UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2003
Commission File Number
OPTELECOM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
52-1010850
(IRS employer identification number)
12920 CLOVERLEAF CENTER DRIVE, GERMANTOWN, MARYLAND 20874
(Address of principal executive offices)(Zip code)
Registrant’s telephone number, including area code: (301) 444-2200.
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock $0.03 Par Value.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
At September 30, 2003, shares of the registrant’s Common Stock, $0.03 Par Value, held by persons other than “affiliates” of the registrant had an aggregate market value of $37,728,445 based on the average closing bid and asked prices as reported by the National Association of Securities Dealers Automated Quotation System for such date.
At March 26, 2004, the registrant had outstanding 3,151,243 shares of Common Stock, $.03 Par Value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated by reference into Part III hereof.
OPTELECOM, INC.
FISCAL YEAR 2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
2
Optelecom, Inc. is a Delaware corporation whose business activities began in 1972. Optelecom’s early business commenced with the design and delivery of specialized laser systems and fiber optic communications products for the defense arm of the Federal government. During the mid-1990’s we successfully transitioned from having a significant number of military customers to being an industry provider of copper and fiber optic based communications products for commercial and government customers. We have focused on providing integrated multi-media products for communicating video, audio, and other data over both copper wire and optical network systems.
Optelecom currently manages its operations under two business segments: the Communication Products Division (CPD) and the Electro-optics Technology unit (EO). The Communication Products Division is focused on the development, manufacture and sale of optical fiber-based data communication equipment to both commercial and Government clients. The Electro-optics Technology unit develops and manufactures innovative optical devices under contract, primarily to government and defense industry customers. Prior to 2003, the Company managed its operations under three business segments: the Optical Products unit, the Electro-optics Technology unit and the Copper Products Unit. During 2003 the Optical Products unit and Copper Products unit were combined into the current Communication Products Division. As a result of this integration, the Copper Products unit, formerly operating under the name Paragon Audio Visual, was renamed Optelecom Europe Limited (OEL). As a result, OEL will support the full range of Optelecom’s fiber optic product line in Europe, the Middle East and Africa. Segment information for all prior periods presented has been restated to conform to the current presentation.
During 2003 the Company established a new business unit called Integrated Systems. This unit will focus on delivering video content management solutions to both new and existing customers. Initial product offerings will include rich media communications and networked security systems. While the Company incurred insignificant costs in developing the Integrated Systems unit during 2003, management expects the unit to begin generating revenue in 2004 when it intends to report it as a separate operating unit.
Fiber optic communications equipment is the main element of Optelecom’s sales. The marketplace served by Optelecom is experiencing a period of continuous growth and change as the industry continues to grow. Technology development is constantly and rapidly improving the capability to transmit at increasing data rates over even greater distances with fiber-based communication systems.
In the Electro-optics Technology unit, emphasis has been placed on fabrication of precision-wound coils of optical fiber used as the sensing elements of fiber optic gyroscopes. During the past decade, Optelecom has received U.S. Government contracts to investigate advanced manufacturing technology related to gyro coil winding. Optelecom currently pursues this tradition of business development and continues to seek out technology development opportunities with potential for production follow-on. The Electro-optics unit also produces precision wound coils for applications ranging from optical fiber dispensers used in remote vehicle control systems to precision optical fiber coils for communications systems. Additionally, the group is currently engaged in a series of contracts with the U. S. Air Force and prime contractors to develop elements of a fiber optic data bus network for a new air vehicle.
3
The table below displays the Company’s three-year revenue and operating income (loss) by segment:
|
|
|
2003 |
|
2002 |
|
2001 |
|
||||||||||||||
|
Operating Unit |
|
|
|
Revenue |
|
Operating |
|
Revenue |
|
Operating |
|
Revenue |
|
Operating |
|
||||||
|
Communication Products |
|
$ |
15,327,411 |
|
$ |
1,427,838 |
|
$ |
13,665,771 |
|
$ |
1,235,680 |
|
$ |
12,124,288 |
|
$ |
(980,252 |
) |
||
|
Electro-Optics |
|
1,792,247 |
|
544,497 |
|
1,242,783 |
|
376,439 |
|
1,052,631 |
|
236,195 |
|
||||||||
|
Company Totals |
|
$ |
17,119,658 |
|
$ |
1,972,335 |
|
$ |
14,908,554 |
|
$ |
1,612,119 |
|
$ |
13,176,919 |
|
$ |
(744,057 |
) |
||
PRODUCTS AND MARKETS
COMMUNICATION PRODUCTS DIVISION (CPD)
The Communication Products Division addresses business opportunities in the worldwide optical communication equipment marketplace, specializing in optical fiber transmission technologies. The majority of its current and future revenues are and will be derived from several niche markets that apply the advantages of fiber optic telecommunications to their transmission requirements. Presently, the vertical markets we serve include communications systems for highway traffic monitoring, advanced air traffic control video monitor displays, security surveillance and control systems, and manufacturing process and control communications. Vertical markets that offer future potential sources of revenue include video teleconferencing, healthcare, and broadcasting. CPD offers many product solutions to address our customers’ needs. Its products are classified into the following categories:
Data Communications Products
Data Communications Products include a comprehensive family of fiber optic modems that incorporate standard telecommunications protocols. The market applications for these products include specialty data and timing distribution modems for the military, aerospace and satellite earth station markets as well as commercial, industrial, traffic control and surveillance markets.
Uncompressed Digital Video Transmission Products
Uncompressed digital video products provide an extremely high quality video signal over long distances via optical fiber. The bandwidth required to achieve this performance is considerably greater than that needed for lower video quality systems, however, the enormous bandwidth capacity of fiber optic transmission media provides an obvious path for utilization of digital video technology. Additionally, since the video transmission format is strictly digital, it can be easily combined with digitized voice and digital data streams. This feature facilitates switching and multiplexing of a wide variety of signals.
Current products include one, two, four, and eight channel digital video multiplexing and de-multiplexing units offering near broadcast quality performance, with many also combining audio and data with the digital video for transmission via one optical fiber using one optical wavelength for each transmission direction. During 2003, we introduced a new line of 9 bit single and dual channel video transmitters priced competitively for the security market.
The totally modular approach used in the digital system design architecture reduces the inventory and logistical support investment required to address the increasing demand for these products. Marketplace reception has been positive and new applications involving a combination of our other product offerings with the capabilities of the digital video equipment are being constantly proposed.
4
CWDM (Course Wavelength Division Multiplexer) Systems
CWDM allows the transmission and reception of multiple channels of light operating at different wavelengths through a single optical fiber. With this technology, the user can configure systems which transport the video and data channel count transmitted by one wavelength (typically up to eight) multiplied by the wavelength channel capacity of the CWDM. Optelecom offers CWDM systems with optical wavelength channel counts of from two to seventeen, as well as single channel add/drop multiplexers By using a two channel WDM (Wavelength Division Multiplexer) along with two eight channel digital video multiplexers transmitting at different optical wavelengths, sixteen channels of video along with data and audio may be transmitted via one optical fiber in one direction. Similarly, by using a seventeen channel CWDM (Course Wavelength Division Multiplexer) along with up to seventeen eight channel digital video multiplexers each transmitting at different optical wavelengths, one hundred thirty six channels of very high quality digital video, along with audio and data, may be transmitted via one optical fiber in one direction. Alternately, by using the seventeenth wavelength for return path audio and data, one hundred twenty eight video channels can be transmitted in one direction along with bi-directional audio and data.
Combining Optelecom’s wide variety of transmission products with available CWDM components permits the user to configure multiple variations of point-to-point or distributed linear optical networks for the transmission of video, audio, and data. via a single optical fiber.
High Resolution RGB Video Transmission Products
Red Green Blue (RGB) Video Transmission Products include those used to remotely position a high-resolution display, such as a monitor or projector, from its video source. Because of the high bandwidth and fidelity required to transmit these signals, fiber optics is the only available means to transmit them further than approximately 1,000 feet. While VGA video, in the 1280 x 1024 pixel range, may be transmitted via copper using active baluns (such as offered by the Copper Products unit) up to distances approaching 1,000 feet, the bandwidth required to transmit ultra high resolution 2048 x 2048 pixel RGB video limits the maximum transmission distance possible over copper wire to less than 100 feet. Management is not aware of any other fiber optic RGB video transmission system that meets the performance characteristics of the high-resolution RGB products that we offer. Applications for this technology include air traffic control, military control rooms, remote conference rooms, financial trading desks and process control.
Compressed Digital Video Transmission Products
Applying our expertise in video communications, we have developed a low cost, high quality, compressed digital video MPEG II product set that leverages the advantages of new microprocessor technology recently made available to the marketplace. MPEG II has become the defacto compression standard embraced by the consumer and other electronics marketplaces. The products we have developed will replace older compression products since their low cost, high performance characteristics render the previous family obsolete.
These products involve the digitization and compression of National Television System Committee (NTSC) and Phase Alternation by Line (PAL) video signal sources, allowing transmission using T1, E1, or Ethernet, over IP (Internet Protocol). They are being offered to the security and traffic markets as well as to other markets whose users are turning to video communications as a way to increase productivity. The explosive growth of the Internet facilitates the need for low cost, high quality compressed digital video for use over various private and public networks.
5
ELECTRO OPTICS TECHNOLOGY UNIT (EO)
The Electro Optics Technology Unit focuses on Interferometric Fiber Optic Gyro (IFOG) coils, which are components in rotation-sensing instruments that are beginning to replace mechanical and laser gyros in aircraft, missiles, and other vehicles. Optelecom has used its expertise derived from prior Department of Defense activities to develop winding technology for IFOG coils and to manufacture these coils. In 2003, continued improvements were incorporated to increase production capacity in anticipation of increased requirements for these coils. Optelecom currently supports Boeing in a program for Wright-Patterson AFB which is devoted to development of military aircraft photonic network systems. Optelecom is in the implementation stage of an effort to develop a demonstration of photonic vehicle control feedback components. Under a related Small Business Innovation Research (SBIR) contract completed in 2003, Optelecom investigated photonics systems optimized for aerospace vehicles, which culminated in the design of an optical subsystem prototype. Our photonic aerospace vehicle work provides an opportunity for Optelecom to apply its optical development and fabrication expertise to an important aircraft system application with potential application to commercial markets.
SALES AND MARKETING
COMMUNICATION PRODUCTS DIVISION
The Communication Products Division sells its products domestically through direct sales, select commercial integrators and resellers. In addition, several vendors incorporate Optelecom products in their product offerings. This enables Optelecom to penetrate markets we do not address directly.
The Company continues to focus it’s resources on developing additional sales and distribution channels. Specifically, in 2003 we added seven representatives and forty-seven integrators domestically. Internationally, we added seven new integrators. We expect this number to continue to grow in 2004 as we further expand the market share of our fiber transmission products.
The Company’s primary method of making new customer contacts has been through participation in an expanded trade show schedule in both the Security and Traffic markets. These trade shows have resulted in a significant increase in quotations and order activity. In addition, our updated web site (www.optelecom.com) has enabled the convenient and rapid dissemination of information required by our distribution channel personnel and other interested parties to gather information necessary to select our equipment.
ELECTRO OPTICS TECHNOLOGY UNIT
The Electro-optics unit sales are pursued independently of other corporate sales functions. This unit relies on established contacts, response to request for proposals (RFP’s) and participation in technical conferences to market precision wound coils and other contract services.
RESEARCH AND DEVELOPMENT
|
|
|
2003 |
|
2002 |
|
2001 |
|
|
Expenditures on Company sponsored research and development activities |
|
$979,000 |
|
$847,000 |
|
$958,000 |
|
During 2003, the Company invested in the development of several new products. These products will permit us to increase our penetration of the present vertical markets we serve by permitting our customers to increase information throughput at reduced price points. It is anticipated that the new Digital Video (DV) products, both compressed and uncompressed, will gain significant market share due to their
6
extremely high reliability, increased bandwidth/channel capacities, and robust video compression techniques.
A network software management card incorporating an Ethernet capability was developed and introduced in 2002. This unit allows remote access to, and management of Optelecom equipment from a customers existing network.
MANUFACTURING PROCESSES
Optelecom has established and maintains a Quality Assurance system fully compliant with the requirements of ISO-9001 (an internationally recognized quality system standard for companies that design and manufacture products). All operating segments have received registration to the standard. This registration is re-validated every six months by an independent third party audit. The company successfully passed audits in January and July of 2003. During the successful January audit Optelecom was updated from the 1994 version of ISO-9001 to the 2000 version; Optelecom was compliant to the updated standard throughout 2003 (a year ahead of the deadline). The Corrective Action and feedback process along with Quality Council meetings continue to be aggressively utilized to drive continuous improvements.
COMMUNICATION PRODUCTS DIVISION
The Communication Products Division performs routine and specialized manufacturing, assembly, and product testing functions in our corporate headquarters. We use equipment to automatically assemble components onto printed circuit boards at high speed, thereby lowering manufacturing costs and reducing the time-to-market for new product designs. We also maintain a quality assurance function and testing area that performs optical and electrical testing and quality control. Raw materials and supplies used in our business include optical materials, plastic products, and various electronic components, most of which are available from numerous sources. Although the number of companies from which we can obtain optical emitters and detectors for use in our circuit assemblies is limited, availability is presently not a limiting factor. During 2003, manufacturing basics continued to be an area of primary focus. This involved correcting, reassessing and improving many of the core manufacturing processes.
The Electro-Optics unit uses custom facilities designed and fabricated by Optelecom for precision wound coil production and contract research and development. Currently, five coil winding machines are employed in satisfying contract winding production requirements.
COMPETITION
The two business segments of Optelecom compete in separate and distinct markets.
COMMUNICATION PRODUCTS DIVISION
This Unit competes with other companies of roughly equal size that have similar resources. The majority of our competitors are privately held companies. We estimate the total market for Optelecom transmission products to be approximately $180 million in 2003. The size of the traffic and security surveillance markets, which represents the largest segment, is estimated to be approximately $60 million worldwide. The competition in these markets has established mature sales channels that allow for continued market penetration in both domestic and international markets. We anticipate that the expansion of Optelecom’s sales and distribution channels worldwide will be the basis for sustained growth. The Company expects to increase its share of these expanding markets. In addition, our products contain
7
two technologies that are in limited supply to these markets: the compressed and uncompressed Digital Video products.
Products offered by Electro-optics are sold to both small companies and large defense contractors who tend to dominate the market. These companies have greater marketing, manufacturing, financial, research and personnel resources than Optelecom. Furthermore, as Department of Defense contracting activity has declined, these companies have started to compete in markets that were primarily addressed by companies with resources similar to Optelecom’s. Our approach to this competitive environment is to offer services and second source production capabilities which complement the capabilities and interests of our customers.
Optelecom’s products are based on communications equipment technology. As such, seasonality affects our revenues to the extent that normal contracting activities are affected by capital budget seasonality.
PATENTS
Although Optelecom holds certain patents which relate to optical modulator technology and optical fiber networks, our business as a whole is not materially dependent upon ownership of any one patent or group of patents. We do not license any patents from other parties.
BACKLOG
At the end of 2003, the estimated backlog for each business segment was $1,100,000 in the Communication Products Division and $705,000 in the Electro Optics Products Unit. The Company expects to recognize a majority of the backlog as revenue in the first quarter of 2004.
EMPLOYEES
At December 31, 2003, a total of 69 full-time employees worldwide were employed at Optelecom, including 13 in research, development and engineering, 13 in sales and marketing, 31 in manufacturing and 12 in general management, administration and finance. The number of employees by operating segment is as follows: Optical Products Unit—64; Electro Optics—5. We expect a slight increase in headcount over the next 12 months, primarily in the areas of sales, marketing and manufacturing. Our future success will depend in part on our ability to attract, train, retain and motivate highly qualified employees. There can be no assurance that we will be successful in attracting and retaining such personnel. Our employees are not represented by any collective bargaining organization and we consider our employee relations to be good.
The statements contained in this report on Form 10-K that are not purely historical are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, including, without limitations, statements regarding Optelecom’s expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future. Forward-looking statements include, but are not limited to, statements contained in “Item 1. Business,” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding Optelecom’s business and strategies, product markets, sales, marketing, customer support and service, research and development, manufacturing, competition, backlog, employees, financial performance, revenue and expense levels in the future and the sufficiency of our
8
existing assets to fund future operations and capital spending needs. Actual results could differ from those projected in any forward-looking statements for the reasons, among others, detailed under “Risk Factors” in this Report on Form 10-K. The fact that some of the risk factors may be the same or similar to Optelecom’s past filings means only that the risks are present in multiple periods. We believe that many of the risks detailed here are part of doing business in the industry in which we compete and will likely be present in all periods reported. The fact that certain risks are endemic to the industry does not lessen the significance of the risk. The forward-looking statements are made as of the date of this Form 10-K and we assume no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements.
Fluctuations In Financial Performance
Optelecom has experienced and may, in the future, continue to experience fluctuations in our quarterly and annual operating results. Factors that may cause operating results to vary include, but are not limited to, changing technology, new product transitions, delays in new product introductions, competition, shortages of system components, changes in the mix of products and services sold and timing of investments in additional personnel, facilities and research and development. As a result of the impact of these and other factors, past financial performance should not be considered to be a reliable indicator of the future performance in any particular fiscal period. We are somewhat limited in our ability to reduce expenses quickly in response to any revenue shortfalls. Therefore, Optelecom’s business, financial condition, and operating results could be adversely affected if increased revenues are not achieved.
For the twelve months ended December 31, 2003 approximately 21% of our revenues were accounted for by sales to five commercial customers. This is a decline from the prior year when five customers represented 22% of our revenues. In the event of a reduction, delay or cancellation of orders from one or more significant customers or if one or more significant customers selects products from one of our competitors for inclusion in future product generations, our business, financial condition and operating results could be materially and adversely affected. There can be no assurance that Optelecom’s current customers will continue to place orders with us, that orders by existing customers will continue at current or historical levels or that we will be able to obtain orders from new customers. The loss of one or more of our current significant customers could materially and adversely affect Optelecom’s business, financial condition and operating results.
Optelecom’s products are sold in markets that are subject to rapid technological change. Our future success will depend in part upon our ability to enhance our current products and to develop and introduce new products that keep pace with technological developments and emerging industry standards and that address the increasingly sophisticated needs of our customers. There can be no assurance that we will be successful in developing and marketing such products or producing enhancements that meet these changing demands, that Optelecom will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or that our new products and product enhancements will adequately meet the demands of the marketplace and achieve market acceptance. Our inability to develop and introduce new products or product enhancements in a timely manner or our failure to achieve market acceptance of a new product could have a material adverse effect on Optelecom.
9
We face intense and increasing competition from a large number of competitors, some of which are larger than Optelecom and have larger product development, research and sales staffs. We believe that the products developed in 2002 and 2003 and the products currently being developed will position us to compete effectively through 2004 and well into 2005. There can be no assurance, however, that our competitors will not develop products that are as, or possibly more, effective than ours. We continuously monitor our competitors’ product introductions to evaluate our ability to compete.
Future Capital Needs; Uncertainty Of Additional Funding
Optelecom believes that our existing capital resources, including an existing $3,500,000 bank line-of-credit and future operating cash flows, will generate the funds needed for our long-term cash requirements.
If our growth rate should exceed expectations, or if we should fail to generate the anticipated operating cash flows, Optelecom would be required to seek additional funding. In those circumstances, the Company would look to increase its line of credit and/or pursue equity financing. There can be no assurance that additional financing will be available in a timely manner or on acceptable terms. If issuing equity securities raises additional funds, further dilution to existing stockholders will result. If adequate funds are not available when needed, we may be required to delay, scale back or eliminate product research and development and overhead costs.
Need To Attract And Retain Key Employees
Optelecom is substantially dependent on the business and technical expertise of our senior management and on our ability to attract and retain key management and technical employees. The loss of members of senior management or of other key employees or our inability to attract and retain other employees with necessary business or technical skills in the future would have a material adverse effect on Optelecom’s business.
Price Volatility In Public Market
Optelecom’s Common Stock currently trades on the NASDAQ Small Cap Market. The securities markets have from time-to-time experienced significant price and volume fluctuations that were unrelated to our operating performance. In addition, the market prices of the common stock of many publicly traded technology companies have in the past been, and can in the future be expected to be, especially volatile. Announcements of technological innovations or new products of Optelecom or our competitors, developments or disputes concerning proprietary rights, publicity regarding products under development by Optelecom or our competitors, regulatory developments in both the United States and foreign countries, and economic and other external factors, as well as period-to-period fluctuations in our operating and product development results, may have a significant impact on the market price of Optelecom’s Common Stock.
Absence Of Dividends; Dilution
Optelecom has not paid any cash dividends since our inception and we do not anticipate paying any cash dividends in the foreseeable future. Dilution will occur upon the exercise of outstanding stock options and may occur upon future equity financing that could be required to fund operations.
10
The Company’s corporate office and manufacturing facility are located at 12920 Cloverleaf Center Drive, Germantown, Maryland. This facility has 30,000 square feet of space, 26,000 of which are occupied by Optelecom, with the remaining 4,000 square feet sub-leased. Our move in 2003 to this facility which has been specifically designed and fitted to accommodate our current requirements and our anticipated near-term growth needs is expected to improve our ability to serve our customers.
As part of the 2001 restructuring of Optelecom Europe Limited, its facilities were consolidated in a smaller, but superior, facility in Thatcham, England, consisting of approximately 2,100 square feet of office space. This lease expires in June 2006, and the premises are in good repair, and are adequate for current requirements.
From time to time, Optelecom is involved in legal proceedings and litigation arising in the ordinary course of business. As of the date of this report Optelecom is not a party to any litigation or other legal proceeding that, in the opinion of management, could have a material adverse effect on our business, financial condition or results of operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted for a vote of our shareholders during the fourth quarter of 2003.
Item 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company’s Common Stock, representing its only class of publicly traded equity securities, is traded on the NASDAQ Small-Cap market under the symbol OPTC. Set forth below are the highest and lowest closing bid prices for the Common Stock as reported by the National Association of Securities Dealers Automated Quotation Service (NASDAQ) during each quarter for the two years ended December 31, 2003 and 2002, respectively. Such quotations do not necessarily reflect actual transactions:
|
|
|
Bid Price |
|
||||
|
|
|
High |
|
Low |
|
||
|
| |||||||