UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
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, Suite 201, Annapolis, Maryland 21401
(Address of principal executive offices)
Registrant's telephone number, including area code: (410) 224-4415
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____ No __X__
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in rule 12b-2 of the Exchange Act)
Yes__X__ No_____
As of May 6, 2005, a total of 8,119,979 shares of Common Stock, $.75 par value,
were outstanding.
1
33
COMPUDYNE CORPORATION AND SUBSIDIARIES
INDEX
PAGE NO.
Part I. Financial Information
Item 1. Financial Statements - Unaudited
Consolidated Balance Sheets - March 31, 2005
and December 31, 2004 3
Consolidated Statements of Operations -
Three Months Ended March 31, 2005 and 2004 4
Consolidated Statement of Changes in
Shareholders' Equity - Three Months Ended
March 31, 2005 5
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2005 and 2004 6
Notes to Consolidated Financial Statements 7-14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15-26
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 27
Item 4. Controls and Procedures 28-29
Part II. Other Information 30
Signature 31
2
ITEM 1. FINANCIAL STATEMENTS
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31, December 31,
ASSETS 2005 2004
-------- ---------
(dollars in thousands)
Current Assets
Cash and cash equivalents $ 4,183 $ 5,198
Marketable securities 10,769 19,577
Cash and marketable securities - pledged 489 --
Accounts receivable, net 33,325 34,291
Contract costs in excess of billings 15,060 16,087
Inventories 4,894 5,165
Prepaid expenses and other 5,014 5,412
--------- ---------
Total Current Assets 73,734 85,730
Cash and marketable securities - pledged 5,510 --
Property, plant and equipment, net 11,689 12,094
Goodwill 25,913 25,894
Other intangible assets, net 8,352 8,460
Other 901 713
--------- ---------
Total Assets $ 126,099 $ 132,891
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued liabilities $ 16,605 $ 21,771
Billings in excess of contract costs incurred 12,276 13,497
Deferred revenue 6,693 5,998
Current portion of notes payable 440 440
--------- ---------
Total Current Liabilities 36,014 41,706
Notes payable 3,565 3,565
Convertible subordinated notes payable, net 39,165 39,118
Deferred tax liabilities 2,072 2,072
Other 514 599
--------- ---------
Total Liabilities 81,330 87,060
--------- ---------
Commitments and Contingencies
Shareholders' Equity
Preferred stock, 2,000,000 shares authorized and unissued -- --
Common stock, par value $.75 per share: 50,000,000 shares
authorized at March 31, 2005 and December 31, 2004;
8,943,856 shares issued at March 31, 2005 and
December 31, 2004 6,707 6,707
Additional paid-in-capital 44,368 44,368
Accumulated deficit (591) (272)
Accumulated other comprehensive (loss) income (99) 14
Treasury stock, at cost; 820,377 and 721,077 shares
at March 31, 2005 and December 31, 2004, respectively (5,616) (4,986)
--------- ---------
Total Shareholders' Equity 44,769 45,831
--------- ---------
Total Liabilities and Shareholders' Equity $ 126,099 $ 132,891
========= =========
The accompanying notes are an integral part of these financial statements.
3
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended March 31,
2005 2004
-------- ---------
(in thousands, except per share data)
Revenues:
Contract revenues earned $ 32,478 $ 36,436
Other revenues 3,828 2,591
-------- --------
Total revenues 36,306 39,027
Cost of sales 23,923 28,829
-------- --------
Gross profit 12,383 10,198
Selling, general and administrative expenses 10,027 8,162
Research and development 2,111 1,755
-------- --------
Income from operations 245 281
-------- --------
Other expense (income)
Interest expense 803 749
Interest income (228) (78)
Other expense (income) (11) 121
-------- --------
Total other expense 564 792
-------- --------
(Loss) before income taxes (319) (511)
Income taxes expense (benefit) - (204)
-------- --------
Net loss $ (319) $ (307)
======== ========
(LOSS) PER SHARE:
Basic (loss) per common share $ (.04) $ (.04)
======== ========
Weighted average number of common
shares outstanding 8,163 8,009
======== ========
Diluted (loss) per common share $ (.04) $ (.04)
======== ========
Weighted average number of common
shares and equivalents 8,163 8,009
======== ========
The accompanying notes are an integral part of these financial statements.
4
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited)
(in thousands)
Accumulated
Other
Additional Comprehensive
Common Stock Paid-in Accumulated Income Treasury Stock
Shares Amount Capital Deficit (Loss) Shares Amount Total
--------------- ------- ------ ---------- ------ --------- ---------
Balance at December 31, 2004 8,944 $6,707 $44,368 $ (272) $ 14 721 $ (4,986) $ 45,831
Purchase of treasury shares 99 (630) (630)
-----------------------------------------------------------------------------------
Subtotal 8,944 6,707 44,368 (272) 14 820 (5,616) 45,201
Comprehensive income:
Net (loss) (319) (319)
Other comprehensive
income, net of tax:
Unrealized (loss) on
available for
sale marketable securities (113) (113)
---------
Comprehensive (loss) (432)
-----------------------------------------------------------------------------------
Balance at March 31, 2005 8,944 $6,707 $44,368 $ (591) $ (99) 820 $ (5,616) $ 44,769
======= ====== ======= ====== ========== ====== ========= =========
The accompanying notes are an integral part of these financial statements.
5
COMPUDYNE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31,
2005 2004
--------- ----------
(in thousands)
Cash flows from operating activities:
Net (loss) $ (319) $ (307)
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization 877 704
(Gain) from disposal of property, plant and equipment (3) (1)
Amortization of debt discount 47 36
Unrealized loss on interest rate swap -- 126
Amortization of discount on marketable securities 5 --
Changes in assets and liabilities:
Accounts receivable 966 539
Contract costs in excess of billings 1,027 2,801
Inventories 271 830
Prepaid expenses and other current assets 471 463
Other assets (188) 150
Accounts payable and accrued liabilities (5,166) (3,975)
Billings in excess of contract costs incurred (1,221) (2,460)
Deferred revenue 695 (576)
Other liabilities (85) --
-------- --------
Net cash flows used in operating activities (2,623) (1,670)
-------- --------
Cash flows from investing activities:
Purchase of marketable securities (3,739) (22,212)
Redemption of marketable securities 6,650 --
Additions to property, plant and equipment (364) (167)
Proceeds from sale of property, plant and equipment 3 1
Net payment for acquisition (18) --
-------- --------
Net cash flows provided by (used in) investing activities 2,532 (22,378)
-------- --------
Cash flows from financing activities:
Issuance of common stock -- 252
Purchase of treasury shares (630) --
Restricted cash (294) --
Repayment of bank notes and line of credit -- (13,213)
Borrowings of convertible subordinated notes payable -- 38,942
-------- --------
Net cash (used in) provided by financing activities (924) 25,981
-------- --------
Net change in cash and cash equivalents (1,015) 1,933
Cash and cash equivalents at beginning of period 5,198 1,869
-------- --------
Cash and cash equivalents at end of period $ 4,183 $ 3,802
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 1,296 $ 135
State income tax, net of refunds $ 204 $ 187
Federal tax refund $ (766) $ --
The accompanying notes are an integral part of these financial statements.
6
COMPUDYNE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation:
The accompanying unaudited consolidated financial statements of CompuDyne
Corporation and its subsidiaries (the "Company") have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission. The
consolidated balance sheet as of December 31, 2004 has been derived from the
Company's December 31, 2004 audited financial statements. Certain information
and note disclosures included in the annual financial statements, prepared in
accordance with accounting principles generally accepted in the United States of
America, have been condensed or omitted pursuant to those rules and regulations,
although the Company believes that the disclosures made in this Form 10-Q are
adequate to make the information presented not misleading.
In the opinion of management, the accompanying unaudited consolidated financial
statements reflect all necessary adjustments and reclassifications (all of which
are of a normal, recurring nature, unless otherwise disclosed) that are
necessary for the fair presentation of the periods presented. It is suggested
that these consolidated unaudited financial statements be read in conjunction
with the consolidated financial statements and the notes thereto included in the
Company's annual report filed with the Securities and Exchange Commission on
Form 10-K for the year ended December 31, 2004. Operating results for the three
month periods ended March 31, 2005 and 2004 are not necessarily indicative of
operating results for the entire fiscal year.
STOCK-BASED COMPENSATION
As of March 31, 2005, 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 the results of operations, 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 (loss) and
earnings (loss) per share if the Company had applied the fair value recognition
provisions of SFAS No. 123(R), "Accounting for Stock-Based Compensation," to
stock-based employee compensation.
For the Three Months Ended March 31,
2005 2004
------------ ------------
(in thousands, except per share data)
Net (loss), as reported $ (319) $ (307)
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects (234) (249)
-------- ------------
Pro forma net (loss) $ (553) $ (556)
======== ========
(Loss) per share:
Basic - as reported $ (.04) $ (.04)
Basic - pro forma $ (.07) $ (.07)
Diluted - as reported $ (.04) $ (.04)
Diluted - pro forma $ (.07) $ (.07)
The fair value of the Company's stock-based option awards to employees was
estimated using the Black-Scholes model assuming no expected dividends and the
following weighted-average assumptions:
For the Three Months Ended
March 31,
2005 2004
------ -----
Expected life in years 5.3 5.5
Risk-free interest rate 4.2% 2.8%
Expected volatility 82.8% 76.6%
7
INCOME TAXES
The effective tax rate was zero for the three months ended March 31, 2005 and
the effective tax rate was approximately 39.9% for the three months ended March
31, 2004. The Company has decided to fully reserve its net deferred tax assets,
as it has determined it is not more likely than not that the asset will be
realized due to the Company's recent operating losses.
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.
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 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 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 123R. The Company is evaluating the alternatives
allowed under the standard, which the Company is required to adopt beginning in
the first quarter of 2006.
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.
Reclassifications - Certain prior year amounts have been reclassified to conform
with the current year's presentation.
2. 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, warrants, or convertible
securities. Diluted earnings per share is computed using the weighted average
number of common and common stock equivalent shares outstanding during the
period; common stock equivalent shares are excluded from the computation if
their effect is antidilutive. Stock options and warrants to purchase 1,442,533
shares for 2005 and 1,361,427 shares for 2004 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 both 2005 and 2004 as the effect is antidilutive.
8
The computations of the Company's basic and diluted earnings per common share
amounts were as follows:
Three Months Ended
March 31,
2005 2004
-------------------------------------
(in thousands, except per share data)
Net (loss) $ (319) $ (307)
========= =========
Weighted average common shares outstanding 8,163 8,009
Effect of dilutive stock options and warrants - -
--------- ---------
Diluted weighted average common shares outstanding 8,163 8,009
========= =========
Net (loss) per common share
Basic $ (.04) $ (.04)
Diluted $ (.04) $ (.04)
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. 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 ("participation rights")
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 three months ended March 31, 2005 or March 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.
3. INVESTMENTS IN MARKETABLE SECURITIES
The Company's marketable securities are categorized as available-for-sale
securities, as defined by SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." At March 31, 2005 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
cost for marketable securities was determined using the specific identification
method and adjusted for accretion of discounts from the date of purchase to
maturity. The accretion is included in interest income. The fair values of
marketable securities are estimated based on the quoted market price for these
securities.
Effective March 4, 2005, the Company has agreed to pledge to its bank marketable
securities equal to 111.11% of the value of its outstanding letters of credit
issued by the Company's bank under the Amended and Restated Credit agreement, or
cash equal to 100% of the value of its outstanding letters of credit, or a
combination thereof.
At March 31, 2005, $6.0 million of cash and marketable securities, at fair
value, ($100 thousand more than was required) were pledged to the Company's bank
to secure the $5.3 million of letters of credit issued by the bank. Of this $6.0
million of cash and marketable securities, approximately $500 thousand was
classified as a current asset, with the remainder classified as a long-term
asset.
Marketable securities at March 31, 2005 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 $ 16,639 $ - $ 165 $16,474
The cost and estimated fair value of current marketable securities at March 31,
2005, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because the issuers of the securities 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 $16,639 $ 16,474
------- --------
Total debt securities $16,639 $ 16,474
======= ========
9
4. INVENTORIES
Inventories consist of the following, in thousands:
March 31, December 31,
2005 2004
--------- ----------
Raw materials $ 4,204 $ 4,241
Work in progress 1,750 1,890
Finished goods 284 396
-------- ----------
Total inventory 6,238 6,527
Reserve for excess and obsolete inventory (1,344) (1,362)
-------- ----------
Inventory, net $ 4,894 $ 5,165
======= =========
5. GOODWILL
The December 31, 2004 and March 31, 2005 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 and March 31, 2005 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 the
assets 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 $25.9 million at March 31, 2005.
Goodwill, by segment, consists of the following, in thousands:
March 31, December 31,
2005 2004
--------- --------
Attack Protection $ 728 $ 728
Public Safety & Justice 25,185 25,166
--------- ---------
$ 25,913 $ 25,894
========= =========
6. INTANGIBLE ASSETS
The December 31, 2004 and March 31, 2005 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. Intangible assets for the 90 Degrees
asset acquisition are approximately $60 thousand.
The December 31, 2004 and March 31, 2005 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 Copperfire on December 15, 2004. Intangible assets for the Copperfire
asset acquisition are approximately $60 thousand.
The weighted average life for purposes of amortization of identified intangible
assets acquired in 2004 was two years for the covenant not to compete agreements
and employment contracts.
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.
10
Intangible assets consist of the following, in thousands:
March 31, December 31, Amortizable
2005 2004 Lives
---------- ----------- -------------
(in years)
Trade names $ 5,673 $ 5,673 Indefinite
Customer relationships 2,500 2,500 14
Backlog 300 300 Fully amortized
Other 1,305 1,305 1-20
---------- -----------
9,778 9,778
Less: accumulated amortization (1,426) (1,318)
---------- -----------
$ 8,352 $ 8,460
========== ===========
Amortization expense for the Company's intangible assets for the three months
ended March 31, 2005 was $108 thousand. The following schedule lists the
expected amortization expense for each of the next five years ending December
31, in thousands:
YEAR
2005 (remaining) $ 203
2006 265
2007 257
2008 225
2009 225
----------
Total $ 1,175
==========
7. NOTES PAYABLE AND LINE OF CREDIT
March 31, December 31,
2005 2004
---------- -----------
(in thousands)
Industrial revenue bond, interest payable quarterly at a variable rate of 1.65%
to 2.53% (2.53% at March 31, 2005) 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 $ 1,400
Industrial revenue bond, interest payable quarterly at a variable rate
of 1.62% to 2.43% (2.43% at March 31, 2005) 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 2,605
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 40,250
--------- ---------
Total notes payable 44,255 44,255
Less convertible subordinated notes discount 1,085 1,132
--------- ---------
Subtotal 43,170 43,123
Less amount due within one year 440 440
--------- ---------
$ 42,730 $ 42,683
========= =========
11
Maturities of notes payable are as follows, in thousands:
Year Ending December 31, Amount
------------------------ --------
2005 (remaining) $ 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 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
March 31, 2005 carrying value is listed below, in thousands.
Face value $ 40,250
Underwriters discounts, net 1,085
------------
$ 39,165
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 debt issuance costs for the 2011 Notes 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 underwriters' discounts on the 2011 Notes totaled $63
thousand and $49 thousand for the three months ended March 31, 2005 and 2004,
respectively.
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 was to mature on March 1, 2005. At March 31, 2005, $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 $15.0 million line of credit maturing
March 2005 and to require borrowings under its $10.0 million line of credit to
be collateralized by pledged marketable securities equal to 111.11% of the value
of such borrowings or cash equal to 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. On May 3, 2005, the Company's lender
confirmed in writing that there will not be any event of default under the
various credit agreements, by virtue of the Company's failure to file an
amendment to its Annual Report on Form 10-K for the year ended December 31, 2004
(the "2004 10-K") to provide management's report on internal control over
financial reporting as of December 31, 2004 and the related report of the
Company's independent registered public accounting firm on management's
assessment of the effectiveness of internal control over financial reporting
(together, the "404 Report") required by Section 404 of the Sarbanes-Oxley Act
of 2002.
12
As long as the Company maintains pledged marketable securities equal to 111.11%
of the value of its borrowings under the credit agreement or cash equal to the
value of its borrowings, 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 its 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
three months ended March 31, 2005 was a gain of $13 thousand, resulting in a
remaining liability for the investment of $8 thousand. Future changes in the
value of the interest rate swap will be recognized in earnings.
8. PRODUCT WARRANTIES
Included in accounts payable and accrued liabilities are estimated expenses
related to warranties made at the time products are sold or services are
rendered. These accruals are established using historical information on the
nature, frequency, and average cost of warranty claims. The Company warrants
numerous products, the terms of which vary widely. In general, the Company
warrants its products against defect and specific non-performance. As of March
31, 2005 the Company had a product warranty accrual in the amount of $333
thousand. The changes in the product warranty liability are displayed in the
following table, in thousands:
Beginning balance at January 1, 2005 $ 359
Plus: accruals for product warranties 54
Less: warranty charges/claims (80)
-----
Ending balance at March 31, 2005 $ 333
=====
9. OPERATING SEGMENT INFORMATION
The following is the operating segment information for the three months ended
March 31, 2005 and 2004, in thousands:
Revenues Pre-tax Income (Loss)
-------- ---------------------
2005 2004 2005 2004
---- ---- ---- ----
Institutional Security Systems $ 15,732 $ 16,057 $ 1,230 $ 207
Attack Protection 6,898 6,953 499 (679)
Integrated Electronic Systems 2,019 3,575 (8) 200
Public Safety and Justice 11,657 12,442 (482) 435
CompuDyne Corporate -- -- (1,558) (674)
-------- -------- -------- -------
$ 36,306 $ 39,027 $ (319) $ (511)
======== ======== ======== =======
10. CONTINGENCIES
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 the businesses, especially Institutional Security Systems, involve
working as a subcontractor to a prime contractor. From time to time the Company
makes claims against the prime contractor, or the prime contractor makes claims
against the Company. At any point in time the Company is 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.
In addition to claims with prime contractors, the Company may also make claims
against customers and customers may make claims against the Company.
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.
13
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.
On May 4, 2005, the Company received a notice from the Listing Qualifications
Department of The Nasdaq Stock Market stating that due to the Company's failure
to timely file the 404 Report, the Company was no longer in compliance with the
requirements of Marketplace Rule 4350(c)(14) (the "Rule"). The Rule requires the
Company to file with Nasdaq copies of all reports required to be filed with the
Securities and Exchange Commission (the "SEC") on or before the date they are
required to be filed with the SEC.
The Nasdaq Stock Market notified the Company that the Company's securities will
be delisted from The Nasdaq Stock Market at the opening of business on May 13,
2005, unless the Company requests a hearing appealing the delisting with The
Nasdaq Stock Market's Listings Qualifications Panel (the "Panel") in accordance
with the Marketplace Rules 4800 Series. Such a request for an appeal to the
Panel will stay the delisting of the Company's securities pending the Panel's
decision.
The Company intends to appeal the delisting to the Panel and is working
diligently to file the 404 Report as described in the Form 8-K dated May 2,
2005. There can be no assurance the Panel will grant the Company's request for
continued listing.
14
ITEM 2. COMPUDYNE CORPORATION AND SUBSIDIARIES
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 ("ISS"); Attack Protection ("AP"); Integrated
Electronic Systems ("IES"); and Public Safety and Justice ("PS&J").
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 typically serves as a subcontractor, responsible for
their portion of the 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 240 systems installed at more than 65
facilities, most of which are 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 Integrated Electronic Systems (formerly known as Federal Security Systems)
segment is known as CompuDyne-Integrated Electronics Division, LLC. Its customer
base includes the military, governmental agencies, and state and local
governmental units. Integrated Electronic 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. Integrated Electronic 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 also
designs and manufactures advanced digital signal processing products used in
reconnaissance of foreign telecommunications signals designed for the United
States Government and its foreign allies.
15
The Public Safety and Justice segment consists of CompuDyne-Public Safety and
Justice, Inc. (formerly Tiburon, Inc.), CorrLogic, LLC, and the recently
acquired assets of 90 Degrees and Copperfire. PS&J's software systems are used
in a wide range of applications within the public safety and criminal justice
sectors of governmental units, including police, fire and emergency medical
services computer-aided dispatch systems, and police, fire, jail, prosecution,
probation and court records management systems. We are also a leading developer
of inmate management and institutional medical software systems. We specialize
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.
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 Emergency Medical Service 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.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements made in this Form 10-Q 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-Q, 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, capital spending patterns of the security market and the
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, costs of
compliance with Sarbanes-Oxley requirements and the impact of the failure to
comply with such requirements, risks associated with internal control weaknesses
identified in complying with Section 404 of Sarbanes-Oxley, and general economic
conditions. Risks inherent in the Company's business and with respect to future
uncertainties are further described in our other filings with the Securities
Exchange Commission.
MANAGEMENT OUTLOOK
We continue to find ourselves in very challenging times. We have three 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 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 $115.7 million at
March 31, 2005 as shown in the following table:
16
Institutional Integrated Public
Security Attack Electronics 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
March 31, 2005 $ 42,700 $ 20,139 $ 8,395 $ 44,488 $115,722
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. In recent months, tax revenues have been improving resulting
in increased activity preparatory to the issuance of bids and ultimately the
awarding of new projects. In addition, we have increased our sales and marketing
efforts with a specific objective of marketing to the commercial sector which
inherently offers faster project implementation schedules.
Our second area of focus is the reengineering of our business model so that it
contains a greater percentage of recurring revenue. As indicated in the
following table, approximately 13.4% of our first three months of 2005 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.
Three Months Ended March 31, 2005
----------------------------------
(In Thousands) One-time Revenue % Recurring Revenue % Total
----------------- ------- ----------------- ------ ----------
Institutional Security Systems $ 14,565 40.1 $ 1,167 3.2 $ 15,732
Attack Protection 6,898 19.0 - - 6,898
Integrated Electronic Systems 2,019 5.6 - - 2,019
Public Safety and Justice 7,949 21.9 3,708 10.2 11,657
----------- ------- --------- ----- ---------
Total $ 31,431 86.6 $ 4,875 13.4 $ 36,306
=========== ======= ========= ===== =========
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 focus area is to improve our cost structure, quality, and client and
employee satisfaction. Our Institutional Security Systems 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 began 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-oriented 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. In addition, in light of the
escalating selling, general and administrative costs largely associated with the
current heightened regulatory environment, we are evaluating our structure and
strategy to determine if a less decentralized, or other organizational structure
would result in lower selling, general and administrative costs.
17
We believe that if we address and implement successfully the above three 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.
On May 2, 2005, we filed a Form 8-K disclosing that the we failed to timely file
an amendment to our Annual Report on Form 10-K for the year ended December 31,
2004 to provide management's report on internal control over financial reporting
as of December 31, 2004 and the related report of our independent registered
public accounting firm on management's assessment of the effectiveness of
internal control over financial reporting (together, the "404 Report") required
by Section 404 of the Sarbanes-Oxley Act of 2002.
On May 4, 2005, we received a notice from the Listing Qualifications Department
of The Nasdaq Stock Market stating that due to our failure to timely file the
404 Report, we were no longer in compliance with the requirements of Marketplace
Rule 4350(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the Securities and Exchange Commission on or before
the date they are required to be filed with the SEC.
The Nasdaq Stock Market notified us that our securities will be delisted
from The Nasdaq Stock Market at the opening of business on May 13, 2005, unless
we request a hearing appealing the delisting with The Nasdaq Stock Market's
Listings Qualifications Panel in accordance with the Marketplace
Rules 4800 Series. Such a request for an appeal to the Panel will stay the
delisting of our securities pending the Panel's decision.
We intend to appeal our delisting to the Panel and are working diligently to
file our 404 Report as described in our Form 8-K dated May 2, 2005. There can be
no assurance the Panel will grant our request for continued listing.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
Revenues. The Company had revenues of $36.3 million and $39.0 million for the
three months ended March 31, 2005 and March 31, 2004, respectively, representing
a decrease of $2.7 million or 7.0%. As discussed below, much of this decline
occurred in our IES segment.
Revenues from the Institutional Security Systems segment were $15.7 million in
the three months ended March 31, 2005, a decrease from $16.1 million for the
same period of 2004 representing a decrease of $0.4 million or 2.0%. 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 backlog had
decreased from $99.5 million at December 31, 2002 to $57.3 million at December
31, 2003 resulting in less work available to be performed in the year ended
December 31, 2004 compared to the year ended December 31, 2003. Backlog declined
further to $49.3 million and $42.7 million at December 31, 2004 and March 31,
2005, respectively. 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 2003 and 2004, the types of
projects that the Company solicits, namely large-scale medium to maximum
security installations, declined significantly 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 $6.9 million in the three
months ended March 31, 2005, a decrease from $7.0 million for the same period of
2004 representing a decrease of $0.1 million or 0.8%. 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 three months ended March 31, 2005 the Norshield line experienced a 22.9%
decline in revenues as compared to the three months ended March 31, 2004,
whereas the Fiber SenSys line experienced a 55.8% increase in revenues for the
comparable period, bolstered by its largest order ever. The Company continues to
see heightened interest for its Fiber SenSys products and expects sales for
these items to continue to experience sustainable growth. The slow-down in the
government building process experienced during 2002 and 2003 has reversed.
Projects are now 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. 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. We believe that this increased level of new embassy construction will
continue for the next several years.
18
Revenues from Integrated Electronic Systems were $2.0 million in the three
months ended March 31, 2005, a decrease from $3.6 million for the same period of
2004 representing a decrease of $1.6 million or 43.5%. A significant portion of
this segment's revenue is backlog driven. Backlog at both December 31, 2003 and
December 31, 2004 was $8.3 million. IES' revenue decline was largely due to
certain government clients, for which the segment receives repeat business,
having had their budgets significantly reduced. In addition, IES had planned to
work on one significant project in the first quarter of 2005 which, due to
customer imposed delays due to its falling behind on infrastructure
construction, was not available to be worked on.
Revenues from the Public Safety and Justice segment were $11.7 million in the
three months ended March 31, 2005, a decrease from $12.4 million for the same
period of 2004 representing a decrease of $0.8 million or 6.3%. The decline was
primarily the result of lower backlogs, the deferral of an expected change order
into the second quarter, and this segment delaying a CAD version upgrade until
the second quarter instead of the first quarter when it was originally planned
to be released. 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.
Expenses. Cost of sales of $23.9 million in the three months ended March 31,
2005 were down $4.9 million or 17.0% from $28.8 million during the same period
of 2004. 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 34.1% for the three months ended March 31, 2005 as compared to 26.1% in 2004.
Cost of goods sold in the Institutional Security Systems segment of $12.2
million for the three months ended March 31, 2005 were down $1.4 million or
10.2% from $13.6 million during the same period of 2004. This decrease was
greater than the related sales decrease of this segment of 2.0%, resulting in a
7.1% increase in the gross profit percentage to 22.7% from 15.6% in the three
months ended March 31, 2005. This increase in gross profit percentage also
resulted from certain of this segment's customers terminating contracts for
convenience, resulting in the recognition of $1.3 million in gross margin due to
contract closeout activities. 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, 2004 and 2005. 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 projects and
believe that all future costs on these projects have been adequately considered
through March 31, 2005. It should be noted that as the West Coast office is
being downsized to a sales and support office, new profitable projects which
previously would have been executed by this office have been and will continue
to be transferred to the ISS Montgomery office division headquarters where
execution will occur. This has left the West Coast office to run the remaining
projects which have little or no gross margin in them. Therefore, since this
office will be performing work on which no profit is available to be made,
combined with the fact that the office has fixed overhead costs, will cause this
office to lose money through 2005.
19
The West Coast problems, including project overruns, resulted in losses recorded
in the following periods, in thousands:
Second Half of 2002 $ 2,698
First Quarter of 2003 595
Second Quarter of 2003 1,079
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
First Quarter of 2005 740
-------
Total West Coast Losses $13,617
=======
To address this situation, the Company is implementing more centralized
controls, replaced certain personnel at its West Coast operations and its
Alabama headquarters, hired a Chief Operating Officer and is restructuring the
function of the West Coast office.
Cost of goods sold in the Attack Protection segment of $4.5 million for the
three months ended March 31, 2005 decreased $1.5 million or 24.9% from $6.0
million during the same period of 2004. This decrease was far greater than the
related sales decrease of this segment of 0.8%, resulting in a 21.1% increase in
the gross profit percentage to 34.3% from 13.2% during the three months ended
March 31, 2004. Significant factors contributing to this increase in gross
profit included significant growth in the Fiber SenSys business line. Fiber
SenSys sales have a higher margin than does the windows and door component of
the Attack Protection segment. In addition, one of this segment's customers
terminated its contracts for convenience resulting in the recognition of $0.2
million in gross margin due to contract closeout activities.
Cost of goods sold in the Integrated Electronic Systems segment of $1.7 million
in the three months ended March 31, 2005 decreased $1.3 million or 43.7% from
$3.1 million during the same period of 2004. This decrease was consistent with
the related sales decrease of this segment of 43.5%, resulting in a 0.3%
increase in the gross profit percentage to 14.0% from 13.7% in the three months
ended March 31, 2004. Substantially all of the projects awarded in this segment
are discrete projects.
Cost of goods sold in the Public Safety and Justice segment of $5.5 million for
the three months ended March 31, 2005 was down $0.7 million or 10.8% from $6.2
million during 2004. This decrease was more than the related sales decrease of
this segment of 6.3%, resulting in a 2.4% increase in the gross profit
percentage to 52.9% from 50.5% in the three months ended March 31, 2004.
Substantially all of the projects awarded in this segment are discrete projects.
Selling, general and administrative expenses were $10.0 million for the three
months ended March 31, 2005, an increase of $1.9 million or 22.8% from $8.2
million for the same period of 2004. Much of this increase is related to
additional costs incurred by the Company related to compliance with new
requirements mandated by the Sarbanes-Oxley Act and the SEC. The Company
expended approximately $0.4 million to perform its 2003 audit, which did not
require a SOX 404 report. This was paid to our independent registered public
accounting firm for audit and audit related services. For the 2004 audit, the
Company has expended or accrued $2.2 million for external third party costs to
complete its 2004 audit and its SOX 404 report which is not yet complete. Of
this amount, approximately $1.6 million was paid to our independent registered
public accounting firm for audit and audit related services with the balance
paid to various consultants and others who have assisted the Company in the 404
process. Expenses related thereto of $1.1 million and $0.2 million were recorded
during the periods ended March 31, 2005 and 2004, respectively.
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.
20
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 $57 thousand in the first three
months of 2005, which is included in operating expenses.
Research and development expenses were $2.1 million for the three months ended
March 31, 2005, an increase of $0.4 million or 20.3% from $1.8 million for the
same period of 2004. 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 $0.8 million for the three months ended March 31,
2005 from $0.7 million for the three months ended March 31, 2004 due to an
increase in average borrowings outstanding and higher interest rates. The
following table compares the weighted average of the Company's three months
ended March 31, 2005 and 2004 interest bearing borrowings, in thousands, and the
related rates charged thereon:
Monthly Weighted Monthly Weighted
Average - 2005 Average - 2004
Amount Rate Amount Rate
------------ ----- -------- -----
Bank borrowings $ - -% $ 2,467 4.2%
Industrial revenue bonds $ 4,005 3.0% $ 4,445 3.4%
Subordinated borrowings $ 40,250 6.3% $33,989 6.3%
Swap hedge agreement $ 2,029 2.4% $ 4,735 3.8%
In addition the Company recorded the following non-cash interest expense, in
thousands:
Amortization and write-off
of deferred financing charges $67 $128
Taxes on Income. The effective tax rate was zero for the three months ended
March 31, 2005 and the effective tax rate was approximately 39.9% for the three
months ended March 31, 2004. The Company has decided to fully reserve its net
deferred tax assets, as it has determined it is not more likely than not that
the asset will be realized due to the Company's recent operating losses.
Net Loss. The Company reported a net loss of $0.3 million in the three months
ended March 31, 2005 and 2004. The net loss in the three months ended March 31,
2005 is due primarily to lower revenue and higher selling, general and
administrative expenses. Diluted earnings per share was a loss of $.04 in the
three months ended March 31, 2005 and 2004. The weighted average number of
common shares outstanding and equivalents used in computing EPS was 8.2 million
in 2005 and 8.0 million in 2004.
Liquidity and Capital Resources
The Company funds its operations through cash flows generated from its
operations, bank and public financings, and the sale of its common stock. The
Company's liquidity requirements arise from cash necessary to carry its
inventories and billed and unbilled receivables, for capital expenditures, to
repurchase shares of its common stock under its share repurchase program, for
payments of principal and interest on outstanding indebtedness and for
acquisitions. The ultimate 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.
As of March 31, 2005, the Company had working capital of $37.7 million compared
with $44.0 million as of December 31, 2004.
Net cash used in operating activities was $2.6 million in the three months ended
March 31, 2005 versus $1.7 million used in operating activities in the three
months ended March 31, 2004. The largest component of cash used in operating
activities was a decrease in accounts payable and accrued liabilities of $5.2
million. This decrease was largely caused by the decline in revenues experienced
by the Company during 2004 and the first quarter of 2005.
21
Net cash provided by investing activities was $2.5 million in the three months
ended March 31, 2005 compared to net cash used of $22.4 million in the three
months ended March 31, 2004. In the three months ended March 31, 2005, the net
of marketable securities bought and redeemed was an increase of cash of $2.9
million. In the three months ended March 31, 2004 the net purchase of marketable
securities was $22.2 million.
Net cash used by financing activities amounted to $0.9 million in the three
months ended March 31, 2005 compared with a net provided cash of $26.0 million
in the three months ended March 31, 2004. The amount in 2004 was primarily
provided through the issuance of the 2011 Notes offset by the repayment of $13.2
million of our bank borrowings.
The following table summarizes the long term debt and related interest of the
Company as of March 31, 2005 and the payments due by period, in thousands.
Long-term Debt Interest On Contractual Obligations
-------------- -----------------------------------
December 31:
2005 (remaining) $ 440 $1,963
2006 440 2,596
2007 440 2,585
2008 440 2,575
2009 440 2,564
Thereafter 42,055 3,311
------- -------
Totals $44,255 $15,594
======= =======
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 $40.25 million principal amount. 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
did not repay any of its Industrial Revenue Bond ("IRB") borrowings as it
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 October 29, 2004 and March 4, 2005, the Company and its bank entered into
amendments to its credit agreement pursuant to which the bank 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 its $15 million line of credit maturing March
2005 and to require borrowings under its $10 million line of credit to be
collateralized by cash or in the case of marketable securities by 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. This line matures on March 1, 2007.
As 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 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 March 31, 2005 amounted to
approximately $43.2 million, net of broker's discounts. The 2011 Notes accounted
for $39.2 million, net of 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 March 31, 2005 for its
industrial revenue bonds was 2.5%. The variable interest rate for these
borrowings fluctuated between 1.6% and 2.5% during the three months ended March
31, 2005 based on weekly market conditions. These bonds are fully collateralized
by bank letters of credit issued under the Company's bank 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.
22
Other than the Company's letters of credit, which amounted to $5.3 million at
March 31, 2005, the Company has no other material off balance sheet liabilities.
At March 31, 2005 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 its currently available cash 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 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.
On May 2, 2005, we filed a Form 8-K disclosing that the we failed to timely file
an amendment to our Annual Report on Form 10-K for the year ended December 31,
2004 to provide management's report on internal control over financial reporting
as of December 31, 2004 and the related report of our independent registered
public accounting firm on management's assessment of the effectiveness of
internal control over financial reporting (together, the "404 Report") required
by Section 404 of the Sarbanes-Oxley Act of 2002. On May 3, 2005, the Company's
lender confirmed in writing that there will not be any event of default under
the various credit agreements, by virtue of the Company's failure to file its
report required by Section 404 of Sarbanes-Oxley in a timely manner.
On May 4, 2005, we received a notice from the Listing Qualifications Department
of The Nasdaq Stock Market stating that due to our failure to timely file the
404 Report, we were no longer in compliance with the requirements of Marketplace
Rule 4350(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the Securities and Exchange Commission on or before
the date they are required to be filed with the SEC.
The Nasdaq Stock Market notified us that our securities will be delisted from
The Nasdaq Stock Market at the opening of business on May 13, 2005, unless we
request a hearing appealing the delisting with The Nasdaq Stock Market's
Listings Qualifications Panel in accordance with the Marketplace Rules 4800
Series. Such a request for an appeal to the Panel will stay the delisting of our
securities pending the Panel's decision.
We intend to appeal our delisting to the Panel and are working diligently to
file our 404 Report as described in our Form 8-K dated May 2, 2005. There can be
no assurance the Panel will grant the Company's request for continued listing.
Another consequence of not filing the SOX 404 report timely as noted above
includes our inability to use a shorter form registration document for one year
in the event we were to engage in an offering of our securities. The
above-discussed delisting proceedings and our failure to timely file the SOX 404
report could have an adverse impact on our ability to raise capital and the cost
of raising capital.
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. In addition, in light of the escalating selling,
general and administrative costs largely associated with the current heightened
regulatory environment, we are evaluating our strategy to determine if a revised
strategy would result in lower selling, general and administrative costs. As a
result, in order to enhance its profitability, the Company will continue to seek
ways to reduce its costs.
23
TOTAL BACKLOG
CompuDyne's backlog amounted to $115.7 million at March 31, 2005. This was a
decrease of 8.8% from the Company's December 31, 2004 backlog of $126.9 million.
The break down of the Company's backlog by segment is as follows, in thousands:
March 31, December 31,
2005 2004
--------- -----------
Institutional Security Systems $ 42,700 $ 49,324
Attack Protection 20,139 20,803
Integrated Electronic Systems 8,395 8,299
Public Safety and Justice 44,488 48,434
-------- --------
Total $115,722 $126,860
======== ========
Included in the backlog of the Public Safety and Justice segment at March 31,
2005 and December 31, 2004 is $5.9 million and $5.1 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. In light of the continued decline of the
Company's backlog at March 31, 2005 as compared to December 31, 2004, the
Company expects the second quarter results to be weak.
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
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 Corporation, was re-formed as
CompuDyne-Integrated Electronics Division, LLC, and our Public Safety and
Justice group, formerly known as Tiburon, was renamed CompuDyne-Public Safety
and Justice, Inc. In addition, CorrLogic, Inc. was converted to CorrLogic, LLC
and Fiber SenSys, Inc. was converted to Fiber SenSys, LLC. The impact of this
reorganization is not expected to have a material effect on operations. In
addition, in light of the escalating selling, general and administrative costs
largely associated with the current heightened regulatory environment, we are
evaluating our structure to determine if another organizational structure would
result in lower selling, general and administrative costs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
A complete description of the Company's significant accounting policies appears
in the Company's Annual Report on Form 10-K for the year ended December 31,
2004.
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 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.
24
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.
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 $25.9 million and
$5.6 million, respectively, and intangible assets subject to amortization which
totaled approximately $2.7 million, net, at March 31, 2005.
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 had been contracted for was sometimes being deferred by the customer
into the future. In recent months, it appears the state and local government
revenues have been improving, resulting in increased activity preparatory to the
issuance of requests for new bids and ultimately, the Company expects the
awarding of new projects. It appears to us that we are in the early stages of an
economic recovery.
After the occurrence of the tragic events of the September 11, 2001 terrorist
attacks, there was a general perception that our Integrated Electronic 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 four years the Company has
experienced a more challenging marketplace than it experienced in several years
prior to September 11, 2001.
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
September 30, 2005. At March 31, 2005 the notional amount of the swap agreement
had declined to $1.4 million at a fixed rate of 4.9%. In January 2004 the
interest rate swap ceased to be a highly-effective cash flow hedge when the
related debt was repaid. Consequently, the amounts previously recorded in other
comprehensive income as changes in fair value of the interest rate swap were
recognized in earnings for the 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 three months ended March
31, 2005 was a gain of $13 thousand, resulting in a remaining liability for the
investment of $8 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 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.
25
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 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 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 first quarter of 2006.
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.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
CompuDyne has fixed and variable rate notes payable. These on-balance sheet
financial instruments expose the Company to interest rate risk, with the primary
interest rate exposure resulting from changes in the bond market used to
determine the interest rate applicable to the borrowings under the Company's IRB
borrowings.
The following information summarizes our sensitivity to market risks associated
with fluctuations in interest rates as of March 31, 2005. To the extent that the
Company's financial instruments expose the Company to interest rate risk, they
are presented in the table below. The table presents principal cash flows and
related interest rates by year of maturity of the Company's notes payable with
variable rates of interest in effect at March 31, 2005.
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 (remaining) $ 440 2.46% $ - -
2006 440 2.46% - -
2007 440 2.46% - -
2008 440 2.46% - -
2009 440 2.46% - -
- -
Thereafter 1,805 2.46% 40,250 6.25%
------- ------
Total $ 4,005 2.46% $40,250 6.25%
Fair Value $ 4,005 2.46% $33,500 11.00%
Interest Rate Swaps Variable
Year Ending Rate ($) Average Variable Average
December 31 (In Thousands) Pay Rate Receive Rate
------------ -------------- ----------------- --------------
2005 (remaining) $ 1,353 4.90% 3.09%
Total $ 1,353 4.90% 3.09%
Fair Value $ (8)
27
ITEM 4. 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
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. Management is in the process
of completing its evaluation of the Company's internal control over financial
reporting as of December 31, 2004. To date, management has identified two
material weaknesses, which also existed as of December 31, 2004. 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.
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 constituted a material
weakness.
Management 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 control deficiency could
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 constituted 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 will 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.
28
Securities and Exchange Commission Release No. 34-50754, subject to certain
conditions, provided up to 45 additional days (until May 2, 2005) beyond the due
date of a company's 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. The
Company originally qualified for this exemption. On February 23, 2005, the
Company issued a press release announcing its intent to avail itself of this
extension. 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 were not filed with its Form 10-K but were
expected to be filed via an amendment to its Annual Report on Form 10-K. On May
2, 2005, the Company filed a Form 8-K whereby the Company announced that it did
not timely file an amendment to its Annual Report on Form 10-K for the year
ended December 31, 2004 (the "2004 10-K") to provide management's report on
internal control over financial reporting as of December 31, 2004 and the
related report of the Company's independent registered public accounting firm on
management's assessment of the effectiveness of internal control over financial
reporting (together, the "404 Report") required by Section 404 of the
Sarbanes-Oxley Act of 2002 ("SOX 404").
The Company is working diligently to complete its testing of its internal
control over financial reporting. The Company is unable to predict, however,
when the Company will be able to issue its report. The lenders under the
Company's Amended and Restated Credit Agreement have confirmed that there will
not be any event of default thereunder arising by virtue of the Company's
failure to file the 404 Report in a timely manner. The Company is evaluating the
impact, if any, under its various other agreements of not filing the 404 Report
in a timely manner. Other consequences of not timely filing the SOX 404 report
include the inability to use a shorter form registration document for one year
in the event the Company were to engage in an offering of its securities. On May
4, 2005, we received a notice from the Listing Qualifications Department of The
Nasdaq Stock Market stating that due to our failure to timely file the 404
Report, we were no longer in compliance with the requirements of Marketplace
Rule 4350(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the Securities and Exchange Commission on or before
the date they are required to be filed with the SEC. The Nasdaq Stock Market
notified us that our securities will be delisted from The Nasdaq Stock Market at
the opening of business on May 13, 2005, unless we request a hearing appealing
the delisting with The Nasdaq Stock Market's Listings Qualifications Panel in
accordance with the Marketplace Rules 4800 Series. Such a request for an appeal
to the Panel will stay the delisting of our securities pending the Panel's
decision. We intend to appeal our delisting to the Panel and are working
diligently to file our 404 Report as described in our Form 8-K dated May 2,
2005. There can be no assurance the Panel will grant our request for continued
listing. The Company cannot predict at this time what other steps the SEC or the
NASD may pursue.
Upon completion of our ongoing evaluation of internal control over financial
reporting the Company may discover additional control deficiencies, and those
control deficiencies, alone or in combination with others, may constitute
material weaknesses as of December 31, 2004, in addition to those material
weaknesses described above. As of the current date, the Company is not aware of
any material weaknesses in its internal control over financial reporting as of
December 31, 2004, other than those described above.
As a result of the material weaknesses that existed as of December 31, 2004 and
March 31, 2005, the Company's management will conclude in its Management Report
on Internal Control Over Financial Reporting to be filed as an amendment to the
2004 10-K, that the Company's internal control over financial reporting was not
effective as of December 31, 2004. Also, the Company's management believes that
the report of its independent registered public accounting firm to be filed as
an amendment to the 2004 10-K will contain an adverse opinion with respect to
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 first quarter
of 2005 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, who is not from the Company's independent registered
public accounting firm, and has implemented 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.
29
PART II - OTHER INFORMATION
Item 6: Exhibits.
Exhibits -
31.1 Certification by Mr. Martin Roenigk, Chief Executive Officer pursuant to
Rule 13a-14(a), filed herewith.
31.2 Certification by Mr. Geoffrey F. Feidelberg, Chief Financial Officer
pursuant to Rule 13a-14(a), filed herewith.
32.1 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002, 18
U.S.C. Section 1350, for Mr. Martin Roenigk, Chief Executive Officer, filed
herewith.
32.2 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002, 18
U.S.C. Section 1350, for Mr. Geoffrey F. Feidelberg, Chief Financial
Officer, filed herewith.
30
SIGNATURE
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
COMPUDYNE CORPORATION
Date: May 10, 2005 /S/ MARTIN ROENIGK
------------------
Martin Roenigk
Chief Executive Officer
/S/ GEOFFREY F. FEIDELBERG
---------------------------
Geoffrey F. Feidelberg
Chief Financial Officer