10-Q 1 f10q_051704.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 2004 Commission File No. 1-7939 ------------------------------- -------- Vicon Industries, Inc. -------------------------------------------------------------------------------- New York State 11-2160665 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) identification No.) 89 Arkay Drive, Hauppauge, New York 11788 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (631) 952-2288 ---------------------------- (Former name, address, and fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 under the Securities Exchange Act of 1934) Yes No X ------- ------- At March 31, 2004, the registrant had outstanding 4,605,524 shares of Common Stock, $.01 par value. PART I - FINANCIAL INFORMATION ------------------------------ ITEM 1. FINANCIAL STATEMENTS ----------------------------- VICON INDUSTRIES, INC. AND SUBSIDIARIES --------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ----------------------------------------------- (UNAUDITED) Three Months Ended ------------------ 3/31/04 3/31/03 ------- ------- Net sales $12,234,953 $13,081,881 Cost of sales 7,710,157 8,440,887 ----------- ----------- Gross profit 4,524,796 4,640,994 Operating expenses: Selling, general and administrative expense 4,155,268 3,822,634 Engineering & development expense 1,207,735 1,341,116 ----------- ----------- 5,363,003 5,163,750 Operating loss (838,207) (522,756) Interest expense 45,322 64,439 Interest and other income (61,389) (40,380) ----------- ----------- Loss before income taxes (822,140) (546,815) Income tax expense 79,000 2,187,957 ----------- ----------- Net loss $ (901,140) $(2,734,772) =========== =========== Basic and diluted loss per share $ (.20) $ (.59) =========== =========== Shares used in computing basic and diluted loss per share 4,604,853 4,641,213 See Accompanying Notes to Condensed Consolidated Financial Statements. -2- VICON INDUSTRIES, INC. AND SUBSIDIARIES --------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ----------------------------------------------- (UNAUDITED) Six Months Ended ---------------- 3/31/04 3/31/03 ------- ------- Net sales $26,572,688 $25,099,895 Cost of sales 16,201,341 16,558,346 ----------- ----------- Gross profit 10,371,347 8,541,549 Operating expenses: Selling, general and administrative expense 8,590,889 7,718,138 Engineering & development expense 2,333,131 2,416,562 ----------- ----------- 10,924,020 10,134,700 Operating loss (552,673) (1,593,151) Interest expense 96,713 131,918 Interest and other income (104,413) (101,275) ----------- ----------- Loss before income taxes (544,973) (1,623,794) Income tax expense 234,000 1,809,957 ----------- ----------- Loss before cumulative effect of a change in accounting principle (778,973) (3,433,751) Cumulative effect of a change in accounting principle - (1,372,606) ----------- ----------- Net loss $ (778,973) $(4,806,357) =========== =========== Basic and diluted loss per share: Loss before cumulative effect of a change in accounting principle $ (.17) $ (.74) Cumulative effect of a change in accounting principle - (.30) ----------- ----------- Net loss $ (.17) $ (1.04) =========== =========== Shares used in computing basic and diluted loss per share 4,605,548 4,641,993 See Accompanying Notes to Condensed Consolidated Financial Statements. -3- VICON INDUSTRIES, INC. AND SUBSIDIARIES --------------------------------------- CONDENSED CONSOLIDATED BALANCE SHEETS ------------------------------------- ASSETS 3/31/04 9/30/03 ------ ------- ------- (Unaudited) CURRENT ASSETS -------------- Cash and cash equivalents $ 5,876,622 $ 4,836,148 Marketable securities 3,390,856 3,325,773 Accounts receivable, net 10,586,047 11,056,300 Inventories: Parts, components, and materials 2,563,170 2,071,092 Work-in-process 3,405,627 2,881,592 Finished products 6,539,034 7,141,470 ----------- ----------- 12,507,831 12,094,154 Recoverable income taxes 225,372 2,052,662 Prepaid expenses and other current assets 694,551 701,779 ----------- ----------- TOTAL CURRENT ASSETS 33,281,279 34,066,816 Property, plant and equipment 18,310,554 17,672,247 Less accumulated depreciation and amortization (11,044,869) (10,386,406) ------------ ----------- 7,265,685 7,285,841 Other assets 614,810 540,407 ----------- ----------- TOTAL ASSETS $41,161,774 $41,893,064 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES ------------------- Current maturities of long-term debt 332,793 325,294 Accounts payable 2,432,348 2,527,946 Accrued compensation and employee benefits 1,922,064 2,023,087 Accrued expenses 2,405,479 2,524,858 Unearned revenue 937,938 1,238,944 Income taxes payable 293,406 94,174 ----------- ----------- TOTAL CURRENT LIABILITIES 8,324,028 8,734,303 Long-term debt 2,589,949 2,732,275 Unearned revenue 393,857 547,871 Other long-term liabilities 817,730 643,884 SHAREHOLDERS' EQUITY -------------------- Common stock, par value $.01 48,418 48,326 Capital in excess of par value 22,486,977 22,439,637 Retained earnings 7,077,287 7,856,260 ----------- ----------- 29,612,682 30,344,223 Less treasury stock, at cost (1,053,249) (980,199) Accumulated other comprehensive income 659,406 91,700 Deferred compensation (182,629) (220,993) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY 29,036,210 29,234,731 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $41,161,774 $41,893,064 =========== =========== See Accompanying Notes to Condensed Consolidated Financial Statements. -4- VICON INDUSTRIES, INC. AND SUBSIDIARIES --------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ----------------------------------------------- (UNAUDITED) Six Months Ended ---------------- 3/31/04 3/31/03 ------- ------- Cash flows from operating activities: Net loss $ (778,973) $(4,806,357) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 529,086 532,677 Stock compensation expense 25,428 - Deferred income taxes - 1,853,957 Cumulative effect of a change in accounting principle - 1,372,606 Change in assets and liabilities: Accounts receivable 967,699 287,717 Inventories (225,785) 759,938 Recoverable income taxes 1,827,290 (225,000) Prepaid expenses and other current assets 28,414 (88,585) Other assets (72,189) 21,980 Accounts payable (172,784) (512,686) Accrued compensation and employee benefits (127,240) 225,242 Accrued expenses (172,197) 184,398 Unearned revenue (455,020) 33,367 Income taxes payable 182,945 46,805 Other liabilities 175,324 45,466 ------------ ----------- Net cash provided by (used in) operating activities 1,731,998 (268,475) Cash flows from investing activities: Capital expenditures (353,355) (325,651) Purchases of marketable securities (69,911) (1,539,708) ------------ ----------- Net cash used in investing activities (423,266) (1,865,359) Cash flows from financing activities: Repayments of bank mortgage debt (165,327) (316,198) Proceeds from exercise of stock options 22,006 16,169 Repurchases of common stock (73,050) (53,057) Repayments of U.S. term loan - (450,000) ------------ ----------- Net cash used in financing activities (216,371) (803,086) ------------ ----------- Effect of exchange rate changes on cash (51,887) (59,924) ------------ ----------- Net increase (decrease) in cash 1,040,474 (2,996,844) Cash at beginning of year 4,836,148 9,771,804 ------------ ----------- Cash at end of period $ 5,876,622 $ 6,774,960 ============ =========== See Accompanying Notes to Condensed Consolidated Financial Statements. -5- VICON INDUSTRIES, INC. AND SUBSIDIARIES --------------------------------------- NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) ---------------------------------------------------------------- March 31, 2004 -------------- Note 1: Basis of Presentation ------------------------------ The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ended September 30, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2003. Certain prior year amounts have been reclassified to conform to the current period presentation. Note 2: Marketable Securities ------------------------------ Marketable securities consist of mutual fund investments in U.S. government debt securities. Such securities are stated at market value and are classified as available-for-sale under Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 115, with unrealized gains and losses reported in other comprehensive income as a component of shareholders' equity. The cost of such securities at March 31, 2004 was $3,402,239, with $11,383 of cumulative unrealized losses reported at March 31, 2004. Note 3: Accounts Receivable ---------------------------- Accounts receivable is stated net of an allowance for uncollectible accounts of $1,193,000 and $1,135,000 as of March 31, 2004 and September 30, 2003, respectively. Note 4: Earnings per Share --------------------------- Basic earnings (loss) per share (EPS) is computed based on the weighted average number of common shares outstanding for the period. Diluted EPS reflects the maximum dilution that would have resulted from the exercise of stock options and incremental common shares issuable under deferred compensation agreements. The weighted average number of shares of common stock used in determining basic and diluted EPS was 4,604,853 and 4,641,213 for the three months ended March 31, 2004 and 2003, respectively. The weighted average number of shares of common stock used in determining basic and diluted EPS was 4,605,548 and 4,641,993 for the six months ended March 31, 2004 and 2003, respectively. For the three months ended March 31, 2004 and 2003, 249,585 and 46,063 shares, respectively, have been omitted from the calculation of diluted EPS as their effect would have been antidilutive. For the six months ended March 31, 2004 and 2003, 217,172 and 47,169 shares, respectively, have been omitted from the calculation of diluted EPS as their effect would have been antidilutive. -6- Note 5: Comprehensive Income (Loss) ------------------------------------- The Company's total comprehensive loss for the three month and six month periods ended March 31, 2004 and 2003 was as follows: Three Months Six Months Ended March 31, Ended March 31, ---------------------- --------------------- 2004 2003 2004 2003 ------ ------ ------ ------ Net loss $ (901,140) $(2,734,772) $ (778,973) $(4,806,357) Other comprehensive income (loss), net of tax: Net unrealized (gain) loss on securities 16,354 32 (4,828) 3,748 Unrealized gain (loss) on derivatives 92,524 13,519 (36,886) (4,065) Foreign currency translation adjustment 130,208 (176,166) 609,420 (19,156) ----------- ---------- ------------ ----------- Comprehensive loss $ (662,054) $(2,897,387) $ (211,267) $(4,825,830) =========== ============ ============ ============ The accumulated other comprehensive income balances at March 31, 2004 and September 30, 2003 consisted of the following: March 31, September 30, 2004 2003 ----------- ------------- Foreign currency translation adjustment $ 924,405 $ 314,985 Unrealized loss on derivatives (253,616) (216,730) Unrealized loss on securities (11,383) (6,555) ---------- --------- Accumulated other comprehensive income $ 659,406 $ 91,700 ========== ========== Note 6: Segment and Related Information ----------------------------------------- The Company operates in one industry which encompasses the design, manufacture, assembly and marketing of video surveillance systems and system components for the electronic protection segment of the security industry. The Company manages its business segments primarily on a geographic basis. The Company's principal reportable segments are comprised of its United States (U.S.) and United Kingdom (Europe) based operations. Its U.S. based operations consists of Vicon Industries, Inc., the Company's corporate headquarters and principal operating entity. Its Europe based operations consist of Vicon Industries Limited, a wholly owned subsidiary which markets and distributes the Company's products principally within Europe and the Middle East. The other segment includes the operations of TeleSite U.S.A., Inc. and subsidiary, an Israeli based designer and producer of digital video products. The Company evaluates performance and allocates resources based on, among other things, the net profit or loss for each segment, excluding intersegment sales and profits. Segment information for the three month and six month periods ended March 31, 2004 and 2003 was as follows: Three Months Ended March 31, 2004 U.S. Europe Other Consolid. Totals ----------------- ---------- ---------- --------- ---------- ------- Net sales to external customers $ 7,864,000 $4,226,000 $ 145,000 $ - $12,235,000 Intersegment net sales 1,155,000 - 2,086,000 (3,241,000) - Net income (loss) (1,065,000) 325,000 (109,000) (52,000) (901,000) Total assets 30,182,000 10,234,000 4,729,000 (3,983,000) 41,162,000 -7- Three Months Ended March 31, 2003 U.S. Europe Other Consolid. Totals ----------------- ---------- ---------- --------- ---------- ------- Net sales to external customers $ 8,459,000 $4,268,000 $ 355,000 $ - $13,082,000 Intersegment net sales 1,653,000 - 707,000 (2,360,000) - Net income (loss) (2,558,000) 140,000 (254,000) (63,000) (2,735,000) Total assets 33,683,000 8,978,000 3,542,000 (4,481,000) 41,722,000 Six Months Ended March 31, 2004 U.S. Europe Other Consolid. Totals ----------------- ---------- ---------- --------- ---------- ------- Net sales to external customers $17,119,000 $9,195,000 $ 259,000 $ - $26,573,000 Intersegment net sales 2,182,000 - 3,916,000 (6,098,000) - Net income (loss) (1,384,000) 645,000 8,000 (48,000) (779,000) Total assets 30,182,000 10,234,000 4,729,000 (3,983,000) 41,162,000 Six Months Ended March 31, 2003 U.S. Europe Other Consolid. Totals ----------------- ---------- ---------- --------- ---------- ------- Net sales to external customers $16,215,000 $8,093,000 $ 792,000 $ - $25,100,000 Intersegment net sales 3,056,000 - 1,267,000 (4,323,000) - Net income (loss) (3,401,000) 361,000 (319,000)(1,447,000) (4,806,000) Total assets 33,683,000 8,978,000 3,542,000 (4,481,000) 41,722,000 The consolidating segment information above includes the elimination and consolidation of intersegment transactions. Note 7: Derivative Instruments -------------------------------- At March 31, 2004, the Company had interest rate swaps and forward exchange contracts outstanding with notional amounts aggregating $1.8 million and $3.6 million, respectively, whose aggregate fair value was a liability of approximately $254,000. The change in the amount of the liability for these instruments is shown as a component of accumulated other comprehensive income. Note 8: Goodwill ------------------ The Company adopted SFAS No. 142 on October 1, 2002, and accordingly, discontinued amortization of goodwill as of that date. The Company performed the transitional goodwill impairment testing required under SFAS No. 142, which included a comparison of the fair value of each of the Company's reporting units to the carrying amounts of each unit's net assets to determine the implied fair value of each reporting unit's goodwill. Based upon an independent valuation conducted as of October 1, 2002, and the results of the transitional impairment testing, the Company recognized an impairment charge of approximately $1.4 million (primarily resulting from a change in measurement from undiscounted to discounted cash flows), as a cumulative effect of a change in accounting principle for the six months ended March 31, 2003. -8- Note 9: Stock-Based Compensation ---------------------------------- The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations in accounting for its employee stock-based compensation. Under APB No. 25, compensation expense would be recorded if, on the date of grant, the market price of the underlying stock exceeded its exercise price. As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123" ("SFAS No. 148"), the Company has retained the accounting prescribed by APB No. 25 and has presented the disclosure information prescribed by SFAS No. 123 and SFAS No. 148 below. Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of this Statement. The fair value for options was estimated at the date of grant using the Black-Scholes option pricing model. In the Company's condensed consolidated financial statements, no compensation expense has been recognized for stock option grants issued under any of the Company's fixed stock option plans. Had compensation expense for stock option grants issued been determined under the fair value method of SFAS No. 123, the Company's net income (loss) and earnings (loss) per share (EPS) for the three and six month periods ended March 31, 2004 and 2003 would have been: Three Months Six Months Ended March 31, Ended March 31, ---------------------- ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Reported net loss $ (901,140) $(2,734,772) $(778,973) $(4,806,357) Stock-based compensation cost (27,479) (51,210) (63,782) (91,698) ----------- ----------- --------- ----------- Pro forma net loss $ (928,619) $(2,785,982) $(842,755) $(4,898,055) =========== =========== ========= =========== Reported basic and diluted EPS $ (.20) $(.59) $ (.17) $(1.04) Pro forma basic and diluted EPS $ (.20) $(.60) $ (.18) $(1.06) Note 10: Recent Accounting Pronouncement ------------------------------------------ In August 2003, the Emerging Issues Task Force reached consensus on EITF Issue No. 03-5 ("EITF 03-5"), "Applicability of AICPA Statement of Position 97-2, "Software Revenue Recognition," to Non-Software Deliverables in an Arrangement Containing More-than-Incidental Software". EITF 03-5, which became effective for the Company on October 1, 2003, provides guidance on determining whether non-software deliverables are included within the scope of SOP 97-2 and, accordingly, whether multiple element arrangements are to be accounted for in accordance with EITF Issue No. 00-21 or SOP 97-2. The provisions of EITF 03-5 did not have an impact on the Company's results of operations or financial position. -9- Note 11: Income Taxes ----------------------- The components of income tax expense (benefit) for the periods indicated are as follows: Three Months Six Months Ended March 31, Ended March 31, --------------- --------------- 2004 2003 2004 2003 ---- ---- ---- ---- Federal: Current $ - $ - $ - $ (225,000) Deferred - 2,106,957 - 1,853,957 --------- ---------- ---------- --------- - 2,106,957 - 1,628,957 State - - 10,000 - Foreign 79,000 81,000 224,000 181,000 --------- ---------- ---------- --------- Total income tax expense $ 79,000 $2,187,957 $ 234,000 $1,809,957 ========= ========== ========== ========== In the quarter ended March 31, 2003, the Company recognized a $2.1 million charge to provide a valuation allowance against its deferred tax assets due to the uncertainty of future realization. The establishment of such valuation allowance was determined to be appropriate during that period due to updated judgments of future results in light of the Company's operating losses in recent years and the inherent uncertainties of predicting future operating results in periods over which such net tax differences become deductible. Income tax expense for the six months ended March 31, 2003 includes the recognition of an available tax effected net operating loss carryback of $225,000. Note 12: Contingencies ------------------------ In May 2003, the Company was served with a summons and complaint in a patent infringement suit that named the Company and thirteen other defendants. The alleged infringement relates to the Company's camera dome systems, which is a significant product line. Among other things, the suit seeks injunctive relief and unspecified damages. The Company and its outside patent counsel believe that the complaint is without merit and the Company intends to vigorously defend itself in this matter. The Company is unable to reasonably estimate a range of possible loss, if any, at this time. Although the Company believes that it has meritorious defenses to such claims, there is a possibility that an unfavorable outcome could ultimately occur that could result in a liability that is material to the Company's results of operations and financial position. The Company plans to present a joint defense with certain other named defendants and also is willing to explore the possibility of settlement. -10- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS --------------------------------------------- Results of Operations --------------------- Three Months Ended March 31, 2004 Compared with March 31, 2003 -------------------------------------------------------------- Net sales for the quarter ended March 31, 2004 decreased $.9 million or 6% to $12.2 million compared with $13.1 million in the year ago period. Domestic sales decreased $.7 million or 9% to $7.0 million compared with $7.7 million in the year ago period. International sales for the quarter decreased 3% to $5.2 million compared with $5.4 million in the year ago period. The backlog of unfilled orders was $6.1 million at March 31, 2004 compared with $7.4 million at September 30, 2003. Gross profit margins for the second quarter of fiscal 2004 increased to 37.0% compared with 35.5% in the year ago period. The margin increase was principally due to sales of the Company's new digital video product line, which carries higher margins. The Company also experienced increased profit margins from its European based operations due to the effects of favorable exchange rate changes as the cost of their U.S. dollar sourced products declined. Such margin increases were offset, in part, by a $182,000 provision for the writedown of a discontinued product line in the second quarter of fiscal 2004. Operating expenses for the second quarter of fiscal 2004 increased to $5.4 million compared with $5.2 million in the year ago period principally as a result of increased legal fees associated with the defense of a patent infringement suit. The Company continued to invest in new product development in the current quarter, incurring $1.2 million of engineering and development expenses compared with $1.3 million in the year ago period. The Company incurred an operating loss of $838,000 in the second fiscal quarter of 2004 compared with an operating loss of $523,000 in the year ago period. Interest expense decreased to $45,000 for the second quarter of fiscal 2004 compared with $64,000 in the year ago period principally as a result of the paydown of bank borrowings. Income tax expense for the second quarter of fiscal 2004 was $79,000 compared with $2.2 million in the year ago period. In the quarter ended March 31, 2003, the Company recognized a $2.1 million income tax charge to provide a valuation allowance against its deferred tax assets due to the uncertainty of future realization. The establishment of such valuation allowance was determined to be appropriate as a result of the Company's operating losses in recent years and the inherent uncertainties of predicting future operating results in periods over which such net tax differences become deductible. As a result, the Company has since ceased providing a deferred tax benefit on its U.S. operation's losses. As a result of the foregoing, the Company incurred a net loss of $901,000 for the second quarter of fiscal 2004 compared with a net loss of $2.7 million in the year ago period. -11- Results of Operations --------------------- Six Months Ended March 31, 2004 Compared with March 31, 2003 ------------------------------------------------------------ Net sales for the six months ended March 31, 2004 increased $1.5 million or 6% to $26.6 million compared with $25.1 million in the year ago period. Domestic sales increased $.6 million or 4% to $15.1 million compared with $14.5 million in the year ago period. International sales increased $.9 million or 8% to $11.5 million compared with $10.6 million in the year ago period. Gross profit margins for the first six months of fiscal 2004 increased to 39.0% compared with 34.0% in the year ago period. The margin increase was principally due to sales of the Company's new digital video product line, which carries higher margins. The Company also experienced increased profit margins from its European based operations due to the effects of favorable exchange rate changes as the cost of their U.S. dollar sourced products declined. Operating expenses for the first six months of fiscal 2004 increased to $10.9 million compared with $10.1 million in the year ago period principally as a result of increased selling costs and legal fees associated with the defense of a patent infringement suit. The Company continued to invest in new product development in the current year period, incurring $2.3 million of engineering and development expenses compared with $2.4 million in the year ago period. The Company incurred an operating loss of $553,000 for the first six months of 2004 compared with an operating loss of $1.6 million in the year ago period. Interest expense decreased to $97,000 for the first six months of fiscal 2004 compared with $132,000 in the year ago period principally as a result of the paydown of bank borrowings. Income tax expense for the first six months of fiscal 2004 was $234,000 compared with $1.8 million in the year ago period. In the six month period ended March 31, 2003, the Company recognized a $1.9 million income tax charge to provide a valuation allowance against its deferred tax assets due to the uncertainty of future realization. The establishment of such valuation allowance was determined to be appropriate as a result of the Company's operating losses in recent years and the inherent uncertainties of predicting future operating results in periods over which such net tax differences become deductible. Income tax expense for the six months ended March 31, 2003 includes the recognition of an available tax effected net operating loss carryback of $225,000. During fiscal 2003, the Company completed its required goodwill impairment tests as of October 1, 2002 and determined that the carrying amount of its goodwill was impaired when tested pursuant to the requirements of the new standard. As a result, a goodwill impairment charge of $1.4 million was recognized effective October 1, 2002 as the cumulative effect of a change in accounting principle reflected in the six months ended March 31, 2003. As a result of the foregoing, the Company incurred a net loss of $779,000 for the first six months of fiscal 2004 compared with a net loss of $4.8 million in the year ago period. -12- MANAGEMENT'S DISCUSSION AND ANALYSIS ------------------------------------ Liquidity and Financial Condition --------------------------------- Net cash provided by operating activities was $1.7 million for the first six months of fiscal 2004 due primarily to the receipt of a $1.8 million federal income tax refund. Net cash used in investing activities was $423,000 for the first six months of fiscal 2004 relating to $353,000 of general capital expenditures and the purchase of $70,000 of marketable securities. Net cash used in financing activities was $216,000, which included $165,000 of scheduled repayments of bank mortgage loans and $73,000 of treasury stock repurchases. As a result of the foregoing, cash increased by $1.0 million for the first six months of fiscal 2004 after the nominal effect of exchange rate changes on the cash position of the Company. The Company has a $5 million secured revolving credit facility with a bank that expires in July 2004. Borrowings under this facility bear interest at the bank's prime rate or, at the Company's option, LIBOR plus 190 basis points (4.00% and 3.01%, respectively, at March 31, 2004). At March 31, 2004 and September 30, 2003, there were no outstanding borrowings under this facility. The Company does not anticipate the need to draw on such facility through its expiration in July 2004. The Company also maintains a bank overdraft facility of one million Pounds Sterling (approximately $1,840,000) in the U.K. to support local working capital requirements of Vicon Industries Limited. This facility expires in March 2005. At March 31, 2004 and September 30, 2003, there were no outstanding borrowings under this facility. Current and long-term debt maturing in the remaining six months ended September 30, 2004 and in each of the subsequent fiscal years approximates $167,000 for the remaining six months ended September 30, 2004, $343,000 in 2005, $349,000 in 2006, $324,000 in 2007 and $1,740,000 in 2008. The Company occupies certain facilities, or is contingently liable, under operating leases that expire at various dates through 2008. The leases, which cover periods from three to eight years, generally provide for renewal options at specified rental amounts. The aggregate operating lease commitment at March 31, 2004 was $444,000 with minimum rentals for the fiscal years shown as follows: for the remaining six months ended September 30, 2004 - $173,000; 2005 - $153,000; 2006 - $38,000; 2007 - $31,000; 2008 - $28,000; 2009 and thereafter - $21,000. The Company believes that it has sufficient cash to meet its anticipated operating, capital expenditures and debt service requirements for at least the next twelve months. -13- In May 2003, the Company was served with a summons and complaint in a patent infringement suit that named the Company and thirteen other defendants. The alleged infringement relates to the Company's camera dome systems, which is a significant product line. Among other things, the suit seeks injunctive relief and unspecified damages. The Company and its outside patent counsel believe that the complaint is without merit and the Company intends to vigorously defend itself in this matter. The Company is unable to reasonably estimate a range of possible loss, if any, at this time. Although the Company believes that it has meritorious defenses to such claims, there is a possibility that an unfavorable outcome could ultimately occur that could result in a liability that is material to the Company's results of operations and financial position. The Company plans to present a joint defense with certain other named defendants and also is willing to explore the possibility of settlement. Critical Accounting Policies ---------------------------- The Company's significant accounting policies are fully described in Note 1 to the Company's consolidated financial statements included in its September 30, 2003 Annual Report on Form 10-K. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility of the resulting receivable is reasonably assured. As it relates to product sales, revenue is generally recognized when products are sold and title is passed to the customer. Shipping and handling costs are included in cost of sales. Advance service billings under a national supply contract with one customer are deferred and recognized as revenues on a pro rata basis over the term of the service agreement. The Company evaluates multiple-element revenue arrangements for separate units of accounting pursuant to EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables", and follows appropriate revenue recognition policies for each separate unit. Elements are considered separate units of accounting provided that (i) the delivered item has stand-alone value to the customer, (ii) there is objective and reliable evidence of the fair value of the delivered item, and (iii) if a general right of return exists relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially within the control of the Company. As applied to the Company, under arrangements involving the sale of product and the provision of services, product sales are recognized as revenue when the products are sold and title is passed to the customer, and service revenue is recognized as services are performed. For products that include more than incidental software, and for separate licenses of the Company's software products, the Company recognizes revenue in accordance with the provisions of Statement of Position 97-2, "Software Revenue Recognition", as amended. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. -14- The Company provides for the estimated cost of product warranties at the time revenue is recognized. While the Company engages in product quality programs and processes, including monitoring and evaluating the quality of its component suppliers, its warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from its estimates, revisions to the estimated warranty liability may be required. The Company writes down its inventory for estimated obsolescence and slow moving inventory equal to the difference between the cost of inventory and the estimated net realizable market value based upon assumptions about future demand and market conditions. Technology changes and market conditions may render some of the Company's products obsolete and additional inventory write-downs may be required. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required. The Company assesses the recoverability of the carrying value of its long-lived assets, including identifiable intangible assets with finite useful lives, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates the recoverability of such assets based upon the expectations of undiscounted cash flows from such assets. If the sum of the expected future undiscounted cash flows were less than the carrying amount of the asset, a loss would be recognized for the difference between the fair value and the carrying amount. The Company's ability to recover the reported amounts of deferred income tax assets is dependent upon its ability to generate sufficient taxable income during the periods over which net temporary tax differences become deductible. In fiscal 2003, the Company recognized a $1.9 million charge to provide a valuation allowance against its deferred tax assets due to the uncertainty of future realization. The establishment of such valuation allowance was determined to be appropriate during that period due to updated judgments in light of the Company's operating losses in current and recent years and the inherent uncertainties of predicting future operating results in periods over which such net tax differences become deductible. The Company plans to provide a full valuation allowance against its deferred tax assets until such time that it can achieve a sustained level of profitability or other positive evidence arises that would demonstrate an ability to recover such assets. The Company is subject to proceedings, lawsuits and other claims related to labor, product and other matters. The Company assesses the likelihood of an adverse judgment or outcomes for these matters, as well as the range of potential losses. A determination of the reserves required, if any, is made after careful analysis. The required reserves may change in the future due to new developments. Recent Accounting Pronouncement ------------------------------- In August 2003, the Emerging Issues Task Force reached consensus on EITF Issue No. 03-5 ("EITF 03-5"), "Applicability of AICPA Statement of Position 97-2, "Software Revenue Recognition," to Non-Software Deliverables in an Arrangement Containing More-than-Incidental Software". EITF 03-5, which became effective for the Company on October 1, 2003, provides guidance on determining whether non-software deliverables are included within the scope of SOP 97-2 and, accordingly, whether multiple element arrangements are to be accounted for in accordance with EITF Issue No. 00-21 or SOP 97-2. The provisions of EITF 03-5 did not have an impact on the Company's results of operations or financial position. -15- Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 -------------------------------------------------------------------------------- Statements in this Report on Form 10-Q and other statements made by the Company or its representatives that are not strictly historical facts including, without limitation, statements included herein under the captions "Results of Operations", "Liquidity and Financial Condition" and "Critical Accounting Policies" are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 that should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment. The forward-looking statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause the actual results, performance and/or achievements of the Company to differ materially from any future results, performance or achievements, express or implied, by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, and that in light of the significant uncertainties inherent in forward-looking statements, the inclusion of such statements should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. The Company also assumes no obligation to update its forward-looking statements or to advise of changes in the assumptions and factors on which they are based. ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK ------------------------------------------------------------------- The Company is exposed to various market risks, including changes in foreign currency exchange rates and interest rates. The Company has a policy that prohibits the use of currency derivatives or other financial instruments for trading or speculative purposes. The Company enters into forward exchange contracts to hedge certain foreign currency exposures and minimize the effect of such fluctuations on reported earnings and cash flow (see Note 7 "Derivative Instruments" to the accompanying condensed consolidated financial statements). The Company's ongoing foreign currency exchange risks include intercompany sales of product and services between subsidiary companies operating in differing functional currencies. At March 31, 2004, substantially all of such foreign currency transactions have been hedged by forward exchange contracts. At March 31, 2004, the Company had $1.8 million of outstanding floating rate bank debt which was covered by interest rate swap agreements that effectively convert the foregoing floating rate debt to stated fixed rates (see "Note 7. Long-Term Debt" to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2003). Thus, the Company has substantially no net interest rate exposures on these instruments. However, the Company had approximately $817,000 of floating rate bank debt that is subject to interest rate risk as it was not covered by interest rate swap agreements. The Company does not believe that a 10% fluctuation in interest rates would have a material effect on its consolidated financial position and results of operations. -16- ITEM 4. CONTROLS AND PROCEDURES -------------------------------- Evaluation of Disclosure Controls and Procedures ------------------------------------------------ The Company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures, as required by Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. Changes in Internal Controls ---------------------------- There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Limitations on the Effectiveness of Controls -------------------------------------------- The Company believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. PART II - OTHER INFORMATION --------------------------- ITEM 1 - LEGAL PROCEEDINGS ------ ----------------- In May 2003, the Company was served with a summons and complaint in a patent infringement suit that named the Company and thirteen other defendants. The alleged infringement relates to the Company's camera dome systems, which is a significant product line. Among other things, the suit seeks injunctive relief and unspecified damages. The Company and its outside patent counsel believe that the complaint is without merit and the Company intends to vigorously defend itself in this matter. The Company is unable to reasonably estimate a range of possible loss, if any, at this time. Although the Company believes that it has meritorious defenses to such claims, there is a possibility that an unfavorable outcome could ultimately occur that could result in a liability that is material to the Company's results of operations and financial position. The Company plans to present a joint defense with certain other named defendants and also is willing to explore the possibility of settlement. ITEM 2 - CHANGES IN SECURITIES ------ --------------------- None ITEM 3 - DEFAULTS UPON SENIOR SECURITIES ------ ------------------------------- None -17- ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------ --------------------------------------------------- None ITEM 5 - OTHER INFORMATION ------ ----------------- None ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K ------ -------------------------------- a) Exhibits -------- 10 Material Contracts (.1) Advice of Borrowing Terms between the Registrant and National Westminster Bank PLC dated April 15, 2004. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K ------------------- (i) On January 6, 2004, the Company filed a Current Report on Form 8-K filing its press release announcing the Company's financial results for its fiscal year ended September 30, 2003. (ii) On January 14, 2004, the Company filed a Current Report on Form 8-K disclosing the Company's inability to file its Annual Report on Form 10-K for the year ended September 30, 2003 within the prescribed time period. (iii)On February 10, 2004, the Company filed a Current Report on Form 8-K announcing the dismissal of KPMG LLP as its certifying accountants and the engaging of BDO Seidman, LLP as its certifying accountants for its fiscal year ending September 30, 2004. (iv) On February 19, 2004, the Company filed a Current Report on Form 8-K filing its press release announcing the Company's financial results for the quarter ended December 31, 2003. -18- Signatures ---------- Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. VICON INDUSTRIES, INC. May 17, 2004 /s/ Kenneth M. Darby /s/ John M. Badke -------------------- -------------------- Kenneth M. Darby John M. Badke Chairman and Senior Vice President, Finance Chief Executive Officer Chief Financial Officer -19-