluted earnings per share increased to $.42 in
2003 from $.23 in 2002. The weighted average number of common shares outstanding
and equivalents increased from 7.9 million in 2002 to 8.2 million 2003.
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 clients 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.
17
As of December 31, 2004, the Company had working capital of $44.0 million
compared with $28.8 million as of December 31, 2003. The most significant
changes in working capital were due to the receipt of the proceeds from the 2011
Notes financing, offset in part by the concurrent pay down of the Company's
debt, with the balance invested in available-for-sale marketable securities and
current acquisitions.
Net cash provided by operating activities was $4.5 million in the year ended
December 31, 2004 versus $11.0 million provided by operating activities in the
year ended December 31, 2003. The largest component of cash provided by
operating activities was a decrease in accounts receivable of $7.5 million. This
decrease was largely caused by the decline in revenues experienced by the
Company.
Net cash used for investing activities was $26.8 million in the year ended
December 31, 2004 compared to net cash used of $1.1 million in the year ended
December 31, 2003. In the year ended December 31, 2004, the net of marketable
securities bought and redeemed was $19.5 million. In addition $5.5 million of
cash was used to fund our two acquisitions and $1.8 million of cash was used to
purchase property, plant and equipment.
Net cash provided by financing activities amounted to $25.6 million in the year
ended December 31, 2004 compared with a net cash use of $9.3 million in the year
ended December 31, 2003. This amount was primarily provided through the issuance
of the 2011 Notes offset by the repayment of $13.5 million of our bank
borrowings.
The following table summarizes the contractual obligations of the Company as of
December 31, 2004 and the payments due by period, in thousands.
Long-Term Debt Operating Leases Interest on Contractual Obligations
-------------- ---------------- -----------------------------------
December 31:
2005 $ 440 $ 2,376 $ 2,637
2006 440 1,259 2,602
2007 440 1,027 2,590
2008 440 539 2,579
2009 440 237 2,567
Thereafter 42,055 3,359
------- -------- -------
Totals $44,255 $ 5,438 $16,334
======= ======== =======
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. The proceeds from the 2011 Notes were used to repay
substantially all of the Company's outstanding borrowings.
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 are 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.
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 matured
on March 1, 2005.
On October 29, 2004 and March 4, 2005, the Company and its banks entered into
amendments to the credit agreement pursuant to which the banks waived the
Company's non-compliance with its fixed charge coverage ratio covenant as of
September 30, 2004 and non-compliance with its minimum EBITDA covenant as of
December 31, 2004, respectively. In addition, the Company and its banks amended
the credit agreement to eliminate the $15 million line of credit maturing March
2005 and to require borrowings under its $10 million line of credit to be
collateralized by pledged marketable securities equal to 111.11% of the value of
such borrowings. The credit agreement was also amended to eliminate the
quarterly minimum EBITDA covenant for the Company's fiscal years ending after
December 31, 2004 and to provide that the minimum fixed charge coverage ratio
covenant, maximum debt to EBITDA ratio covenant and the minimum consolidated
tangible net worth covenant will not become effective until March 31, 2006.
18
So long as the Company maintains pledged marketable securities equal to 111.11%
of the value of its borrowings under the credit agreement, borrowings under the
credit agreement shall bear interest at LIBOR + 1.00% or Prime + 1.00%. 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.
The Company's total outstanding borrowings at December 31, 2004 amounted to
approximately $43.1 million, net of the broker's discounts. The 2011 Notes
accounted for $39.1 million, net of the broker's discounts, of these borrowings.
The remaining amount of $4.0 million resulted from borrowings at variable rates
and consisted of two industrial revenue bonds outstanding in the amounts of $1.4
million and $2.6 million. The interest rate charged to the Company at December
31, 2004 for its industrial revenue bonds was 2.13%. The variable interest rate
for these borrowings fluctuated between 1.01% and 2.13% during the year ended
December 31, 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 and in determining the amount of marketable securities needed to be
pledged as collateral.
Other than the Company's letters of credit, which amounted to $5.3 million at
December 31, 2004, the Company has no other material off balance sheet
liabilities.
At December 31, 2004 the Company had $4.7 million of unused availability,
subject to the pledge of collateral under its line of credit.
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
and beyond. 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. The interest rate environment earlier this year was 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 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 line, it intends to keep this
line available at least to provide the required collateral for its industrial
revenue bond borrowings.
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 clients is limited. As a result, in order to enhance its
profitability, the Company will continue to seek ways to reduce its costs.
Pension Plan
Prior to 2003 the Company maintained a money purchase pension plan, which
covered employees at one of its divisions. All employees at this division were
eligible to participate in this plan after one year of service. Annual
contributions of between 3% and 5% of annual compensation were made by the
Company depending on the employees' years of service. The expense related to
funding the plan was $507 thousand during 2002. Effective December 31, 2002, the
Company ceased contributions to this plan. The participants in this plan were
100% vested. The plan was then terminated and the participants were given three
distribution options: a rollover to their 401K plan, a cash distribution, or an
annuity purchase.
19
Total Backlog
CompuDyne's total backlog amounted to $126.9 million at December 31, 2004. This
was a decrease of 9.0% 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:
December 31, December 31,
2004 2003
-------- --------
Institutional Security Systems $ 49,324 $ 57,258
Attack Protection 20,803 10,043
Federal Security Systems 8,299 8,326
Public Safety and Justice 48,434 63,727
-------- --------
Totals $126,860 $139,354
======== ========
Included in the backlog of the Public Safety and Justice segment at December 31,
2004 and December 31, 2003 is $5.1 million and $12.0 million, respectively,
representing awards received by the segment, for which the clients have not yet
entered into signed contracts. These awards are expected to result in signed
contracts over the next twelve months.
Corporate Reorganization
As part of the Company's efforts to better manage its costs, during the first
quarter of 2005 the Company implemented a corporate reorganization whereby it
dissolved an inactive subsidiary and converted several corporate entities into
LLCs (Limited Liability Corporations). This activity was designed to improve the
Company's tax reporting structure and should help better manage the Company's
state income tax obligations. In conjunction with this reorganization, our
Federal Security Systems group, formerly known as Quanta Systems, was renamed
CompuDyne - Integrated Electronics, and our Public Safety and Justice group,
formerly known as Tiburon, was renamed CompuDyne - Public Safety and Justice,
Inc. The impact of this reorganization is not expected to have a material effect
on operations.
Critical Accounting Policies and Estimates
Percentage of Completion Accounting and Revenue Recognition.
Approximately 65% 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 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 affect
many of the balance sheet and statement of operations accounts including net
sales, cost of goods sold, accounts receivable, contract costs in excess of
billings and billings in excess of contract costs incurred.
Revenues for support and maintenance contracts are deferred and recognized
ratably over the life of the contract. Sales of products unrelated to contract
revenue are recognized as revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; the seller's price to the buyer is fixed or determinable;
and collectibility is reasonably assured.
Provisions for estimated losses on uncompleted contracts are recognized in the
period such losses are determined.
Inventories are stated at the lower of cost or market, using the First-in,
First-out (FIFO) method. Costs included in inventories consist of materials,
labor, and manufacturing overhead, which are related to the purchase and
production of inventories.
Warranty reserves are estimated and made at the time products are sold or
services are rendered. They are established using historical information on the
nature, frequency and average cost of warrant 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.
Accounts receivable are expected to be substantially collected within one year
except for a portion of the receivables recorded as retainage. Retainage
expected to be collected in over one year is reflected as a current asset as it
will be collected within the operating cycle under the related contract.
20
Tax valuation allowances are established when the Company believes it is not
"more likely than not" that the Company will be able to receive tax benefits in
the future.
Goodwill and Intangible Assets.
The Company reviews the carrying value of goodwill and intangible assets not
subject to amortization annually during the fourth quarter of the year or when
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 Company's reporting units' 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 not subject to amortization which totaled approximately $31.6 million and
intangible assets subject to amortization which totaled approximately $2.8
million, net, at December 31, 2004.
Stock Compensation Policy.
The Company accounts for its stock-based compensation using the intrinsic value
method and in accordance with the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. No stock-based employee compensation 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
resulting 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 clients 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.
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 CompuDyne's operations during
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 December 31, 2004 the notional amount of the swap agreement
had declined to $2.0 million at a fixed rate of 4.9%. In January 2004 the
interest rate swap ceased to be a highly-effective cash flow hedge when the
related debt was repaid. Consequently, the amounts previously recorded in other
comprehensive income as changes in fair value of the interest rate swap were
recognized in earnings for the year ended December 31, 2004. Upon determination
of the hedge ineffectiveness, the cumulative loss on the fair value of the
interest rate swap was $155 thousand, which was recognized in other income. The
change in fair value of the interest rate swap for the year ended December 31,
2004 was a gain of $134 thousand, resulting in a remaining liability for the
investment of $21 thousand. Future changes in the value of the interest rate
swap will be recognized in earnings.
On January 22, 2004, the Company completed an offering of $40.25 million
principal amount of the 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 outstanding borrowings
under its variable rate bank notes. Subsequent to the pay-down of its bank notes
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.
21
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. Statement 153 addresses the
measurement of exchanges of nonmonetary assets and redefines the scope of
transactions that should be measured based on the fair value of the assets
exchanged. Statement 153 is effective for nonmonetary asset exchanges occurring
in fiscal periods beginning after June 15, 2005. The Company does not believe
adoption of Statement 153 will have a material effect on its consolidated
financial position, results of operations or cash flows.
In December 2004, the FASB issued FASB Staff Position No. 109-1, Application of
FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004 (FSP 109-1).
FSP 109-1 clarifies that the manufacturer's deduction provided for under the
American Jobs Creation Act of 2004 (AJCA) should be accounted for as a special
deduction in accordance with SFAS 109 and not as a tax rate reduction. The
adoption of FSP 109-1 will have no impact on the Company's results of operations
or financial position for fiscal year 2005 because the manufacturer's deduction
is not available to the Company until fiscal year 2006. The company is
evaluating the effect that the manufacturer's deduction will have in subsequent
years.
In December 2004, the FASB issued FASB Staff Position No. 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a special
one-time dividends received deduction on the repatriation of certain foreign
earnings to a U.S. taxpayer (repatriation provision), provided certain criteria
are met. FSP 109-2 provides accounting and disclosure guidance for the
repatriation provision. The Company believes that the adoption of this statement
will have no effect on the financial position, results of operations, or cash
flows of the Company.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," a
revision of SFAS No. 123, "Accounting for Stock-Based Compensation" and
superseding APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS
No. 123R requires the Company to expense grants made under its stock option and
employee stock purchase plan programs. That cost will be recognized over the
vesting period of the plans. SFAS No. 123R is effective for the first interim or
annual period beginning after June 15, 2005. The Company has not yet determined
the method of adoption or the effect of adopting SFAS 123R, and has not
determined whether the adoption will result in amounts that are similar to the
current pro forma disclosures under SFAS 123. The Company is evaluating the
alternatives allowed under the standard, which the Company is required to adopt
beginning in the third quarter of 2005.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs," an amendment
to ARB No. 43, Chapter 4, "Inventory Pricing," to clarify that abnormal amounts
of idle facility expenses, freight, handling costs and wasted materials
(spoilage) should be recognized as current-period charges. In addition, FAS 151
requires that allocation of fixed production overhead to the costs of conversion
be based on the normal capacity of the production facilities. SFAS No. 151 is
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The Company believes there will be no material effect on the financial
position, results of operations, or cash flows of the Company upon adoption of
this statement.
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. The
consolidation provisions of FIN 46(R) were effective immediately for interests
created after January 31, 2003 and were effective on March 31, 2004 for
interests created before February 1, 2003. The adoption of this standard did not
have a material effect on the financial position, results of operations or cash
flows of the Company.
22
ITEM 7A. 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 following information summarizes our sensitivity to market risks associated
with fluctuations in interest rates as of December 31, 2004. To the extent that
the Company's financial instruments expose the Company to interest rate risk,
they are presented in the table below. The table presents principal cash flows
and related interest rates by year of maturity of the Company's notes payable
with variable rates of interest in effect at December 31, 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 $13.89 per share. The Company used a portion of the proceeds of the
2011 Notes to pay down its variable bank notes payable. The pay down of its
variable borrowings reduced the Company's interest rate risk.
Financial Instruments by Expected Maturity Date
Notes Payable Variable Fixed
Year Ending Rate ($) Average Variable Rate ($) Average Fixed
December 31 (in thousands) Interest Rate (in thousands) Interest Rate
------------ --------------- -------------- -------------- -------------
2005 $ 440 2.63% $ - -
2006 440 2.63% - -
2007 440 2.63% - -
2008 440 2.63% - -
2009 440 2.63% - -
Thereafter 1,805 2.63% 40,250 6.25%
-------- ---------
Total $ 4,005 2.63% $ 40,250 6.25%
Fair Value $ 4,005 2.63% $ 33,500 11.00%
Interest Rate Swaps Variable
Year Ending Rate ($) Average Variable Average
December 31 (in thousands) Pay Rate Receive Rate
------------ --------------- -------------- --------------
2005 $2,029 4.90% 2.55%
2006 - - -
2007 - - -
2008 - - -
2009 - - -
Thereafter - - -
--------
Total $2,029 4.90% 2.55%
Fair Value $ (21)
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of the Corporation and its
subsidiaries are included herein as indicated below:
Report of Independent Registered Public Accounting Firm -
PricewaterhouseCoopers LLP
Report of Independent Registered Public Accounting Firm - Deloitte & Touche
LLP
Consolidated Balance Sheets at December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended December 31,
2004, 2003 and 2002
Consolidated Statement of Changes in Shareholders' Equity for the years
ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003 and 2002
Notes to Consolidated Financial Statements
24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
CompuDyne Corporation
Annapolis, Maryland
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statement of operations, changes in shareholders' equity and cash
flows present fairly, in all material respects, the financial position of
CompuDyne Corporation and its subsidiaries at December 31, 2004 and the results
of its operations and its cash flows for the year ended December 31, 2004 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule for the
year ended December 31, 2004 listed in the index appearing under Item 15(a)(2)
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audit. We conducted our audit of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
Baltimore, Maryland
March 31, 2005
25
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
CompuDyne Corporation
Annapolis, Maryland
We have audited the accompanying consolidated balance sheets of CompuDyne
Corporation and subsidiaries as of December 31, 2003, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the two years in the period ended December 31, 2003. Our audits also
included the financial statement schedule for the years ended December 31, 2003
and 2002, listed in the Index at Item 15a(2). These financial statements and
financial statement schedule are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of CompuDyne Corporation and
subsidiaries at December 31, 2003, and the results of their operations and their
cash flows for each of the two years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
DELOITTE & TOUCHE LLP
Baltimore, Maryland
March 8, 2004
26
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 2004 2003
---------- -------
(dollars in thousands)
Current Assets
Cash and cash equivalents $ 5,198 $ 1,869
Marketable securities 19,577 -
Accounts receivable, net 34,291 41,780
Contract costs in excess of billings 16,087 17,568
Inventories 5,165 6,704
Deferred tax assets - 1,371
Prepaid expenses and other 5,412 2,322
-------- --------
Total Current Assets 85,730 71,614
Property, plant and equipment, net 12,094 10,079
Goodwill, net 25,894 23,350
Other intangible assets, net 8,460 9,785
Other 713 904
-------- --------
Total Assets $132,891 $115,732
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities $ 21,771 $ 21,078
Billings in excess of contract costs incurred 13,497 13,551
Deferred revenue 5,998 6,036
Current portion of notes payable 440 2,103
-------- --------
Total Current Liabilities 41,706 42,768
Notes payable 3,565 15,555
Convertible subordinated notes payable, net 39,118 -
Deferred tax liabilities 2,072 3,662
Other 599 820
-------- --------
Total Liabilities 87,060 62,805
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 December 31, 2004 and
2003, respectively; 8,943,856 and 8,567,680 shares issued
at December 31, 2004 and 2003, respectively 6,707 6,426
Additional paid-in-capital 44,368 42,755
Retained earnings (accumulated deficit) (272) 7,926
Accumulated other comprehensive gain (loss) 14 (93)
Treasury stock, at cost; 721,077 shares and 594,877
shares at December 31, 2004 and 2003, respectively
(4,986) (4,087)
-------- --------
Total Shareholders' Equity 45,831 52,927
-------- --------
Total Liabilities and Shareholders' Equity $132,891 $115,732
======== ========
The accompanying notes are an integral part of these financial statements.
27
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
2004 2003 2002
------------ ----------- ------------
(in thousands, except per share data)
Revenues:
Contract revenues earned $114,899 $160,709 $122,727
Other revenues 27,883 32,554 32,829
------------ ----------- ------------
Total revenue 142,782 193,263 155,556
Cost of Sales 105,104 146,867 120,740
------------ ----------- ------------
Gross profit 37,678 46,396 34,816
Selling, general and administrative expenses 36,219 32,305 25,785
Research and development
7,755 7,374 4,916
Impairment of goodwill and other intangibles
1,826 - -
------------ ----------- ------------
-- --
(Loss) income from operations (8,122) 6,717 4,115
------------ ----------- ------------
Other expense (income)
Interest expense 3,298 1,389 1,427
Interest income (1,009) (338) (33)
Other (income) expense
19 (90) (119)
------------ ----------- ------------
Total other expense 2,308 961 1,275
------------ ----------- ------------
(Loss) income before income taxes (10,430) 5,756 2,840
Income taxes (benefit) expense (2,232) 2,348 1,026
------------ ----------- ------------
Net (loss) income $ (8,198) $ 3,408 $ 1,814
============ =========== ============
Earnings (loss) per share:
- -------------------------
Basic earnings (loss) per common share $ (1.01) $ .43 $ .24
============ =========== ============
Weighted average number of common
shares outstanding 7,456
8,136 7,895
Diluted earnings (loss) per common share $ (1.01) $ .42 $ .23
============ =========== ============
Weighted average number of common
shares and equivalents 8,136 8,158 7,940
============ =========== ============
The accompanying notes are an integral part of these financial statements.
28
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)
Accumulated
Additional Retained Other
Common Stock Paid-in Earnings Comprehensive Treasury Stock
Shares Amount Capital (Deficit) Income (Loss) Shares Amount Total
---------------- ------- --------- ------------- ---------------- -----
Balance at January 1, 2002 7,133 $ 5,350 $ 27,976 $ 2,704 $ (114) 478 $(3,279) $ 32,637
Tax benefit from the exercise
of stock options
253 253
Common stock issued in
connection with acquisition
of Tiburon, Inc. 1,124 843 13,406 14,249
Warrant issued in
connection with acquisition
of Tiburon, Inc. 262 262
Warrants exercised in
cashless exercise 9 6 58 4 (64) -
Stock options exercised 126 95 553 648
Purchase of treasury shares
92 (577) (577)
--------------------------------------------------------------------------------------------
Subtotal 8,392 6,294 42,508 2,704 (114) 574 (3,920) 47,472
Comprehensive income:
Net income 1,814 1,814
Other comprehensive income,
net of tax:
Loss on interest rate swap
agreement (74) (74)
Translation adjustment (8) (8)
-------------
Comprehensive income (loss) 1,732
--------------------------------------------------------------------------------------------
Balance at December 31, 2002 8,392 6,294 42,508 4,518 (196) 574 (3,920) 49,204
Tax benefit from the exercise
of stock options 127 127
Acquisition of Tiburon
Purchase price adjustment (370) (370)
Stock options exercised 128 96 360 456
Warrants exercised 48 36 130 21 (166) -
Purchase of treasury shares
- (1) (1)
--------------------------------------------------------------------------------------------
Subtotal 8,568 6,426 42,755 4,518 (196) 595 (4,087) 49,416
Comprehensive income:
Net income 3,408 3,408
Other comprehensive
income, net of tax:
Gain on interest rate
swap agreement 110 110
Translation adjustment (7) (7)
-------------
Comprehensive income (loss)
3,511
--------------------------------------------------------------------------------------------
Balance at December 31, 2003
8,568 6,426 42,755 7,926 (93) 595 (4,087) 52,927
Common stock issued in
connection with acquisition 72 54 585 639
Stock options exercised 304 227 1,028 1,255
Purchase of treasury shares 126 (899) (899)
--------------------------------------------------------------------------------------------
Subtotal 8,944 6,707 44,368 7,926 (93) 721 (4,986) 53,922
Comprehensive income:
Net loss (8,198) (8,198)
Other comprehensive
income, net of tax:
Gain on interest rate swap
agreement 93 93
Unrealized gain on available
for
sale marketable securities 14 14
-------------
Comprehensive income (loss) (8,091)
--------------------------------------------------------------------------------------------
Balance at December 31, 2004 8,944 $ 6,707 $ 44,368 $ (272) $ 14 721 $(4,986) $ 45,831
=============================================================================================
The accompanying notes are an integral part of these financial statements.
29
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2004 2003 2002
------- ------- -------
(in thousands)
Cash flows from operating activities:
Net (loss) income $(8,198) $ 3,408 $ 1,814
Adjustments to reconcile net (loss) income to net cash provided by
(used in) operations:
Depreciation and amortization 2,921 2,988 2,848
Deferred income tax (benefit) expense (219) 245 (288)
Equity earnings in affiliated company - - (23)
Gain (loss) from disposition of property, plant and equipment 2 - (1)
Impairment of goodwill and other intangibles 1,826 - -
Amortization of debt discount 176 - -
Unrealized loss on interest rate swap 21 - -
Amortization of discounts of marketable securities (18) - -
Changes in assets and liabilities:
Accounts receivable 7,507 3,388 (4,828)
Contract costs in excess of billings 1,481 1,305 4,533
Inventories 1,539 (303) (158)
Prepaid expenses and other current assets (3,160) 188 (67)
Other assets 191 (237) (49)
Accounts payable and accrued liabilities 616 (830) (4,887)
Billings in excess of contract costs incurred (54) (51) 1,871
Deferred revenue (38) 224 1,021
Other liabilities
(66) 665 (9)
------- ------- -------
Net cash flows provided by operating activities 4,527 10,990 1,777
------- ------- -------
Cash flows from investing activities:
Purchase of marketable securities (42,361) - -
Redemption of marketable securities 22,824 - -
Additions to property, plant and equipment (1,784) (1,068) (3,150)
Proceeds from sale of property, plant and equipment 4 14 40
Net payment for acquisitions (5,526) (71) (10,362)
------- ------- -------
Net cash flows used in investing activities (26,843) (1,125) (13,472)
------- ------- -------
Cash flows from financing activities:
Warrants exercised - 166 64
Stock options exercised 1,255 583 902
Purchase of treasury stock (899) (167) (641)
Repayments of subordinated notes payable - - (1,762)
Borrowings of bank notes - - 15,500
Repayment of bank notes and lines of credit (13,653) (9,852) (1,390)
Borrowings of convertible subordinated notes payable 38,942
------- ------- -------
- -
Net cash flows provided by (used in) financing activities 25,645 (9,270) 12,673
------- ------- -------
Net change in cash and cash equivalents 3,329 595 978
Cash and cash equivalents at the beginning of the year 1,274 296
------- ------- -------
1,869
Cash and cash equivalents at the end of the year $ 5,198 $ 1,869 $ 1,274
======= ======= =======
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 1,573 $ 1,087 $ 1,314
Income taxes, net of refunds $ 771 $ 1,873 $ 2,137
Common stock issued in connection with acquisition $ 639 - $14,300
The accompanying notes are an integral part of these financial statements.
30
COMPUDYNE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations CompuDyne Corporation, a Nevada corporation, operates in
four sectors of the security industry - Institutional Security Systems, Attack
Protection, Public Safety and Justice, and Federal Security Systems.
The Institutional Security Systems segment provides physical and electronic
security products and services to the corrections industry (jails and prisons),
and to the courthouse, municipal and commercial markets.
The Attack Protection segment manufactures bullet, blast and attack resistant
windows and doors designed for high-end security applications, including
embassies, courthouses, Federal Reserve buildings and banks; and also
manufactures fiber optic systems used to detect physical intrusion, protect
large perimeters and for the physical protection of data lines; and, fixed,
removable, semi-automatic vehicle bollards and wedge barrier security systems.
The Federal Security Systems segment provides the United States military,
governmental agencies and state and local units with specialty engineering and
security services, often of a classified nature.
The Public Safety and Justice segment provides a fully integrated suite of
products including computer assisted dispatching, records management, court and
probation software systems for the law enforcement, fire and rescue, corrections
and justice environments. In addition, the Company's Public Safety and Justice
segment provides sophisticated inmate management software.
Summary of Significant Accounting Policies The consolidated financial statements
of CompuDyne Corporation and its subsidiaries have been prepared in accordance
with accounting principles generally accepted in the United States of America.
Principles of Consolidation The consolidated financial statements include the
accounts of CompuDyne Corporation and its subsidiaries (collectively "CompuDyne"
or "the Company"). On May 2, 2002, CompuDyne completed its acquisition of all of
the issued and outstanding shares of Tiburon at which time Tiburon, Inc.
("Tiburon") became a wholly owned subsidiary of CompuDyne. Prior to May 2, 2002
the Company accounted for its investment in Tiburon using the equity method and
such investment was included in Investment in Affiliated Company. All
significant inter-company balances and transactions have been eliminated in
consolidation.
Use of Estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. These include estimates of
percentage-completion on long-term contracts and valuation allowances for
contracts, accounts receivable, inventories and deferred tax assets. Actual
results could differ from those estimates.
Revenue Recognition Much of the Company's revenues are derived from long-term
contracts where revenue is recognized under the percentage of completion method
of accounting. Revenues and the associated costs from software products and
related hardware installations, as well as computer programming and systems
engineering services delivered as part of the Company's delivery of its software
products, are recognized using the percentage-of-completion method using labor
hours incurred relative to total estimated contract hours as the measure of
progress towards completion. The Company's construction contracts utilize costs
incurred to date on a project divided by the total expected project costs to
determine the completion percentage. Revenue under cost reimbursable contracts
is recognized to the extent of costs incurred to date plus a proportionate
amount of the fee earned. Revenue under time and materials contracts is
recognized to the extent of billable rates times hours incurred plus materials
expense incurred. Revenue from fixed price construction contracts is recognized
under the percentage of completion method, whereby a portion of the total
contract price is recognized based on the amount of costs incurred to date as a
percentage of total estimated costs. Changes in revenue, costs, and profit
estimates occurring during the course of a contract are recognized in the period
in which the revisions are determined. Revenues for support and maintenance
contracts are deferred and recognized ratably over the life of the service
contract once the system is installed. Sales of products unrelated to contract
revenue are recognized as revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; the seller's price to the buyer is fixed or determinable;
and collectibility is reasonably assured. Provisions for estimated losses on
uncompleted contracts are recognized in the period such losses are determined.
Costs and estimated earnings in excess of billings on uncompleted contracts
represent the excess of contract revenues recognized to date over billings to
date on certain contracts. Billings in excess of costs and estimated earnings on
uncompleted contracts represent the excess of billings to date over the amount
of revenue recognized to date on certain contracts.
31
Research and Development Expenditures for research and development are charged
to operations as incurred.
Goodwill Goodwill represents the cost in excess of the fair value of net assets
acquired. In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets", which was effective January 1, 2002. SFAS 142
requires, among other things, the discontinuance of goodwill amortization. In
addition, the standard includes provisions for the reclassification of certain
existing recognized intangibles as goodwill, reassessment of the useful lives of
existing recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS 142 also
requires the Company to complete a transitional goodwill impairment test six
months from the date of adoption. The result of this impairment test identified
that as of January 1, 2002 there were no impairments of goodwill or intangible
assets. CompuDyne will continue to conduct impairment assessments annually as of
October 1 of each fiscal year or when events indicate a triggering event has
occurred. During the fourth quarter of 2004, the Company concluded that the
continuing decline in the backlog in its ISS segment constituted a triggering
event. The Company performed our interim impairment test of the reporting unit
as of December 31, 2004 and based on our valuation concluded it was necessary to
write off the value of the segment's goodwill in the amount of $739 thousand.
This write-off is included in impairment of goodwill and other intangibles in
the 2004 statement of operations. As of October 1 and December 31, 2004, there
were no other impairments of goodwill.
Cash and Cash Equivalents The Company considers all highly liquid investments
with an original or remaining maturity of three months or less to be cash
equivalents. The Company deposits cash and cash equivalents with high credit
quality financial institutions. These deposits may exceed the federally insured
limits.
Marketable Securities 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," 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. The cost for marketable
securities was determined using the specific identification method. The fair
values of marketable securities are estimated based on the quoted market price
for these securities.
Property, Plant, and Equipment Property, plant and equipment are stated at cost
less accumulated depreciation. Depreciation of plant and equipment is computed
principally by the straight-line method based upon the estimated useful lives of
the various classes of assets. Leasehold improvements are amortized over their
useful lives or the term of the underlying lease, whichever is shorter.
Maintenance and repair costs are charged to operations as incurred; major
renewals and betterments are capitalized. Any gain or loss from the retirement
or sale of an asset is credited or charged to operations.
Inventories Inventories are stated at the lower of cost or market, using the
First-in, First-out (FIFO) method. Costs included in inventories consist of
materials, labor, and manufacturing overhead, which are related to the purchase
and production of inventories.
Warranty Reserves In November 2002, the FASB issued Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires the
recognition of liabilities for guarantees that are issued or modified subsequent
to December 31, 2002. The liabilities should reflect the fair value, at
inception, of the guarantors' obligations to stand ready to perform, in the
event that the specified triggering events or conditions occur. The adoption of
this standard did not have a material effect on the financial position, results
of operations or cash flows of CompuDyne. The Interpretation also requires
disclosure of accounting policies and methodologies with respect to warranty
accruals, as well as a reconciliation of the change in these accruals for the
reporting period. Refer to Note 13, "Product Warranties," in the Notes to
Consolidated Financial Statements for additional information.
Deferred Revenue The Company provides ongoing maintenance and service for many
of its completed projects. Much of this work is performed pursuant to
maintenance agreements, which typically cover such services for a twelve month
period. The Company recognizes revenue under these contracts ratably over the
term of the contract. Any revenues not yet earned under the contract is recorded
as deferred revenue in the accompanying financial statements
32
Fair Value and Hedging The Company hedged the cash flows of some of its
long-term debt using an interest rate swap. The Company entered into these
derivative contracts to manage its exposure to interest rate movements by
achieving a desired proportion of fixed rate versus variable rate debt. In the
interest rate swap, the Company agreed to exchange the difference between a
variable interest rate and either a fixed or another variable interest rate,
multiplied by a notional principal amount.
Income Taxes The Company follows Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes". Under SFAS 109, deferred income
taxes are recognized for the future tax consequences of differences between tax
bases of assets and liabilities and financial reporting amounts, based upon
enacted tax laws and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income.
Stock-Based Compensation As of December 31, 2004, the Company continues to
account for its stock-based compensation plans, 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 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 Year Ended December 31,
2004 2003 2002
------- ------- ------
(in thousands, except per share data)
Net (loss) income, as reported $(8,198) $ 3,408 $ 1,814
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards net of related tax effects 1,040 1,117 1,374
------- ------- ------
Pro forma net (loss) income $(9,238) $ 2,291 $ 440
======= ======= ======
(Loss) earnings per share:
Basic - as reported $ (1.01) $ .43 $ .24
Basic - pro forma $ (1.14) $ .29 $ .06
Diluted - as reported $ (1.01) $ .42 $ .23
Diluted - pro forma $ (1.14) $ .28 $ .06
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 Year Ended December 31,
2004 2003 2002
----- ------ -----
Expected life in years 5.4 6.6 7.5
Risk-free interest rate 3.4% 2.9% 5.0%
Expected volatility 75.3% 79.5% 74.0%
Corporate Reorganization As part of the Company's efforts to better manage its
costs, during the first quarter of 2005 the Company implemented a corporate
reorganization whereby it dissolved an inactive subsidiary and converted several
corporate entities into LLCs (Limited Liability Corporations). This activity was
designed to improve the Company's tax reporting structure and should help better
manage the Company's state income tax obligations. In conjunction with this
reorganization, our Federal Security Systems group, formerly known as Quanta
Systems, was renamed CompuDyne - Integrated Electronics, and our Public Safety
and Justice group, formerly known as Tiburon, was renamed CompuDyne - Public
Safety and Justice, Inc.
Other Recently Issued Accounting Pronouncements
In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. Statement 153 addresses the
measurement of exchanges of nonmonetary assets and redefines the scope of
transactions that should be measured based on the fair value of the assets
exchanged. Statement 153 is effective for nonmonetary asset exchanges occurring
in fiscal periods beginning after June 15, 2005. The Company does not believe
adoption of Statement 153 will have a material effect on its consolidated
financial position, results of operations or cash flows.
33
In December 2004, the FASB issued FASB Staff Position No. 109-1, Application of
FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004 (FSP 109-1). FSP 109-1 clarifies that the manufacturer's
deduction provided for under the American Jobs Creation Act of 2004 (AJCA)
should be accounted for as a special deduction in accordance with SFAS 109 and
not as a tax rate reduction. The adoption of FSP 109-1 will have no impact on
the Company's results of operations or financial position for fiscal year 2005
because the manufacturer's deduction is not available to the Company until
fiscal year 2006. The company is evaluating the effect that the manufacturer's
deduction will have in subsequent years.
In December 2004, the FASB issued FASB Staff Position No. 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a special
one-time dividends received deduction on the repatriation of certain foreign
earnings to a U.S. taxpayer (repatriation provision), provided certain criteria
are met. FSP 109-2 provides accounting and disclosure guidance for the
repatriation provision. The Company believes that the adoption of this statement
will have no effect on the financial position, results of operations, or cash
flows of the Company.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," a
revision of SFAS No. 123, "Accounting for Stock-Based Compensation" and
superseding APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS
No. 123R requires the Company to expense grants made under its stock option and
employee stock purchase plan programs. That cost will be recognized over the
vesting period of the plans. SFAS No. 123R is effective for the first interim or
annual period beginning after June 15, 2005. The Company has not yet determined
the method of adoption or the effect of adopting SFAS 123R, and has not
determined whether the adoption will result in amounts that are similar to the
current pro forma disclosures under SFAS 123. The Company is evaluating the
alternatives allowed under the standard, which the Company is required to adopt
beginning in the third quarter of 2005.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs," an amendment
to ARB No. 43, Chapter 4, "Inventory Pricing," to clarify that abnormal amounts
of idle facility expenses, freight, handling costs and wasted materials
(spoilage) should be recognized as current-period charges. In addition, FAS 151
requires that allocation of fixed production overhead to the costs of conversion
be based on the normal capacity of the production facilities. SFAS No. 151 is
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The Company believes there will be no material effect on the financial
position, results of operations, or cash flows of the Company upon adoption of
this statement.
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. The
consolidation provisions of FIN 46(R) were effective immediately for interests
created after January 31, 2003 and were effective on March 31, 2004 for
interests created before February 1, 2003. The adoption of this standard did not
have a material effect on the financial position, results of operations or cash
flows of the Company.
Reclassifications - Certain prior year amounts have been reclassified to conform
with the current year's presentation.
34
2. ACQUISITION OF TIBURON, INC.
On January 25, 2002, the Company and Tiburon, Inc. entered into a First
Amendment Agreement whereby upon the satisfaction of certain conditions, the
Company agreed to purchase all of the issued and outstanding common shares and
other common stock equivalents it did not already own for a combination of cash
and stock. All requisite conditions were met and the Company completed the
purchase of Tiburon, Inc. on May 2, 2002. CompuDyne distributed approximately
1.1 million shares of CompuDyne common stock and approximately 91,000 warrants
to purchase shares of the Company's stock, valued collectively at $14.3 million
and approximately $10.4 million, net in cash to acquire the portion of Tiburon
that the Company did not previously own. Including the Company's initial
investment of $6.0 million in Tiburon and transaction costs resulted in the
Company recording $35.5 million as the value of the consideration paid for this
acquisition. At December 31, 2004 the Company recorded additional goodwill and a
deferred tax liability for the indefinite lived intangible asset recorded at the
time of purchase and also reflected this adjustment in the 2003 balance sheet.
This deferred tax liability was valued at $2.1 million. To fund the cash portion
of the Tiburon acquisition, the Company negotiated a $10.0 million increase in
its borrowing facility from its banks. The remainder of the cash consideration
paid was funded from the Company's working capital.
Tiburon provides a fully integrated suite of products including
computer-assisted dispatch, records management and court and probation software
systems for the law enforcement, fire and rescue, corrections and justice
environments. The Company believes Tiburon is a worldwide market leader in the
development, implementation and support of public safety and justice automation
systems.
The purchase price was recorded as follows (in thousands):
Goodwill $ 21,883
Current assets 20,215
Property plant and equipment 3,653
Other long-term assets 8,917
Liabilities assumed (19,168)
--------
Purchase price $ 35,500
========
The following are the Company's unaudited pro-forma results assuming the
acquisition of Tiburon had occurred on January 1, 2002:
Twelve Months Ended
December 31, 2002
-------------------------------------
(in thousands, except per share data)
Revenue $ 169,304
Net income $ 2,077
Earnings per share
Basic $ .28
Diluted $ .26
These unaudited pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of the results of operations which
would have actually resulted had the combination been effective on January 1,
2002, or of future results of operations.
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 729,800
shares for 2004, 901,770 shares for 2003 and 488,500 shares for 2002 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 for the year ended December 31, 2004 as the effect is
antidilutive.
35
The computations of the Company's basic and diluted earnings per common share
amounts were as follows:
2004 2003 2002
--------------------------------------------
(in thousands, except per share data)
Net (loss) income $(8,198) $ 3,408 $ 1,814
======= ======= =======
Weighted average common shares outstanding 8,136 7,895 7,456
Effect of dilutive stock options and warrants 263 484
------- ------- -------
-
Diluted weighted average common shares outstanding $ 8,136 $ 8,158 $ 7,940
======= ======= =======
Net earnings (loss) per common share
Basic $ (1.01) $ .43 $ .24
Diluted $ (1.01) $ .42 $ .23
In March 2004, the EITF reached a final consensus on Issue 03-6, "Participating
Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per
Share" ("Issue 03-6"), effective June 30, 2004 (see Note 1). Issue 03-6 requires
the use of the two-class method to compute earnings per share for 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 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
contingency was not met for the year ended December 31, 2004. Accordingly, no
undistributed earnings have been allocated to the 2011 Notes. At each reporting
period, the Company assesses whether the contingency criteria have been met and
consequently if undistributed earnings should be allocated to participating
securities.
4. INVESTMENTS IN MARKETABLE SECURITIES
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 December
31, 2004 all of the Company's investments in marketable securities were
classified as available-for-sale, and as a result, were reported at fair value.
Unrealized gains and losses are reported as a component of accumulated other
comprehensive income in shareholders' equity. The amortized costs of debt
securities is adjusted for accretion of discounts from the date of purchase to
maturity. The accretion is included in interest income on the investments. The
cost for marketable securities was determined using the specific identification
method. The fair values of marketable securities are estimated based on the
quoted market price for these securities.
Marketable securities at December 31, 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 $ 19,554 $ 23 $ - $19,577
The cost and estimated fair value of current debt securities at December 31,
2004, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because the issuers of the securities may have the
right to repay obligations without prepayment penalties. It is the Company's
policy to classify available-for-sale securities that are available for use in
current operations as a current asset.
Estimated
(in thousands) Cost Fair Value
-------- --------
Due after one year and beyond $ 19,554 $ 19,577
-------- --------
Total debt securities $ 19,554 $ 19,577
======== ========
In conjunction with the waivers obtained by the Company from its bank, the
Company has agreed to pledge to its bank, marketable securities equal to 111.11%
of the value of its outstanding obligation to the bank, as defined. The
provisions of this pledge were formally agreed to in March 2005. Had these
provisions been in effect at December 31, 2004, the Company would have been
required to pledge approximately $5.9 million of its marketable securities as
collateral for its bank obligations.
36
5. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
December 31,
-------------------------
2004 2003
-------- --------
U.S. Government Contracts (in thousands)
Billed $ 6,181 $ 1,946
Unbilled 384 805
-------- --------
6,565 2,751
-------- --------
Commercial
Billed 23,760 31,078
Retainage 5,885 9,203
-------- --------
29,645 40,281
-------- --------
Total accounts receivable 36,210 43,032
Less: allowance for doubtful accounts (1,919) (1,252)
-------- --------
Accounts receivable, net $ 34,291 $ 41,780
======== ========
The Company expects to collect substantially all receivables within one year
except for a portion of the receivables recorded as retainage. Retainage
expected to be collected in over one year amounts to $1.4 million, or 25% of the
total retainage amount at December 31, 2004, and is reflected as a current asset
as it will be collected within the operating cycle under the related contract.
Substantially all of the U.S. Government billed receivables result from cost
reimbursable or time-and-material contracts. Direct sales to the U.S. Government
for the years ended December 31, 2004, 2003 and 2002 were approximately $9.9
million, $12.6 million, and $11.5 million, respectively, or 7.0%, 6.5%, and 7.4%
of the Company's total net sales for the respective years. The sales to the U.S.
Government were in the Institutional Security Systems and Federal Security
Systems segments. No single customer accounted for greater than 10% of the
Company's net sales. Contract costs for services provided to the U.S.
Government, including indirect expenses, are subject to audit by the Defense
Contract Audit Agency ("DCAA"). All contract revenues are recorded in amounts
expected to be realized upon final settlement. In the opinion of management,
adequate provisions have been made for adjustments, if any, that may result from
the government audits. The Company received final approval on its indirect costs
billed to the U. S. Government for 2000 from DCAA in April 2004 and final
approval on its indirect costs billed to the U.S. Government for 2001 from DCAA
in August 2004. No significant payments or billings were made as a result of the
approval of the 2000 and 2001 rates. The years 2002, 2003 and 2004 are still
open and subject to audit. The Company does not expect the audit of these years
to have a material effect on its financial position or results of operations.
6. CONTRACTS IN PROCESS
Amounts included in the financial statements, which relate to recoverable costs
and accrued profits not yet billed on contracts in process, are classified as
current assets. Billings on uncompleted contracts in excess of incurred cost and
accrued profits are classified as current liabilities. The Company expects to
bill and collect substantially all costs in excess of billings within one year.
Summarized below are the components of the amounts:
December 31,
-------------------------
2004 2003
--------- ---------
(in thousands)
Costs and estimated earnings on uncompleted contracts $ 286,041 $ 285,297
Less customer progress payments 289,449 287,316
--------- ---------
$ (3,408) $ (2,019)
========= =========
Included in the consolidated balance sheets:
Costs and estimated earnings in excess of billings
on uncompleted contracts $ 16,087 $ 17,568
Billings in excess of contract costs and estimated
on uncompleted contracts (13,497) (13,551)
Deferred revenue (5,998) (6,036)
========= =========
$ (3,408) $ (2,019)
========= =========
37
7. INVENTORIES
Inventories consist of the following:
December 31,
-------------------------
2004 2003
------- -------
(in thousands)
Raw materials $ 2,929 $ 3,745
Work in progress 1,840 2,310
Finished goods 396 649
------- -------
$ 5,165 $ 6,704
======= =======
Reserve for excess and absolute inventory $ 1,362 $ 840
======= =======
8. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
December 31, Estimated
------------------------- Useful Life
2004 2003 In Years
-------- -------- -----------
(in thousands)
Land $ 435 $ 435
Buildings and leasehold improvements 4,897 4,888 7-39
Machinery and equipment 7,050 6,982 3-10
Furniture and fixtures 1,191 1,132 3-10
Automobiles 458 530 3-7
Software 9,027 6,111 3-7
Construction in progress 605 -
-------- --------
23,663 20,078
Less: accumulated depreciation and amortization (11,569) (9,999)
-------- --------
$ 12,094 $ 10,079
======== ========
The Company acquired software in purchases of the assets of 90 Degrees and
Copperfire at $2.2 million and $0.6 million, respectively.
Depreciation expense for the years ended December 31, 2004, 2003, and 2002 was
$2.6 million, $2.6 million and $2.4 million, respectively.
9. GOODWILL
The December 31, 2004 audited consolidated financial statements include the fair
market value of the assets acquired and liabilities assumed and the related
allocations of the purchase price related to the acquisition of the assets of 90
Degrees on August 11, 2004. Goodwill recorded for the 90 Degrees asset
acquisition was approximately $1.9 million.
The December 31, 2004 audited consolidated financial statements also include the
fair market value of the assets acquired and liabilities assumed and the related
allocations of the purchase price related to the acquisition of Copperfire on
December 15, 2004. Goodwill recorded for the Copperfire asset acquisition was
approximately $1.4 million.
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 $26.0 million at December 31, 2004. During the fourth
quarter of 2004, the Company concluded that the continuing decline in the
backlog in its ISS segment constituted a triggering event which caused the
Company to conclude it was necessary to write off the value of the segment's
goodwill in the amount of $739 thousand.
38
Goodwill, by segment, consists of the following, in thousands:
December 31, December 31,
2004 2003
-------- --------
Institutional Security Systems $ - $ 739
Attack Protection 728 728
Public Safety & Justice 25,166 21,883
-------- --------
$ 25,894 $ 23,350
======== ========
10. INTANGIBLE ASSETS
The December 31, 2004 audited consolidated financial statements include the fair
market value of the assets acquired and liabilities assumed and the related
allocations of the purchase price related to the acquisition of 90 Degrees on
August 11, 2004. Intangible assets for the 90 Degrees asset acquisition are
approximately $60 thousand.
The December 31, 2004 audited consolidated financial statements include the fair
market value of the assets acquired and liabilities assumed and the related
allocations of the purchase price related to the acquisition of Copperfire on
December 15, 2004. Intangible assets for the Copperfire asset acquisition are
approximately $60 thousand.
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. With the exception of trade names, which have indefinite lives, the
intangible assets are being amortized using the straight-line method.
The weighted average life for purposes of amortization of identified intangible
assets acquired in 2004 was two years for the covenant not to complete
agreements and employment contracts.
Intangible assets consist of the following, in thousands:
December 31,
------------------------- Amortizable
2004 2003 Lives
-------- -------- -----------
(in thousands) (in years)
Trade names $ 5,673 $ 6,913 Indefinite
Customer relationships 2,500 2,500 14
Backlog 300 300 2
Other 1,305 1,220 1-20
-------- --------
9,778 10,933
Less: accumulated amortization (1,318) (1,148)
-------- --------
$ 8,460 $ 9,785
======== ========
Amortization expense for the Company's intangible assets for the year ended
December 31, 2004 was $358 thousand. During the fourth quarter of 2004, the
Company concluded that the continuing decline in the backlog in its ISS segment
constituted a triggering event which caused the Company to conclude it was
necessary to write off certain of the segment's intangible assets in the amount
of $1.1 million as a result of these assets being impaired. There were no other
impairments of intangible assets. The following schedule lists the expected
amortization expense for each of the years ending December 31, in thousands:
Year
----
2005 $ 310
2006 265
2007 257
2008 225
2009 225
-------
Total $ 1,282
=======
39
11. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities at December 31, 2004 and 2003 consisted
of the following:
2004 2003
----------------------------------
(in thousands)
Accounts payable $ 9,406 $ 14,456
Liability for marketable security purchased 4,336 -
Accrued payroll costs 3,323 4,375
Income taxes payable 707 -
Other accrued expenses 3,999 2,247
-------- --------
$ 21,771 $ 21,078
======== ========
12. NOTES PAYABLE AND LINE OF CREDIT
December 31, December 31,
2004 2003
------------- -----------
(in thousands)
Industrial revenue bond, interest payable quarterly at a variable rate of 1.14%
to 2.13% (2.13% at December 31, 2004) principal payable in quarterly
installments of $35,000. The bond is fully collateralized
by a $1.4 million letter of credit and a bond guarantee agreement. $ 1,400 $ 1,540
Industrial revenue bond, interest payable quarterly at a variable rate
of 1.01% to 2.13% (2.13% at December 31, 2004) principal payable
in yearly installments of $300,000 until 2013 when the installments become
$100,000. 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 44,255 17,658
Less convertible subordinated notes discount 1,132 -
-------- --------
Subtotal 43,123 17,658
Less amount due within one year 440 2,103
-------- --------
$ 42,683 $ 15,555
======== ========
40
Maturities of notes payable are as follows, in thousands:
Year Ending December 31, Amount
------------------------ ------
2005 $ 440
2006 440
2007 440
2008 440
2009 440
Thereafter 42,055
-------
$44,255
=======
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 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.
The 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 1,132
------------
$ 39,118
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, at a premium of two percent of the face value plus accrued interest 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 may
redeem the 2011 Notes in whole but not in part 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.
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 a
straight-line basis to interest expense over the term of the 2011 Notes.
Interest expense recorded for the total of the deferred debt issuance costs and
underwriter's discounts on the 2011 Notes totaled $245 thousand for the year
ended December 31, 2004.
During January 2004, the Company repaid all of its outstanding bank borrowings
from the proceeds of the issuance of the 2011 Notes.
On 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.
The new agreement also contains various financial covenants, including among
other things, a minimum fixed charge coverage ratio, maximum debt to earnings
before interest, taxes, depreciation and amortization ("EBITDA") ratio, minimum
EBITDA covenant, a minimum consolidated tangible net worth covenant, a maximum
permitted capital expenditures covenant, and a covenant restricting the payment
of dividends. Of this line of credit $10.0 million matures on March 1, 2007 and
$15.0 million matured on March 1, 2005. At December 31, 2004 $5.3 million was
committed principally as letters of credit securing the Industrial Revenue
Bonds.
On October 29, 2004 and March 4, 2005, the Company and its banks entered into
amendments to the credit agreement pursuant to which the banks waived the
Company's non-compliance with its fixed charge coverage ratio covenant as of
September 30, 2004 and non-compliance with its minimum EBITDA covenant as of
December 31, 2004, respectively. In addition, the Company and its banks amended
the credit agreement to eliminate the $15 million line of credit maturing March
2005 and to require borrowings under its $10 million line of credit to be
collateralized by pledged marketable securities equal to 111.11% of the value of
such borrowings. The credit agreement was also amended to eliminate the
quarterly minimum EBITDA covenant for the Company's fiscal years ending after
December 31, 2004 and to provide that the minimum fixed charge coverage ratio
covenant, maximum debt to EBITDA ratio covenant and the minimum consolidated
tangible net worth covenant will not become effective until March 31, 2006.
41
So long as the Company maintains pledged marketable securities equal to 111.11%
of the value of its borrowings under the credit agreement, borrowings under the
credit agreement shall bear interest at LIBOR + 1.00% or Prime + 1.00%. 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.
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 year ended December 31, 2004. Upon
determination of the hedge ineffectiveness the cumulative loss on the fair value
of the interest rate swap was $155 thousand, which was recognized in other
income. The change in fair value of the interest rate swap for the year ended
December 31, 2004 was a gain of $134 thousand, resulting in a remaining
liability for the investment of $21 thousand. Future changes in the value of the
interest rate swap will be recognized in earnings.
13. 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
December 31, 2004 and 2003, the Company had a product warranty accrual in the
amount of $359 thousand and $517 thousand respectively.
Product Warranty Liabilities December 31,
-----------------------------
2004 2003
----- ----
(in thousands)
--------------
Beginning balance at January 1, $ 517 $ 482
Plus: accruals for product warranties 280 499
Less: warranty charges/claims (438) (464)
----- -----
Ending balance at December 31, $ 359 $ 517
===== =====
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Cash and Cash Equivalents, Accounts Receivable and Accounts Payable and Accrued
Expenses - The carrying amounts reported in the balance sheets for these items
approximate fair value due to the short-term maturities of these assets and
liabilities.
Long-Term Debt - The carrying amounts reported in the balance sheet approximate
fair value as the amounts are at floating rates and terms available to the
Company at December 31, 2004 and 2003 for borrowings for similar transactions.
The Company's 2011 Notes are at a fixed rate of 6.25%, which approximates
current rates for similar obligations.
Interest Rate Swap Agreements - The Company uses interest rate swap agreements
to manage exposure to fluctuations in interest rates. At December 31, 2004, the
Company had an unleveraged swap agreement with a bank with a notional principal
amount of $2.0 million. This agreement was placed on June 26, 2001 with a fixed
rate of 4.9% and is settled in cash on a quarterly basis. The termination date
is September 30, 2005.
In prior years the Company hedged the cash flows of some of its long-term debt
using an interest rate swap. The Company entered into these derivative contracts
to manage its exposure to interest rate movements by achieving a desired
proportion of fixed rate versus variable rate debt. In an interest rate swap,
the Company agrees to exchange the difference between a variable interest rate
and either a fixed or another variable interest rate, multiplied by a notional
principal amount.
As of December 31, 2003, the Company recognized the cash flow hedge at its fair
value of $155 thousand in accounts payable and accrued expenses on the
consolidated balance sheet. As of December 31, 2003 the interest rate swap
qualified for cash flow hedge accounting, therefore an unrealized loss of $155
thousand ($93 thousand net of tax), representing the effective portion of the
change in its fair value, was reported in other comprehensive loss. For the year
ended December 31, 2004, the interest rate swap was determined to be ineffective
and the changes in fair value are recognized in earnings.
42
15. INCOME TAXES
The components of the income tax provision (benefit) are as follows:
For the years ended December 31,
2004 2003 2002
-------- ------- -------
(in thousands)
Current $ (2,013) $ 2,103 $ 1,314
Deferred (219) 245 (288)
-------- ------- -------
$ (2,232) $ 2,348 $ 1,026
======== ======= =======
The tax effects of the primary temporary differences giving rise to the
Company's net deferred tax assets and liabilities at December 31, 2004 and 2003
are summarized as follows:
December 31,
(in thousands)
2004 2003
-------- --------
Deferred tax assets:
Accrued expenses and deferred compensation $ 566 $ 301
Tax operating loss carry-forward 1,064 526
Book reserves in excess of tax 1,093 1,140
Price risk management activities (9) 62
Tax depreciation and amortization in excess
of book depreciation and amortization 440 -
Other 84 -
-------- --------
Total deferred assets 3,238 2,029
-------- --------
Deferred tax liabilities:
Book depreciated and amortization in excess
of tax depreciation and amortization - (538)
Purchased intangibles (3,452) (3,782)
-------- --------
Total deferred tax liabilities (3,452) (4,320)
Valuation allowance (1,858) -
-------- --------
Net deferred tax (liability) asset $ (2,072) $ (2,291)
======== ========
At December 31, 2004 the Company established a valuation allowance to reserve
substantially all of its net deferred tax assets.
The valuation allowance represents temporary differences where the Company
believes it is not "more likely than not" it will be able to receive tax
benefits in the future.
At December 31, 2004, the Company and its subsidiaries have Federal net
operating loss carry-forwards available to offset future taxable income of
approximately $10.0 million subject to severe limitations. Approximately $1.5
million are available for use on an unlimited basis through 2024. The balance of
these carry-forwards expires between 2005 and 2010. Tax loss carry-forwards for
this balance are limited to approximately $235 thousand each year as a result of
an ownership change, which occurred in 1995.
The difference between the statutory tax rate and the Company's effective tax
rate is summarized as follows:
For the years ended December 31,
2004 2003 2002
------ ------ ------
Statutory federal income tax rate (34.0)% 34.0% 34.0%
State income taxes, net of
Federal benefit (0.3) 6.2 6.0
Change in valuation allowance 14.8 - -
Tax effect of NOL utilization - - (0.5)
Tax effect of non-deductible items 0.5 1.1 1.0
Foreign income exclusion (1.9) (2.4) (5.3)
Other (0.5) 1.9 0.9
------ ------ ------
Tax (21.4)% 40.8% 36.1%
====== ====== ======
43
At December 31, 2004, the Company and its subsidiaries have recorded a tax
receivable representing net operating losses which will be carried back to its
2003 and 2002 Federal and State tax returns. The value of these carry backs is
approximately $2.5 million and is recorded within prepaid expenses and other
current liabilities in the accompanying balance sheet as of December 31, 2004.
16. SHAREHOLDERS' EQUITY
Warrants for Common Stock. In connection with a Private Investment in Public
Equity ("PIPE") transaction the Company entered into in October 2001, the
Company granted its underwriter an option to purchase 40,000 shares of the
Company's common stock at $12.00 per share, the price at which the shares were
sold in the PIPE. These options were granted on October 29, 2001 and expire on
October 29, 2006. The shares underlying these warrants have piggyback
registration rights. At the underwriter's option, these piggyback registration
rights may either convert to demand registration rights, with any fees related
to the registration of these warrants and underlying shares paid by the Company,
or the Company may grant the underwriter a put option to sell the shares
underlying the warrants back to the Company at a predetermined price.
In connection with the Company's acquisition of Tiburon, the Company exchanged
warrants and convertible securities to purchase shares of Tiburon into warrants
to purchase shares of the Company. On May 2, 2002, the Company issued 90,962
warrants to purchase shares of CompuDyne common stock at prices ranging from
$3.75 to $6.71 per share. During 2002, 11,909 of the warrants were exercised.
During 2003, 44,417 of the warrants were exercised resulting in 34,636 of such
warrants remaining outstanding at December 31, 2004. The following shows the
exercise price and expiration date of the remaining warrants outstanding:
Number of Warrants Exercise Price Expiration Date
------------------ -------------- ---------------
23,000 $ 5.37 December, 2006
11,636 $ 6.71 December, 2006
Stock Option Plans. The Company has various stock option plans. Under these
plans, 7,991,654 options to purchase common stock may be granted until 2006.
Options generally are granted at fair market value at the date of grant,
typically vest over 1 to 5 years from the date of grant, and expire 10 years
after the date of grant. The plans permit the issuance of either incentive stock
options or non-qualified stock options. Under all plans, there were 5,052,102
shares of common stock reserved for future grants as of December 31, 2004. The
1996 Stock Incentive Plan for Employees was amended on May 27, 2004 to increase
the number of shares available as restricted stock awards to 4,000,000.
Transactions for stock options and warrants are summarized as follows:
Year Year Year
Ended Weighted Ended Weighted Ended Weighted
December 31, Average December 31, Average December 31, Average
2004 Price 2003 Price 2002 Price
--------- --------- --------- --------- --------- ---------
Outstanding, Beginning of Year 1,414,556 $ 8.587 1,489,653 $ 8.324 1,126,160 $ 6.553
Granted 675,000 $ 9.145 271,500 $ 8.131 566,462 $ 11.412
Exercised 303,898 $ 4.131 172,497 $ 3.610 137,690 $ 5.174
Expired or Cancelled 113,700 $ 11.590 174,100 $ 10.554 65,279 $ 11.280
--------- --------- --------- --------- --------- ---------
Outstanding, End of Year 1,671,958 $ 9.418 1,414,556 $ 8.587 1,489,653 $ 8.324
--------- --------- --------- --------- --------- ---------
Exercisable, End of Year 492,861 $ 9.226 616,365 $ 6.625 596,218 $ 5.018
========= ========= ========= ========= ========= =========
Summarized information about stock options and warrants outstanding as of
December 31, 2004 is as follows:
Options and Warrants Outstanding Options and Warrants Exercisable
------------------------------------ --------------------------------
Weighted Average Weighted
Average Remaining Average
Exercise Life Exercise
Exercise Price Range Number Price (In years) Number Price
- -------------------- --------- --------- ---------- -------- ---------
$1.625 - 7.310 216,761 $5.8747 6.30 107,261 $4.7835
$7.375 - 7.640 211,000 $7.5934 9.26 18,250 $7.4708
$7.719 - 8.075 210,000 $7.9906 7.31 96,400 $8.0263
$8.105 - 8.885 169,397 $8.4879 7.33 67,150 $8.5264
$8.960 - 9.585 191,000 $9.1461 9.35 0 $0.0000
$9.675 - 10.460 223,300 $10.3595 8.58 40,200 $10.4200
$11.165 - 12.070 188,500 $11.4640 8.56 55,000 $12.0191
$12.210 - 13.290 44,500 $12.2585 7.17 18,000 $12.2700
$13.445 - 13.445 182,000 $13.4450 7.36 71,600 $13.4450
$13.750 - 16.630 35,500 $15.2551 7.12 19,000 $15.1700
--------- --------
1,671,958 $9.4181 7.97 492,861 $9.2265
========= ========
44
As of December 31, 2004, the Company continues to account for its stock-based
compensation plans 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 Company has provided the additional disclosures specified in SFAS No. 123 as
amended by SFAS No. 148 (see Note 1).
The weighted average fair value at the date of grant for options granted during
2004, 2003 and 2002 was $5.95, $5.80, and $9.40 per option, respectively.
17. COMMITMENTS AND CONTINGENCIES
Operating Leases. The Company leases office space, equipment, distribution,
manufacturing and storage facilities under non-cancelable operating leases with
various expiration dates through December 2009. Rental expense for the years
ended December 2004, 2003 and 2002 totaled $3.2 million, $3.2 million, and $2.4
million, respectively.
As of December 31, 2004, future minimum rental payments required under
non-cancelable operating leases are as follows (in thousands):
Year Ending
December 31, Total
------------- -------
2005 $ 2,376
2006 1,259
2007 1,027
2008 539
2009 237
Thereafter -
-------
$ 5,438
=======
Interest on Contractual Obligations. As of December 31, 2004, the Company has a
$40.25 million note outstanding at a fixed rate of 6.25%. In addition it has
industrial revenue bonds in the amount of $4.0 million and a swap agreement in
the amount of $2.0 million, both of which have variable interest rates and
decreasing principal balances until maturity. Future interest on contractual
obligations is as follows (in thousands):
Year Ending
December 31, Total
------------- -------
2005 $ 2,637
2006 2,602
2007 2,590
2008 2,579
2009 2,567
Thereafter 3,359
-------
$16,334
=======
Purchase Obligations. 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.
Legal Matters. The Company is party to certain legal actions and inquiries for
environmental and other matters resulting from the normal course of business.
Some of our businesses, especially Institutional Security Systems, involve
working as a subcontractor to a prime contractor. From time to time we make
claims against the prime contractor, or the prime contractor makes claims
against us. At any point in time we are engaged in a number of claim disputes
with prime contractors, some of which may have a significant negative outcome.
Although the total amount of potential liability with respect to these matters
can not be ascertained, the Company believes that any resulting liability should
not have a material effect on its financial position, results of future
operations or cash flows.
45
In addition to claims with prime contractors, we may also make claims against
customers and customers may make claims against us.
The Company has learned that the National Association of Securities Dealers
("NASD") is seeking sanctions against purchasers of the Company's common stock
in its 2001 PIPE transaction. In addition, the Company has learned that the
placement agent for this transaction is also being investigated by the SEC and
the NASD. The Company is investigating these matters and is evaluating its
options for recovery.
The Company's Public Safety and Justice segment settled certain litigation with
one of its clients during June 2004. As a result of the settlement agreement,
the Company refunded $350 thousand to this client in exchange for the return of
the hardware and other products previously delivered to this client.
Over the past several years, the Company has been named in lawsuits involving
asbestos related personal injury and death claims in which CompuDyne
Corporation, individually and as an alleged successor, is a defendant. The
Company has been named as a defendant in cases related to claims for asbestos
exposure allegedly due to asbestos contained in certain of its predecessor's
products. The Company has advised its insurers of each of these cases, and the
insurers are providing a defense pursuant to agreement with the Company, subject
to reservation of rights by the insurers. The insurers have advised that claims
in such litigation for punitive damages, exemplary damages, malicious and
willful and wanton behavior and intentional conduct are not covered. One of the
carriers has given notice that asbestos related claims are excluded from certain
of these policies. The insurers have additional coverage defenses, which are
reserved, including that claims may fall outside of a particular policy period
of coverage. Litigation costs to date have not been significant and the Company
has not paid any settlements from its own funds.
The Company cannot ascertain the total amount of potential liability with
respect to these legal matters, but does not believe that any such potential
liability should have a material effect on its financial position, future
operations or future cash flows.
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
and beyond. 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. The interest rate environment earlier this year was 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 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 line, it intends to keep this
line available at least to provide the required collateral for its industrial
revenue bond borrowings.
18. RELATED PARTY TRANSACTION
During 2004 the Company's Federal Security Systems unit recorded revenue of
approximately $200 thousand from a company of which one of CompuDyne's Directors
is a senior vice president and member of its board of directors. Included in
accounts receivable and costs in excess of billings of the Federal Security
Systems unit at December 31, 2004 was approximately $29 thousand and $171
thousand, respectively, related to the company at which this Director is
employed.
19. EMPLOYEE BENEFIT PLANS
The Company established a non-qualified Employee Stock Purchase Plan in October
1999, the terms of which allow for qualified employees (as defined) to
participate in the purchase of shares of the Company's common stock. The Company
matches at a rate of 15% of the employee purchase at the market value of the
common stock for the monthly purchase period. The Company purchases stock on the
open market and distributes the shares monthly to employees' individual
accounts. Expense for matching contributions to the plan was $33 thousand, $34
thousand, and $41 thousand for 2004, 2003, and 2002 respectively.
46
The Company has 401(k) retirement savings plans covering all employees. All
employees are eligible to participate in a plan after completing one year of
service (as defined by the plan). Participants may make before tax contributions
subject to Internal Revenue Service limitations. CompuDyne currently matches up
to 2.5% of employee contributions up to a maximum of 5% of annual earnings.
Expense for matching contributions to the Plan was $694 thousand, $712 thousand
and $609 thousand for 2004, 2003, and 2002, respectively.
The Company had a money purchase pension plan that covered all employees at one
of the Company's divisions. All employees at this division were eligible to
participate in the plan after one year of service. The Company made annual
contributions of 3% to 5% based on years of service. Expense related to this
plan was $0 thousand in 2004 and 2003, and $507 thousand in 2002. Effective
December 31, 2002, the Company ceased contributions to this plan. The balance in
this plan was 100% vested and the plan was then terminated giving participants
three distribution options, rollover to their 401K plan, a cash distribution, or
an annuity purchase.
20. OPERATING SEGMENT INFORMATION
Segment information has been prepared in accordance with the Statement of
Financial Accounting Standards (SFAS) No. 131, "Disclosure about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 defines
"operating segments" to be those components of a business about which separate
financial information is available that is regularly evaluated by management in
deciding how to allocate resources and in assessing performance. SFAS No. 131
further requires that the segment information presented be consistent with the
basis and manner in which management internally desegregates financial
information for the purpose of assisting in making internal operating decisions.
The following segment information includes operating information for CompuDyne's
four operating segments, Institutional Security Systems, Attack Protection,
Federal Security Systems and Public Safety and Justice in addition to Corporate
activities for each of the years ended December 31, 2004, 2003 and 2002. Also
included is operating information from Tiburon, Inc. (Public Safety and Justice
segment) since its date of acquisition, May 2, 2002.
Revenues Gross Profit
-------- ------------
(in thousands) 2004 2003 2002 2004 2003 2002
----------- ----------- ----------- ---------- ----------- ---------
Institutional Security Systems $ 53,952 $ 98,653 $ 84,182 $ 6,437 $14,203 $11,384
Attack Protection 25,161 28,375 28,357 1,551 5,694 4,618
Federal Security Systems 14,293 16,441 13,374 2,019 2,606 2,372
Public Safety and Justice 49,376 49,794 29,643 27,671 23,893 16,442
CompuDyne Corporate - - - - - -
----------- ----------- ----------- ---------- ---------- ---------
$ 142,782 $ 193,263 $ 155,556 $ 37,678 $46,396 $34,816
=========== =========== =========== ========== ========== =========
Total Assets, at Year End Pre-tax Income (Loss)
------------------------- ---------------------
2004 2003 2002 2004 2003 2002
----------- ----------- ----------- ---------- ----------- ---------
Institutional Security Systems $ 26,895 $ 34,343 $ 37,881 $ (5,174) $ 3,613 $ 1,867
Attack Protection 15,760 21,202 21,156 (5,444) 551 (706)
Federal Security Systems 3,807 6,076 6,234 563 953 827
Public Safety and Justice 56,538 49,439 52,561 2,364 407 444
CompuDyne Corporate 29,891 4,672 2,972 (2,739) 232 408
----------- ----------- ----------- ---------- ----------- ---------
$ 132,891 $ 115,732 $ 120,804 $(10,430) $ 5,756 $ 2,840
=========== =========== =========== ========== ========== =========
Capital Expenditures Depreciation and Amortization
-------------------- -----------------------------
2004 2003 2002 2004 2003 2002
----------- ----------- ----------- ---------- ----------- ---------
Institutional Security Systems $ 411 $ 312 $ 119 $ 531 $ 330 $ 562
Attack Protection 64 215 2,580 644 885 622
Federal Security Systems 16 72 - 41 68 70
Public Safety and Justice 1,140 451 396 1,664 1,679 1,573
CompuDyne Corporate 153 18 55 41 26 20
$ 1,784 $ 1,068 $ 3,150 $ 2,921 $ 2,988 $ 2,847
=========== =========== =========== ========== ========== =========
Included in the 2004 results is a $739 thousand pre-tax charge to record the
impairment of the Institutional Security Systems segment's goodwill and a $1.1
million charge to record the impairment of certain of the Institutional Security
Systems segment's other intangible assets. In addition, the continuing problems
in the West Coast office of ISS resulted in the Company recording additional
losses of $6.1 million from the work performed in this office and an additional
$2.0 milion was added to a project's estimated cost to complete. Also included
in 2004's results are charges of $411 thousand for terminated deal costs related
to unconsummated acquisitions, and $2.6 million of interest expense incurred in
connection with the 2011 Notes issued in January 2004; these expenses were
recorded in CompuDyne Corporate's accounts.
47
Included in the 2003 results is a $1.6 million pre-tax charge for a contract in
litigation, which occurred in the Public Safety and Justice segment. During the
second quarter of 2004 this matter was settled resulting in a reversal of $0.3
million of the accrued charge, which was reflected as a reduction of its cost of
sales.
During 2003, the Company increased its allowance for doubtful accounts by
approximately $725 thousand in its Institutional Security Systems segment for
past due receivables. Pre-tax income in the Attack Protection segment benefited
by approximately $900 thousand from a successful arbitration decision related to
a disputed customer receivable.
During 2002, the West Coast operations of the Institutional Security Systems
segment experienced significant cost overruns on many of its projects. These
cost overruns were incurred and recorded during the latter half of the year and
amounted to approximately $2.2 million. As a result, as these projects were
brought to completion in 2003, the revenues generated by them resulted in little
margin or in some cases losses. The Company recorded $3.0 million of additional
write-downs on its West Coast projects that were either completed or neared
completion in 2003. In 2004, the West Coast operations generated pre-tax losses
of $6.1 million.
21. SELECTED QUARTERLY FINANCIAL DATA (Unaudited)
First Second Third Fourth
(In thousands, except per share data) Quarter Quarter Quarter Quarter Total
- ------------------------------------- --------- --------- --------- --------- ---------
Year Ended December 31, 2004
Revenues
Institutional Security Systems $16,057 $13,954 $ 11,783 $12,158 $ 53,952
Attack Protection 6,953 6,741 6,510 4,957 25,161
Federal Security Systems 3,575 4,371 3,296 3,051 14,293
Public Safety and Justice 12,442 12,717 11,771 12,446 49,376
--------- --------- --------- --------- ---------
Total revenues $39,027 $37,783 $ 33,360 $32,612 $142,782
Gross Profit
Institutional Security Systems $ 2,505 $ 2,244 $ 1,773 $ (85) $ 6,437
Attack Protection 919 1,082 (477) 27 1,551
Federal Security Systems 490 611 501 417 2,019
Public Safety and Justice 6,284 7,210 7,011 7,166 27,671
--------- --------- --------- --------- ---------
Total gross profit $10,198 $11,147 $ 8,808 $ 7,525 $ 37,678
Pre-tax Income (loss)
Institutional Security Systems $ 207 $ (84) $ (806) $(4,491) $ (5,174)
Attack Protection (679) (456) (2,101) (2,208) (5,444)
Federal Security Systems 200 214 137 12 563
Public Safety and Justice 435 960 370 599 2,364
Unallocated corporate expense (674) (481) (671) (913) (2,739)
--------- --------- --------- --------- ---------
Pre-tax income from operations $ (511) $ 153 $ (3,071) $(7,001) $(10,430)
Net income $ (307) $ 90 $ (1,850) $(6,131) $ (8,198)
--------- --------- --------- --------- ---------
Basic earnings per share $ (.04) $ .01 $ (.23) $ (.74) $ (1.01)
--------- --------- --------- --------- ---------
Diluted earnings per share $ (.04) $ .01 $ (.23) $ (.74) $ (1.01)
--------- --------- --------- --------- ---------
48
First Second Third Fourth
(In thousands, except per share data) Quarter Quarter Quarter Quarter Total
- ------------------------------------- --------- --------- --------- --------- ---------
Year Ended December 31, 2003
Revenues
Institutional Security Systems $23,448 $25,692 $26,357 $23,156 $ 98,653
Attack Protection 8,343 6,533 6,036 7,463 28,375
Federal Security Systems 3,489 4,261 4,549 4,142 16,441
Public Safety and Justice 11,487 11,052 16,194 11,061 49,794
--------- --------- --------- --------- ---------
Total revenues $46,767 $47,538 $53,136 $45,822 $193,263
Gross Profit
Institutional Security Systems $ 3,277 $ 3,240 $ 3,729 $ 3,957 $14,203
Attack Protection 1,975 1,380 758 1,581 5,694
Federal Security Systems 522 603 934 547 2,606
Public Safety and Justice 6,009 6,564 6,590 4,730 23,893
--------- --------- --------- --------- ---------
Total gross profit $11,783 $11,787 $12,011 $10,815 $ 46,396
Pre-tax Income (loss)
Institutional Security Systems $ 737 $ 835 $ 1,216 $ 825 $ 3,613
Attack Protection 562 (52) (663) 704 551
Federal Security Systems 207 296 223 227 953
Public Safety and Justice 68 482 790 (933) 407
Unallocated corporate expense (2) 166 70 (2) 232
--------- --------- --------- --------- ---------
Pre-tax income from operations $ 1,572 $ 1,727 $ 1,636 $ 821 $ 5,756
--------- --------- --------- --------- ---------
Net income $ 942 $ 1,037 $ 982 $ 447 $ 3,408
--------- --------- --------- --------- ---------
Basic earnings per share $ .12 $ .13 $ .12 $ .06 $ .43
--------- --------- --------- --------- ---------
Diluted earnings per share $ .12 $ .13 $ .12 $ .05 $ .42
--------- --------- --------- --------- ---------
Included in the results of the fourth quarter of 2004 is a $739 thousand pre-tax
charge to record the impairment of the Institutional Security Systems segment's
goodwill and a $1.1 million charge to record the impairment of certain of the
Institutional Security Systems segment's other intangible assets. In addition,
the continuing problems in the West Coast office of ISS resulted in the Company
recording additional losses of $2.2 million from the work performed in this
office.
Included in the results of the fourth quarter of 2003 is a $1.6 million pre-tax
charge for a contract in litigation, which occurred in the Public Safety and
Justice segment. During the second quarter of 2004 this matter was settled
resulting in a reversal of $0.3 million of the accrued charge, which was
reflected as a reduction of its cost of sales.
In the fourth quarter of 2003, the Company increased its allowance for doubtful
accounts by approximately $725 thousand in its Institutional Security Systems
segment for past due receivables. Pre-tax income in the Attack Protection
segment benefited by approximately $900 thousand from a successful arbitration
decision related to a disputed customer receivable.
49
During 2002, the West Coast operations of the Institutional Security Systems
segment experienced significant cost overruns on many of its projects. These
cost overruns were incurred and recorded during the latter half of the year and
amounted to approximately $2.2 million. As a result, as these projects were
brought to completion in 2003, the revenues generated by them resulted in little
margin or in some cases losses. The Company recorded $3.0 million of additional
write-downs on its West Coast projects that were either completed or neared
completion in 2003. In 2004, the West Coast operations generated pre-tax losses
of $6.1 million.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's periodic
Securities Exchange Act reports is recorded, processed, summarized, and reported
within the time periods specified in the SEC's rules and forms, and that such
information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required financial disclosure.
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of Company
management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to the Securities Exchange Act of 1934
("Exchange Act") Rules 13a-15(e) and 15d-15(e). Based upon, and as of the date
of this evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures were not
effective because of the material weaknesses discussed below. To address these
material weaknesses, the Company performed additional analysis and other
post-closing procedures to ensure that the consolidated financial statements
were prepared in accordance with generally accepted accounting principles.
Accordingly, management believes that the financial statements included in this
report fairly present in all material respects the Company's financial
condition, results of operations and cash flows for the periods presented.
Status of Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. The Company's internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions or
that the degree of compliance with established policies or procedures may
deteriorate.
Management is in the process of conducting an evaluation of the Company's
internal control over financial reporting as of December 31, 2004. In making its
assessment of internal control over financial reporting, management is using the
criteria described in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
Management has determined that, as of December 31, 2004, the Company did not
maintain effective controls over the accounting for income taxes, including the
determination of income taxes payable, deferred income tax assets and
liabilities and the related income tax provision. Specifically, the Company did
not have effective controls over the reconciliation of the difference between
the tax basis and the financial reporting basis of the Company's assets and
liabilities with the deferred income tax assets and liabilities. Additionally,
there was a lack of oversight and review over the income taxes payable, deferred
income tax assets and liabilities and the related income tax provision accounts
by accounting personnel with appropriate financial reporting expertise. This
control deficiency resulted in an audit adjustment to the fourth quarter 2004
financial statements. Additionally, this control deficiency could result in a
misstatement of income taxes payable, deferred income tax assets and liabilities
and the related income tax provision that would result in a material
misstatement to annual or interim financial statements that would not be
prevented or detected. Accordingly, management has determined that this control
deficiency constitutes a material weakness.
Management has further determined that, as of December 31, 2004, the Company did
not maintain effective control over the accounting for and review of
significant, non-routine transactions. Specifically, the Company did not have
effective controls over the accounting for a non-routine change order to a
customer contract to ensure that the accounting for the change order was in
accordance with generally accepted accounting principles. This transaction
impacted contract revenues, contract costs in excess of billings and accounts
receivables. This control deficiency resulted in an audit adjustment to the
fourth quarter 2004 financial statements. Additionally, this control deficiency
could result in a misstatement of contract revenues, contract costs in excess of
billings and accounts receivables that would result in a material misstatement
to annual or interim financial statements that would not be prevented or
detected. Accordingly, management has determined that this control deficiency
constitutes a material weakness.
The existence of one or more material weaknesses as of December 31, 2004 would
preclude a conclusion that the Company's internal control over financial
reporting was effective as of that date. Upon completion of our assessment,
management expects to conclude that the Company did not maintain effective
internal control over financial reporting as of December 31, 2004, based on
criteria in Internal Controls--Integrated Framework.
The Company's evaluation of its internal control over financial reporting as of
December 31, 2004 is not complete. Further, there can be no assurance that as a
result of the ongoing evaluation of internal control over financial reporting,
additional deficiencies will not be identified or that any such deficiencies
identified, either alone or in combination with others, will not be considered a
material weakness.
50
Securities and Exchange Commission Release No. 34-50754, subject to certain
conditions, provides up to 45 additional days beyond the due date of this Annual
Report on Form 10-K for the filing of management's annual report on internal
control over financial reporting required by Item 308(a) of Regulation S-K and
the related attestation report of the independent registered public accounting
firm required by Item 308(b) of Regulation S-K. Pursuant to the Release,
management's report on internal control over financial reporting and the
associated report on the audit of management's assessment of the effectiveness
of the Company's internal control over financial reporting as of December 31,
2004 are not filed herein and are expected to be filed no later than May 2, 2005
with an amendment to this Annual Report on Form 10-K.
The Company expects that the material weaknesses identified above will result in
an adverse opinion by the Company's independent registered public accounting
firm on the effectiveness of the Company's internal control over financial
reporting as of December 31, 2004.
Changes in Internal Control Over Financial Reporting
Except as otherwise discussed herein, there has been no change in the Company's
internal control over financial reporting that occurred during the fourth
quarter that has materially affected, or is reasonably likely to materially
affect, such internal control over financial reporting.
To address the material weaknesses described above, the Company has: (1) engaged
an outside tax consultant, other than from the Company's independent registered
public accounting firm, and intends to implement an ongoing training program to
enhance the capabilities of its internal tax personnel, and (2) instituted new
procedures requiring the accounting for all significant, non-routine
transactions to be approved by the Corporate Accounting group.
51
PART III
Information required by Items 10, 11, 12, 13 and 14 about CompuDyne is
incorporated herein by reference from the definitive proxy statement of
CompuDyne to be filed with the SEC within 120 days following the end of the
fiscal year ended December 31, 2004.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements
(1) Index to Financial Statements
Report of Independent
Registered Public Accounting Firm - PricewaterhouseCoopers LLP
Report of Independent Registered Public
Accounting Firm - Deloitte & Touche LLP
Consolidated Balance Sheets at December 31, 2004 and 2003
Consolidated Statements of Operations for the
years ended December 31, 2004, 2003 and 2002
Consolidated Statement of Changes in Shareholders' Equity
for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years
ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(2) Schedule II - Schedule of valuation and qualifying accounts
(b) Exhibits
The Exhibits listed on the index below are filed as a part of this Annual
Report.
52
SCHEDULE II
COMPUDYNE CORPORATION AND SUBSIDIARIES
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2004, 2003, and 2002
($ in thousands)
Balance at Charged to Balance
Beginning Costs and At End
Description Of Period Expenses Deduction Of Period
- ----------- --------- -------- --------- ---------
Year Ended December 31, 2004
Reserve and allowances deducted from asset accounts:
Reserve for excess and slow moving inventory $ 840 649 (127) $ 1,362
Reserve for accounts receivable $ 1,252 1,153 (486) $ 1,919
Deferred tax asset valuation allowance $ - 1,858 - $ 1,858
Year Ended December 31, 2003
Reserve and allowances deducted from asset accounts:
Reserve for excess and slow moving inventory $ 642 367 (169) $ 840
Reserve for accounts receivable $ 1,173 996 (917) $ 1,252
Year Ended December 31, 2002
Reserve and allowances deducted from asset accounts:
Reserve for excess and slow moving inventory $ 385 257 - $ 642
Reserve for accounts receivable $ 1,094 79 - $ 1,173
Deferred tax asset valuation allowance $ 329 - (329) $ _
53
COMPUDYNE CORPORATION
INDEX TO EXHIBITS
(Item 15(b))
2(A). Agreement and Plan of Merger dated as of May 10, 2001 by and among
CompuDyne Corporation, Tiburon, Inc. and New Tiburon, Inc., herein
incorporated by reference to Exhibit 2(c) of Registrant's Quarterly
Report on Form 10-Q filed May 15, 2001.
2(B). First Amendment to Agreement and Plan of Merger dated as of January
25, 2002 by and among CompuDyne Corporation, Tiburon, Inc. and New
Tiburon, Inc., herein incorporated by reference to Exhibit 2(B) of
Registrant's Registration Statement on Form S-4 dated March 25, 2002.
3(A). Articles of Incorporation of CompuDyne Corporation filed with the
Secretary of State of the State of Nevada on May 8, 1996, herein
incorporated by reference to Registrant's Proxy Statement dated May
13, 1996 for its 1996 Annual Meeting of Shareholders.
3(B). Amendment to the Articles of Incorporation of CompuDyne Corporation
increasing the number of authorized common shares filed with the
Secretary of the State of Nevada on February 16, 2001, herein
incorporated by reference to Exhibit 3(B) to the Registrant's 10-K
filed March 27, 2001.
3(C). Agreement and Plan of Merger dated May 8, 1996, herein incorporated by
reference to Exhibit 3(B) to Registrant's 10-K filed March 31, 1997.
3(D). By-Laws, as amended through January 28, 1997 and as presently in
effect, herein incorporated by reference to Exhibit 3(C) to
Registrant's 10-K filed March 31, 1997.
10(A). CompuDyne Corporation 1996 Stock Incentive Compensation Plan for
Employees, herein incorporated by reference to Registrant's Proxy
Statement dated July 17, 2001 for its 2001 Annual Meeting of
Shareholders.
10(B). Credit Agreement dated November 16, 2001 by and among CompuDyne
Corporation, its subsidiaries, certain participating lenders and PNC
Bank, National Association in its capacity as agent for the lenders,
herein incorporated by reference to Exhibit 10 (b) to Registrant's 8-K
filed November 21, 2001.
10(C)(1). Amended and Restated Credit Agreement dated March 31, 2004 by and
among CompuDyne Corporation and its subsidiaries, certain
participating lenders and PNC Bank, National Association, in its
capacity as agent for the lenders, herein incorporated by reference to
Exhibit 3.1 to Registrant's 10-Q filed May 7, 2004.
10(C)(2). Amendment to Amended and Restated Credit Agreement dated October 29,
2004 by and among CompuDyne Corporation, its subsidiaries, certain
participating lenders and PNC Bank, National Association in its
capacity as agent for the lenders, herein incorporated by reference to
Exhibit 10.1 to Registrant's 8-K filed on November 1, 2004.
10(C)(3). Employment Agreement between CompuDyne Corporation and Mr. Daniel
Crawford herein incorporated by reference, filed on Form 8-K, October
27, 2004.
10(C)(4). Transition Agreement by and among CompuDyne Corporation, Norment
Security Group, Inc., and Mr. Jon Lucynski herein incorporated by
reference, filed on Form 8-K, January 26, 2005.
10(C)(5). Report regarding Mr. Bruce Kelling's resignation from the Board of
Directors herein incorporated by reference, filed on Form 8-K,
February 10, 2005.
10(C)(6). Current report on Form 8-K disclosing the death of Director Millard
Pryor filed on March 2, 2005.
10(C)(7). Second Amendment to Amended and Restated Credit Agreement and
Amendment to Securities Pledge Agreement dated March 4, 2005 by and
among CompuDyne Corporation, its subsidiaries, certain participating
lenders and PNC Bank, National Association in its capacity as agent
for the lenders, herein incorporated by referenced to Exhibit 10.1 to
registrant's 8-K filed on March 7, 2005.
54
10(D). 1996 Stock Non-Employee Director Plan, herein incorporated by
reference to Registrant's Proxy Statement dated April 18, 1997 for its
1997 Annual Meeting of Shareholders.
10(E). Stock Option Agreement dated August 21, 1995 by and between Martin A.
Roenigk and CompuDyne Corporation, herein incorporated by reference to
Exhibit (4.5) to Registrant's Form 8-K filed September 5, 1995.
10.3* Compensatory Arrangements.
21.* Subsidiaries of the Registrant.
23.1* Consent of Independent Registered Public Accounting Firm -
PricewaterhouseCoopers LLP.
23.2* Consent of Independent Registered Public Accounting Firm - Deloitte &
Touche LLP.
31.1* Certification of Chief Executive Officer pursuant to Rule 13(a)-14(a)
or 15(d)-14(a).
31.2* Certification of Chief Financial Officer pursuant to Rule 13(a)-14(a)
or 15(d)-14(a).
32.1* Certification Pursuant To 18 U.S.C. Section 1350 As Adopted Pursuant
To Section 906 of The Sarbanes-Oxley Act Of 2002, for Mr. Martin
Roenigk.
32.2* Certification Pursuant To 18 U.S.C. Section 1350 As Adopted Pursuant
To Section 906 of The Sarbanes-Oxley Act Of 2002, for Mr. Geoffrey F.
Feidelberg.
* Filed herewith.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMPUDYNE CORPORATION
(Registrant)
By:/s/ Martin Roenigk
----------------------------
Martin Roenigk
Chief Executive Officer
By:/s/ Geoffrey F. Feidelberg
----------------------------
Geoffrey F. Feidelberg
Dated: March 31, 2005 Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities indicated on March 31, 2005.
/s/ Martin A. Roenigk Director, Chairman, President /s/ David W. Clark, Jr. Director
- ------------------------ and Chief Executive Officer --------------------------
Martin A. Roenigk David W. Clark, Jr.
/s/ John H. Gutfreund Director /s/ Ronald J. Angelone Director
- ---------------------- -----------------------
John H. Gutfreund Ronald J. Angelone
/s/ Philip M. Blackmon Director and /s/ Wade B. Houk Director
- ------------------------ Executive Vice-President ------------------
Philip M. Blackmon Wade B. Houk
/s/ Geoffrey F. Feidelberg Director and /s/ John Michael McConnell Director
- --------------------------- Chief Financial Officer --------------------------
Geoffrey F. Feidelberg John Michael McConnell
56