##### 



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, 2005
  Commission file number 0-8828
 OPTELECOM-NKF, INC.
 (Exact name of registrant as
    specified in its charter)
  DELAWARE

52-1010850(State or other jurisdiction
    of
    incorporation or organization)

(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.
  o þ
  o þ
  þ o
  Form 10-K Form 10-K. o
  Rule 12b-2
  o o þ
  Rule 12b-2 o þ
      DOCUMENTS
    INCORPORATED BY REFERENCE




---



##### 



OPTELECOM-NKF,
    INC.
    FISCAL YEAR 2005
    FORM 10-K
    ANNUAL REPORT
   TABLE OF CONTENTS
  PageItem

Description

NumberPART IItem 1

Business


3Item 1A

Risk Factors


8Item 1B

Unresolved Staff
    Comments


12Item 2

Properties


12Item 3

Legal
    Proceedings


12Item 4

Submission of
    Matters to a Vote of Security Holders


12PART IIItem 5

Market for
    Registrants Common Stock and Related Stockholder
    Matters


13Item 6

Selected
    Consolidated Financial Data


14Item 7

Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


14Item 7A

Qualitative and
    Quantitative Disclosures About Market Risk


21Item 8

Financial
    Statements and Supplementary Data


23Item 9

Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


47Item 9A

Controls and
    Procedures


47PART IIIItem 10

Directors and
    Executive Officers of the Registrant


47Item 11

Executive
    Compensation


47Item 12

Security Ownership
    of Certain Beneficial Owners and Management


47Item 13

Certain
    Relationships and Related Transactions


47Item 14

Principal
    Accounting Fees and Services


48PART IVItem 15

Exhibits, Financial
    Statement Schedules and Reports on
    Form 8-K


48Signatures




49   2




---



##### 



PART I  Form 10-K Item 1-Business, Item 7- Form 10-K. Form 10-K
  Item 1.
    BUSINESS  GENERAL
  Video-Over-IP
    10-K
   3




---



##### 



www.optelecom-nkf.com
    PRODUCTS
    AND MARKETS
  COMMUNICATION
    PRODUCTS DIVISION (CPD)
    Data
    Communications Products
      Uncompressed
    Digital Video Transmission Products
   4




---



##### 



CWDM
    (Coarse Wavelength Division Multiplexer)
    Systems
    point-to-point
  High
    Resolution RGB Video Transmission Products
    IP
    -Video Products
      
    Compatibility between network components
    High efficiency through modularity and scalability
    Improved effectiveness with the aid of powerful intelligent
    software tools
    Reliability and availability of network services 5




---



##### 



ELECTRO
    OPTICS TECHNOLOGY UNIT (EO)
      SALES
    AND MARKETING
  COMMUNICATION
    PRODUCTS DIVISION (CPD)
      IP-video
    ELECTRO
    OPTICS TECHNOLOGY UNIT (EO)
    RESEARCH
    AND DEVELOPMENT
  2005


2004


2003Expenditures on Company sponsored
    research and development activities

$
2,426,000


$
1,155,000


$
979,000      6




---



##### 



MANUFACTURING
    PROCESSES
  QUALITY
    MANAGEMENT SYSTEM
  out-of-box
  COMMUNICATION
    PRODUCTS DIVISION (CPD)
  U.S.-based time-to-market work-in-progress
    ELECTRO
    OPTICS TECHNOLOGY
    COMPETITION
    COMMUNICATION
    PRODUCTS DIVISION
   7




---



##### 



ELECTRO
    OPTICS TECHNOLOGY
    SEASONALITY
    BACKLOG
    EMPLOYEES
    Item 1A.
    RISK
    FACTORS  Fluctuations
    in financial performance could harm our long-term growth
    strategy
    The
    Companys sales and dependence on major
    customers
   8




---



##### 



Any
    failure to remain competitive would harm Optelecom-NKFs
    operating results.
    Competition
    Although
    Optelecom and NKF expect that the merger will result in
    benefits, those benefits may not be realized
    
    Coordinating manufacturing operations in a rapid and efficient
    manner;
    Combining product offerings and product lines effectively and
    quickly;
    Integrating sales efforts so that customers can do business
    easily with the combined company;
    Bringing together the companies marketing efforts so that
    the industry receives useful information about the merger;
    Coordinating research and development activities to enhance
    introduction of new products and technologies; and
    Persuading employees that Optelecomss and NKFs
    business cultures are compatible.   9




---



##### 



Optelecom
    borrowed $23.1 million of senior and subordinated notes in
    connection with its acquisition of NKF.
    Future
    Capital Needs; Uncertainty Of Additional Funding
  line-of-credit
  and/or
  If the
    Company fails to attract and retain key personnel, its business
    could suffer.
      Our
    common stock price is volatile, we have never paid dividends and
    our stock is subject to future dilution.
  time-to-time
 10




---



##### 



period-to-period
    The
    Company faces risks related to its international operations and
    revenue.
      
    its ability to comply with customs, import/export and other
    trade compliance regulations of the countries in which it does
    business, together with any unexpected changes in such
    regulations;
    difficulties in establishing and enforcing its intellectual
    property rights;
    tariffs and other trade barriers;
    political, legal and economic instability in foreign markets,
    particularly in those markets in which it maintains
    manufacturing and research facilities;
    difficulties in staffing and management;
    language and cultural barriers;
    seasonal reductions in business activities in the countries
    where its international customers are located;
    integration of foreign operations;
    longer payment cycles;
    greater difficulty in accounts receivable collection;
    currency fluctuations; and
    potential adverse tax consequences.    If the
    Company fails to manage its exposure to worldwide financial
    markets successfully, its operating results could
    suffer.
   11




---



##### 



The
    Company faces risk from the potential impact of being classified
    as an Accelerated Filer.
    Item 1B.
    UNRESOLVED
    STAFF COMMENTS    Item 2.
    PROPERTIES    Item 3.
    LEGAL
    PROCEEDINGS    Item
    4.
    SUBMISSION
    OF MATTERS TO A VOTE OF SECURITY HOLDERS   12




---



##### 



PART II  Item 5.
    MARKET
    FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER
    MATTERS    Bid PriceQuarter Ended

High


LowDecember 31, 2005

$
14.50


$
12.31September 30, 2005


14.40



9.79June 30, 2005


11.00



9.42March 31, 2005


11.50



8.50December 31, 2004


9.50



8.48September 30, 2004


10.79



7.90June 30, 2004


14.44



9.42March 31, 2004


12.65



8.91         Number of SecuritiesRemaining Available forFuture Issuance UnderNumber of Securities to


Weighted


Equity Compensationbe Issued Upon


Average


Plans (ExcludingExercise of Outstanding


Exercise Price of


Securities Reflected inOptions


Outstanding Options


Column (a)Plan Category

(a)


(b)


(c)Equity compensation plans approved
    by security holders


776,600


$
8.48



339,481Equity compensation plans not
    approved by security holders










Totals


776,600


$
8.48



339,481    Sales of Unregistered Securities
 13




---



##### 



Item 6.
    SELECTED
    CONSOLIDATED FINANCIAL DATA    Year Ended
    December 31,

2005(a)


2004


2003


2002


2001Revenues, net

$
33,865,310


$
19,395,147


$
17,119,658


$
14,908,554


$
13,176,919Net income (loss)


2,681,915



1,594,612



3,553,266



1,644,120



(933,585
)Basic earnings (loss) per common
    share


0.83



0.50



1.18



0.58



(0.33
)Diluted earnings (loss) per common
    share


0.80



0.49



1.11



0.56



(0.33
)As of December 31,Total assets


38,867,907



12,366,409



10,431,897



6,627,223



6,373,679Long-term obligations


18,786,548



242,944



164,020







69,111Stockholders equity


11,753,693



9,934,283



7,956,476



3,667,833



2,086,557     (a)
    
    The results for 2005 include the operations of NKF as of
    March 8, 2005.  Item 7.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  Item 7- Form 10-K. Form 10-K
 14




---



##### 



RESULTS
    OF OPERATIONS
  OVERVIEW
  IP-Ethernet
  
    the expansion of a distribution network both in the United
    States and abroad;
    realization of manufacturing and process improvements;
    development of products with advanced and unique
    capabilities; and
    the comprehensive upgrade of our computer networks, operating
    systems and core financial, sales and manufacturing software
    platforms.      2005
    versus 2004
          2004
    versus 2003
   15




---



##### 



Operating
    Segments
    COMMUNICATION
    PRODUCTS DIVISION
  Communication Products
    Division

2005


2004


2003Net Sales

$
32,895,781


$
17,952,579


$
15,327,411Gross Profit


20,099,989



10,553,077



8,438,028Total Operating Expense


15,658,993



8,622,432



7,010,190Operating Income (Loss)


4,440,996



1,930,645



1,427,838        16




---



##### 



ELECTRO-OPTICS
    TECHNOLOGY UNIT
  2005


2004


2003Net Sales


969,529


$
1,442,568


$
1,792,247Gross Profit


270,953



575,247



845,253Total Operating Expense


117,807



235,917



300,756Operating Income


153,146



339,330



544,497     OTHER
    INCOME (EXPENSE)
  2005


2004


2003Interest
    expense  line of credit

$



$



$
(11,483
)Interest
    expense  long term notes / other

$
(1,112,401
)


(5,445
)


(3,465
)Interest / other income


37,787



25,760



4,602Total other income (expense)


(1,074,614
)

$
20,315


$
(10,346
)     Impact
    of Inflation
    FINANCIAL
    CONDITION
       17




---



##### 



2005


2004


2003Production Materials

$
2,573,578


$
1,604,605


$
1,637,331Work in Process


498,885



192,145



414,639Finished Goods


1,574,360



1,164,264



889,022Allowance for Obsolescence


(434,171
)


(93,132
)


(279,992
)TOTAL

$
4,212,652


$
2,867,882


$
2,661,000         LIQUIDITY
    AND CAPITAL RESOURCES
          line-of-credit. line-of-credit
    line-of-credit. and/or
 18




---



##### 



Less Than 1








More Than 5Total


Year


1-3 Years


4-5 Years


YearsLong-term debt obligations(1)

$
17,387,029


$
1,592,978


$
7,099,371


$
8,694,680


$
Capitalized lease obligations


187,901



72,021



115,880







Operating lease obligations(2)


8,667,859



1,099,683



3,083,275



2,029,350



2,455,551Other long-term liabilities


3,228,618















3,228,618Totals

$
29,471,407


$
2,764,682


$
10,298,526


$
10,724,030


$
5,684,169     (1)
    
    As described above, in connection with the acquisition of NKF,
    the Company entered into new acquisition related debt
    instruments.(2)
    
    Operating leases include our office space in the U.S.,
    Netherlands, Spain, France and the U.K. Total rental expense
    under these leases for fiscal year 2005 was $994,771  NEW
    ACCOUNTING STANDARDS
  Inventory
    Costs, Inventories
  Share-Based Payment Statement of Cash Flows.
  Issue 05-06, (EITF 05-6). EITF 05-6
 19




---



##### 



EITF 05-6 EITF 05-6
  CRITICAL
    ACCOUNTING POLICIES
    Form 10-K.
  Revenue Recognition percentage-of-completion time-and-materials
  Impairment of long lived assets
 20




---



##### 



Allowance for Doubtful Accounts
  Inventories Work-in-process
  Income Taxes
      Item 7A.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS  Market
    Risk
   21




---



##### 



Foreign
    Currency Risk
    Interest
    Rate Risk
     22




---



##### 



Item 8.
    FINANCIAL
    STATEMENTS AND SUPPLEMENTARY DATA  Index
    to the Consolidated Financial Statements
  PageReport of
    Independent Registered Public Accounting Firm


24Consolidated
    Balance Sheets as of December 31, 2005 and 2004


25Consolidated
    Statements of Operations and Comprehensive Income for the three
    years in the period ended December 31, 2005


26Consolidated
    Statements of Cash Flows for the three years in the period ended
    December 31, 2005


27Consolidated
    Statements of Stockholders Equity for the three years in
    the period ended December 31, 2005


28Notes to
    Consolidated Financial Statements


29SCHEDULE II  Schedule
    of Valuation and Qualifying Accounts


50  23




---



##### 



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                   24




---



##### 



OPTELECOM-NKF,
    INC.
  CONSOLIDATED BALANCE SHEETS
    AS OF DECEMBER 31,
  2005


2004ASSETSCURRENT ASSETSCash and cash equivalents

$
3,046,353


$
2,918,959Accounts and contracts receivable,
    net


6,731,373



3,015,588Inventories, net


4,212,652



2,867,882Deferred tax
    asset  current


820,830



767,841Prepaid expenses and other current
    assets


640,050



519,494Total current assets


15,451,258



10,089,764Property and equipment, net


2,677,865



1,870,039Deferred tax
    asset  non-current


589,010



406,606Intangible assets, net


7,719,737



Goodwill


12,430,037



TOTAL ASSETS

$
38,867,907


$
12,366,409LIABILITIES AND
    STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable

$
2,235,665


$
798,965Accrued payroll


1,616,988



394,185Commissions payable


539,352



297,870Current portion of capitalized
    leases


72,021Current portion of notes payable


1,592,978



45,000Accrued warranty reserve


308,570



130,084Taxes payable


568,147



Other current liabilities


1,393,945



523,078Total current liabilities


8,327,666



2,189,182Notes
    payable  Senior


7,099,370



45,000Notes
    payable  Subordinated


8,694,680



Deferred tax liability


2,353,500



Deferred rent liability


224,242



197,944Capitalized Lease Obligations


115,880



Other liabilities


298,876



Total liabilities


27,114,214



2,432,126COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Common stock, $.03 par
    value  shares authorized, 15,000,000; issued and
    outstanding, 3,301,414 and 3,179,109 shares as of 2005 and
    2004, respectively


99,042



95,373Additional paid-in capital


12,255,978



11,318,968Accumulated other comprehensive
    loss


(1,818,350
)


(15,166
)Treasury stock,
    162,672 shares, at cost


(1,265,047
)


(1,265,047
)Retained earnings (accumulated
    deficit)


2,482,070



(199,845
)Total stockholders equity


11,753,693



9,934,283TOTAL LIABILITIES AND
    STOCKHOLDERS EQUITY

$
38,867,907


$
12,366,409    25




---



##### 



OPTELECOM-NKF,
    INC.
  CONSOLIDATED STATEMENTS OF OPERATIONS AND
    COMPREHENSIVE INCOME
    FOR THE YEARS ENDED DECEMBER 31,
  2005


2004


2003Revenues

$
33,865,310


$
19,395,147


$
17,119,658Cost of goods sold


13,494,368



8,266,823



7,836,377Gross profit


20,370,942



11,128,324



9,283,281Operating expenses:Engineering


3,410,014



1,593,174



1,370,933Selling and marketing


6,583,980



3,522,709



2,817,327General and administrative


5,159,101



3,742,466



3,122,686Amortization of intangible assets


623,705







Total operating expenses


15,776,800



8,858,349



7,310,946Income from operations


4,594,142



2,269,975



1,972,335Other income (expense):Interest income (expense), net


(1,074,614
)


20,315



(10,346
)Income before income taxes


3,519,528



2,290,290



1,961,989Benefit (provision) for income
    taxes


(837,613
)


(695,678
)


1,591,277Net income

$
2,681,915


$
1,594,612


$
3,553,266Basic earnings per share

$
0.83


$
0.50


$
1.18Diluted earnings per share

$
0.80


$
0.49


$
1.11Weighted average common shares
    outstanding  basic


3,250,097



3,159,285



3,019,279Weighted average common shares
    outstanding  diluted


3,355,623



3,264,807



3,197,807Net income

$
2,681,915


$
1,594,612


$
3,553,266Foreign currency translation


(1,803,184
)


4,506



(61,210
)Comprehensive income

$
878,731


$
1,599,118


$
3,492,056    26




---



##### 



OPTELECOM-NKF,
    INC.
  CONSOLIDATED STATEMENTS OF CASH FLOWS
    FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
  2005


2004


2003Cash Flows From Operating ActivitiesNet income

$
2,681,915


$
1,594,612


$
3,553,266Adjustments to reconcile net income
    (loss) to net cash provided by (used in) operating activities:Depreciation and amortization


1,359,019



430,180



332,822Accounts receivable provision


45,162



41,111



(54,356
)Inventory provision






(186,859
)


(24,005
)Stock based compensation


39,308



24,900



Stock issued for payment of interest


213,626







Deferred rent


37,824



123,924



62,494Deferred tax (benefit) expense asset


(727,958
)


553,816



(1,624,158
)Other


168,600



103,540



Change in assets and liabilities:Accounts and contracts receivable


(97,031
)


(221,742
)


384,120Inventories


1,084,381



(20,023
)


(183,794
)Prepaid expenses and other assets


20,724



(179,416
)


(157,178
)Other assets


(9,882
)






126,062Accounts payable


631,775



(253,445
)


80,994Other current liabilities


2,353,322



153,726



(219,399
)Net cash provided by operating
    activities


7,800,785



2,164,324



2,276,868Cash Flows From Investing ActivitiesSecurity deposit










11,526Investment in NKF Electronics B.V.,
    net of cash acquired


(16,267,291
)






Capital expenditures


(401,065
)


(948,363
)


(980,205
)Net cash used in investing
    activities


(16,668,356
)


(948,363
)


(968,679
)Cash Flows From Financing ActivitiesBorrowings on bank
    line-of-credit
    payable










2,020,551Payments on bank
    line-of-credit
    payable










(2,596,630
)Borrowings on notes payable


14,607,080







Payments on notes payable and
    capital leases


(5,997,023
)


(67,500
)


(23,506
)Decrease in restricted certificate
    of deposit






129,368



Proceeds from issuance of common
    stock


65,818



59,569



58,636Proceeds from exercise of stock
    options


453,327



190,680



633,847Net cash provided by financing
    activities


9,129,202



312,117



92,898Effect of exchange rates on cash
    and cash equivalents


(134,237
)


3,015



(61,209
)Net increase in cash and cash
    equivalents


127,394



1,531,093



1,339,878Cash and cash
    equivalents  beginning of period


2,918,959



1,387,866



47,988Cash and cash
    equivalents  end of period

$
3,046,353


$
2,918,959


$
1,387,866Supplemental Disclosures of Cash
    Flow Information:Cash paid during the year for
    interest

$
652,330


$
5,445


$
15,436Cash paid during the year for
    income taxes

$
772,953


$
57,564


$
36,374Supplemental information on
    non-cash investing and financing activities:Notes and capital lease obligations
    incurred for new equipment

$
205,475


$



$
180,000    27




---



##### 



OPTELECOM-NKF,
    INC.
  CONSOLIDATED STATEMENTS OF STOCKHOLDERS
    EQUITY
    FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
  Accumu-Retained


latedEarnings


Other





TotalDeferred


(Accumula-


Compre-





Stock-Number


Common


Additional


Compen-


ted


hensive


Treasury


holdersof Shares


Stock


Paid-in Capital


sation


Deficit)


Loss


Stock


EquityBALANCE,January 1, 2003


2,877,891


$
86,336


$
10,152,729


$



$
(5,347,723
)

$
41,538


$
(1,265,047
)

$
3,667,833Common stock issued from exercise
    of options


224,014



6,720



627,126



















633,846Common stock issued from employee
    stock purchase plan


10,993



330



52,181



















52,511Issuance of common stock


2,000



60



20,920



(14,855
)














6,125Foreign currency translation






















(61,210
)






(61,210
)Tax benefit from exercise of options










104,105



















104,105Net income


















3,553,266











3,553,266BALANCE, DECEMBER 31, 2003


3,114,898



93,446



10,957,061



(14,855
)


(1,794,457
)


(19,672
)


(1,265,047
)


7,956,476Common stock issued from exercise
    of options


52,545



1,577



189,103



















190,680Common stock issued from employee
    stock purchase plan


7,666



230



59,339



















59,569Issuance of common stock


4,000



120



43,040



(43,160
)














Stock based compensation














24,900















24,900Foreign currency translation






















(10,246
)






(10,246
)Tax benefit from exercise of options










103,540











14,752







118,292Net income


















1,594,612











1,594,612BALANCE, DECEMBER 31, 2004


3,179,109


$
95,373


$
11,352,083


$
(33,115
)

$
(199,845
)

$
(15,166
)

$
(1,265,047
)

$
9,934,283Common stock issued from exercise
    of options and warrants


83,199



2,495



450,832



















453,327Common stock issued from employee
    stock purchase plan


8,679



261



65,557



















65,818Issuance of common stock


30,427



913



252,713



(40,000
)














213,626Stock based compensation














39,308















39,308Foreign currency translation






















(1,818,350
)






(1,818,350
)Tax benefit from exercise of options










168,600



















168,600Net income


















2,681,915











2,681,915BALANCE, DECEMBER 31, 2005


3,301,414


$
99,042


$
12,289,785


$
(33,807
)

$
2,482,070


$
(1,818,350
)

$
(1,265,047
)

$
11,753,693    28




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
  1.
    NATURE OF
    BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES  Nature of Business
  Principles of Consolidation
  Use of Estimates
  Accounts Receivable
  Revenue Recognition percentage-of-completion time-and-materials
  Product Warranty
  2005


2004Balance, beginning of year

$
130,084


$
60,846Provision for warranty obligations


242,585



152,558Charges of warranty obligations


(64,099
)


(83,320
)Balance, end of year

$
308,570


$
130,084   Inventories Work-in-process
 29




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
    Property, Equipment, and
    Depreciation
  Intangibles and goodwill
  Research and Development Costs
  Income Taxes .
  Stock-Based Compensation  Accounting for Stock Issued to
    Employees Accounting for Stock-Based
    Compensation
    Accounting for Equity Instruments That Are Issued to Other
    Than Employees for Acquiring, or in Conjunction with Selling,
    Goods or Service
 30




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
     2005


2004


2003Net income as reported

$
2,681,915


$
1,594,612


$
3,553,266Less: Stock-based employee
    compensation costs, net of income tax, as if fair value method
    had been applied


(682,770
)


(657,538
)


(279,865
)Net income pro forma

$
1,999,145


$
937,074


$
3,273,401Basic income per share:As reported

$
0.83


$
0.50


$
1.18Pro forma

$
0.62


$
0.30


$
1.08Diluted income per share:As reported

$
0.80


$
0.49


$
1.11Pro forma

$
0.59


$
0.29


$
1.02       2005


2004


2003Expected dividend yield


0
%


0
%


0
%Expected stock price volatility


80
%


87
%


122
%Risk-free interest rate


4.39
%


3.60
%


2.27
%Average expected life


4 years



4 years



4 years   Foreign Currency Translation 
  Cash and Cash Equivalents 
  Restricted Certificate of Deposit
  Fair Value of Financial
    Instruments 
 31




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
    Earnings Per Share
    2005


2004


2003Basic Earnings Per Share:Earning available to common
    stockholders

$
2,681,915


$
1,594,612


$
3,553,266Weighted average common shares
    outstanding


3,250,097



3,159,285



3,019,279Basic earnings per share

$
0.83


$
0.50


$
1.18Diluted Earnings Per Share:Earning available to common
    stockholders

$
2,681,915


$
1,594,612


$
3,553,266Weighted average common shares
    outstanding


3,250,097



3,159,285



3,019,279Effect of stock options and
    warrants


105,526



105,522



178,528Diluted Shares


3,355,623



3,264,807



3,197,807Diluted earnings per share

$
0.80


$
0.49


$
1.11   Recent Accounting Pronouncements  Inventory
    Costs, Inventories
  Share-Based Payment Statement of Cash Flows.
 32




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
    Issue 05-06, (EITF 05-6). EITF 05-6 EITF 05-6 EITF 05-6
  2.
    Acquisition
    of NKF Electronics     33




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
     Cash paid at closing to Seller

$
14,607,080Note tendered at closing to
    Seller, net of purchase price adjustments


9,794,362Direct acquisition costs


2,028,059Total purchase price

$
26,429,501Fair value of identified assets
    acquired and liabilities assumed:Cash

$
367,848Accounts receivable, net


4,176,080Inventory


2,707,358Other current assets


170,777Fixed assets


1,109,467Intangible assets


9,511,512Goodwill


13,921,322Total Assets Acquired


31,964,364Liabilities assumed


(2,788,722
)Deferred tax liability


(3,019,080
)Net Assets Acquired

$
26,429,501     Estimated Fair


Weighted AverageValue


Amortization Period
    (Year)Customer Relationships

$
7,071,260



11Employment Agreement


305,532



3Total Intangibles subject to
    amortization


7,376,792



10.7Tradename and
    trademark  not subject to amortization


2,134,720



N/ATotal

$
9,511,512



10.7     Year

Amount2006

$
744,6852007


744,6852008


659,8152009


642,8412010


642,841Thereafter


3,318,220  34




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
     December 31,


December 31,2005


2004Proforma revenues ($000s)

$
36,599


$
38,430Proforma net income ($000s)


2,924



3,501Proforma earnings per
    share  basic


0.89



1.11Proforma earning per
    share  diluted


0.87



1.07     3.
    ACCOUNTS
    AND CONTRACTS RECEIVABLE    2005


2004Accounts and contracts receivable

$
7,285,842


$
3,158,782Less: Allowance for doubtful
    accounts


(554,469
)


(143,194
)$
6,731,373


$
3,015,588   4.
    INVENTORIES    2005


2004Production materials

$
2,573,578


$
1,604,605Work in process


498,885



192,145Finished goods


1,574,360



1,164,264Allowance for obsolescence


(434,171
)


(93,132
)Net

$
4,212,652


$
2,867,882  35




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
   5.
    PROPERTY
    AND EQUIPMENT    2005


2004Laboratory equipment

$
3,216,911


$
2,133,285Office equipment


2,285,767



2,092,922Furniture and fixtures


204,054



90,083Leasehold improvements


1,309,660



526,890Computer hardware and software


1,000,439



402,2868,016,831



5,245,466Less accumulated depreciation and
    amortization


(5,338,966
)


(3,375,427
)Net property and equipment

$
2,677,865


$
1,870,039     2005


2004Laboratory equipment

$
85,171


$
85,171Office equipment


268,447



52,389353,618



137,560Less accumulated amortization


(124,979
)


(101,912
)Net assets under capital leases

$
228,639


$
35,648     6.
    INCOME
    TAXES    2005


2004


2003U.S. Operations

$
(609,691
)

$
2,111,653


$
1,621,094Non-U.S. Operations


4,129,219



178,637



340,895$
3,519,528


$
2,290,290


$
1,961,989     Current Expense
    (Benefit)

2005


2004


2003U.S. Operations

$
(2,850
)

$
29,299


$
27,153Non-U.S. Operations


1,568,421







$
1,565,571


$
29,299


$
27,153   36




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
  Deferred Expense
    (Benefit)

2005


2004


2003U.S. Operations

$
(322,873
)

$
605,189


$
(1,324,455
)Non-U.S. Operations


(405,085
)


61,190



(293,975
)$
(727,958
)

$
666,379


$
(1,618,430
)Total

$
837,613


$
695,678


$
(1,591,277
)     2005


2004


2003United States Federal tax at
    statutory rates


34.0
%


34.0
%


34.0
%(Reduction) increase of taxes:State taxes, net of federal benefit


(0.3
)


3.3



1.9Valuation allowance related to net
    deferred tax assets










(116.8
)Foreign rate differential


(2.7
)






Business tax credits


(2.0
)


(6.9
)


Change in tax rates


(4.8
)






Other


(0.4
)


(0.1
)


(0.2
)Effective income tax rate


23.80
%


30.3
%


(81.1
)%  37




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
     2005


2004Gross deferred tax assets:Excess book depreciation

$
3,761


$
Inventory


207,944



142,346Accrued vacation


69,731



76,611Deferral of rent expense


82,162



68,304Bad debt reserve


125,338



51,507Tax credits


546,213



484,830Other


153,666



73,587Net operating
    loss  non-US


170,495



140,743Net operating loss


672,649



338,008Deferred tax assets


2,031,959



1,375,936Gross deferred tax liabilities:Intangibles


(2,314,587
)


Excess tax depreciation


(190,762
)


(134,394
)Unrealized exchange gain


(402,923
)


Other


(67,347
)


(67,095
)Deferred tax liabilities


(2,975,619
)


(201,489
)Net deferred tax assets
    (liabilities)

$
(943,660
)

$
1,174,447      38




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
   7.
    LONG TERM
    NOTES PAYABLE    December 31,


December 31,2005


2004Senior term facility with a bank
    due February 2009

$
8,624,848


$
Subordinated note due March 2010


8,694,680



Other


67,500



90,00017,387,028



90,000Less Current Portion


(1,592,978
)


(45,000
)$
15,794,050


$
45,000         Subordinated note at date of
    acquisition

$
12,007,800Impact of change in the exchange
    rate during 2005


(1,099,682
)Adjustment to acquisition
    consideration based on the Share Purchase Agreement


(2,213,438
)Subordinated note balance at
    December 31, 2005

$
8,694,680   line-of-credit
  line-of-credit.
   39




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
       Year Ended
    December 31:2006

$
1,592,9782007


1,525,4782008


1,525,4782009


4,048,4142010


8,694,680$
17,387,028   8.
    COMMITMENTS
    AND CONTINGENCIES  Operating Leases 
      Year Ended
    December 31:

Operating


Capital


Total2006

$
1,099,683


$
86,160


$
1,185,8432007


1,041,183


$
79,160



1,120,3432008


1,025,125


$
46,253



1,071,3782009


1,016,967







1,016,9672010


1,006,308







1,006,308Thereafter


3,478,593







3,478,593Gross Payments


8,667,859



211,573



8,879,432Less Amounts Representing Interest






23,672



23,672Net Minimum Rental Payments

$
8,667,859


$
187,901



8,855,760     Legal Proceedings
 40




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
    9.
    STOCKHOLDERS
    EQUITY  Common Stock 
  Stock Purchase Plan 
  Sales of Unregistered Securities
    Directors Stock Compensation 
  Stock Options
 41




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
        2005


2004


2003Weighted





Weighted





WeightedAverage





Average





AverageExercise





Exercise





ExerciseShares


Price


Shares


Price


Shares


PriceOutstanding, January 1


287,076


$
6.81



187,550


$
4.51



164,938


$
3.72Granted


174,972



9.58



138,091



9.35



103,851



5.30Exercised


(73,945
)


5.56



(33,295
)


3.74



(72,764
)


3.73Canceled


(6,637
)


10.08



(612
)


2.93



(8,475
)


5.45Outstanding, end of year


381,466


$
8.27



291,734


$
6.89



187,550


$
4.51Exercisable options,
    December 31


215,518


$
7.40



148,786


$
5.86



72,915


$
4.31     Options Outstanding


Options ExercisableWeighted








WeightedAverage


Weighted





AverageNumber


Remaining


Average


Number


ExerciseRange of Exercise
    Price

Outstanding


Life in Years


Exercise Price


Exercisable


Price$1.44 to $8.99


93,350



1.83


$
4.34



88,775


$
4.33$9.05 to $9..05


104,373



4.02



9.05



24,188



9.05$9.15 to $9.17


700



3.82



9.16



525



9.16$9.19 and above


183,043



3.54



9.83



102,030



9.66381,466



3.25


$
8.27



215,518


$
7.40    42




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
     2005


2004


2003Weighted





Weighted





WeightedAverage





Average





AverageExercise





Exercise





ExerciseShares


Price


Shares


Price


Shares


PriceOutstanding, January 1


70,250


$
8.65



55,500


$
6.14



91,250


$
3.85Granted


28,000



10.68



34,000



9.78



15,500



9.81Exercised


(9,000
)


4.38



(19,250
)


3.43



(51,250
)


3.18Canceled


(5,250
)


14.65















Outstanding, end of year


84,000


$
9.41



70,250


$
8.65



55,500


$
6.14Exercisable options,
    December 31


84,000


$
9.41



70,250


$
8.65



55,500


$
6.14     Options Outstanding


Options ExercisableWeighted








WeightedAverage


Weighted





AverageNumber


Remaining


Average


Number


ExerciseRange of Exercise
    Price

Outstanding


Life in Years


Exercise Price


Exercisable


Price$2.41 to $8.72


24,000



2.71


$
6.15



24,000


$
6.15$8.81 to $10.00


22,000



3.77



9.43



22,000



9.43$10.20 to $10.79


21,000



3.61



10.40



21,000



10.40$10.82 and above


17,000



3.79



12.73



17,000



12.7384,000



3.43


$
9.41



84,000


$
9.41   10.
    EMPLOYEE
    BENEFIT PLANS      11.
    BUSINESS
    SEGMENT INFORMATION  Description
    of the Types of Products from which each Segment Derives its
    Revenues
   43




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
    Measurement
    of Segment Profit of Loss and Segment Assets
    Factors
    Management Used to Identify the Companys Reportable
    Segments
    Year Ended
    December 31, 2005Communication


Electro-Products Division


Optics Division


TotalRevenues

$
32,895,781


$
969,529


$
33,865,310Depreciation and amortization


1,359,019



0



1,359,019Income from operations


4,440,996



153,146



4,594,14,2Assets


38,637,707



230,200



39,266,907Capital expenditures


606,540



0



606,540   Year Ended
    December 31, 2004Communication


Electro-Products Division


Optics Division


TotalRevenues

$
17,952,579



1,442,568


$
19,395,147Depreciation and amortization


430,180







430,180Income from operations


1,930,645



339,330



2,269,975Assets


12,157,605



208,804



12,366,409Capital expenditures


948,363







948,363   Year Ended
    December 31, 2003Electro-Communication


OpticsProducts Division


Division


TotalRevenues

$
15,327,411


$
1,792,247


$
17,119,658Depreciation and amortization


332,822







332,822Income from operations


1,427,838



544,497



1,972,335Assets


10,125,473



306,424



10,431,897Capital expenditures


1,160,205







1,160,205  44




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
     2005


2004


2003Operating income (loss) by segment

$
4,594,142


$
2,269,975


$
1,972,335Interest
    expense  line of credit










(11,483
)Interest
    expense  long term notes


(1,112,401
)


(5,445
)


(3,465
)Other income (expense)


37,787



25,760



4,602Total other income (expense)


(1,074,614
)


20,315



(10,346
)Income (loss) before provision for
    income taxes

$
3,519,528


$
2,290,290


$
1,961,989     Significant
    Customers and Foreign Exports
       2005


2004


2003Long Lived





Long Lived





Long LivedSales


Assets


Sales


Assets


Sales


AssetsUnited States

$
14,913


$
2,319


$
16,707


$
2,260


$
13,606


$
2,118Netherlands


14,122



21,049















Spain


1,828



33















United Kingdom


2,338



2



2,688



17



3,514



20Other


664



17















$
33,865


$
23,416


$
19,395


$
2,277


$
17,120


$
2,138  45




---



##### 



OPTELECOM-NKF,
    INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2005, 2004 AND
    2003  (Continued)
   12.
    QUARTERLY
    INFORMATION (UNAUDITED)    March 31


June 30


September 30


December 31(Amounts in thousands except per
    share data)2005:Revenues, net

$
5,487


$
9,018


$
9,359


$
10,002Gross profit


3,001



5,475



5,525



6,370Operating income


310



1,025



1,449



1,810Net income


151



488



774



1,269Earnings per
    share  basic

$
0.05


$
0.15


$
0.24


$
0.38Earnings per
    share  diluted

$
0.05


$
0.15


$
0.23


$
0.372004:Revenues, net

$
4,180


$
4,265


$
5,530


$
5,420Gross profit


2,411



2,433



3,143



3,141Operating income


441



449



755



625Net income


303



303



569



420Earnings per
    share  basic

$
0.10


$
0.10


$
0.18


$
0.13Earnings per
    share  diluted

$
0.09


$
0.09


$
0.17


$
0.13  46




---



##### 



Item 9.
    CHANGES
    IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
    DISCLOSURE    Item 9A.
    CONTROLS
    AND PROCEDURES  Rule 13a-15
    Item 9B.
    OTHER
    INFORMATION   PART III  Item 10.
    DIRECTORS
    AND EXECUTIVE OFFICERS OF THE REGISTRANT    www.optelecom-nkf.com Form 8-K
  Item 11.
    EXECUTIVE
    COMPENSATION    Item 12.
    SECURITY
    OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
    MANAGEMENT    Item 13.
    CERTAIN
    RELATIONSHIPS AND RELATED TRANSACTIONS   47




---



##### 



Item 14.
    PRINCIPAL
    ACCOUNTANT FEES AND SERVICES   PART IV  Item 15.
    EXHIBITS AND
    FINANCIAL STATEMENT SCHEDULES  Number

DescriptionThe following documents are filed
    as a part of this report:(1)


All financial statements;The consolidated financial
    statements of the Company and its subsidiaries on pages 23
    through 26 hereof, and the reports thereon of Grant Thornton LLP
    appearing on page 22 hereof.(2)


Financial Statement ScheduleSchedule II for the years
    ended December 31, 2005, 2004 and 2003 and the report
    thereon of Grant Thornton LLP appearing on page 22 hereof.
    All other schedules have been omitted because they are not
    applicable or are not required. All other required schedules are
    included in the Consolidated Financial Statements or notes
    therein.(3)


Exhibits2.1

Share Purchase Agreement dated
    March 8, 2005, by and among Optelecom, Inc., NKF
    Electronics B.V., Draka Holding, N.V. and NKF Vastgoed B.V.
    (incorporated by reference from
    Form 8-K
    filed March 11, 2005)3.1

Certificate of Incorporation, as
    amended (incorporated by reference from
    Form 10-K
    filed March 31, 1998 and
    Form 8-K
    filed April 19, 2005)3.2

By-Laws (Incorporated by reference
    from
    Form 10-K
    filed March 31, 1998)10.1

Employment
    Agreement  Edmund Ludwig10.2

Employment
    Agreement  James Armstrong10.3

Employment
    Agreement  Thomas Overwijn10.4

Subordinated Promissory Note dated
    March 8, 2005 (incorporated by reference from 8-K filed
    March 11, 2005)10.5

Financing and Security Agreement
    date March 8, 2005 by and among Optelecom, Europe Limited,
    NKF B.V., and Inc., Optelecom UK Electronics I bena
    Manufacturers and Limited, Optelecom S.L., NKF Traders Trust
    Electronics, Company (incorporated by reference from 8-K filed
    March 11, 2005).21

List of Subsidiaries23.1

Consent of Grant Thornton
    LLP  Independent Registered Public Accounting
    Firm31.1

Certification of Chief Executive
    Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
    of 200231.2

Certification of Chief Financial
    Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
    of 200232

Certification Pursuant to
    18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002  48




---



##### 



SIGNATURES    OPTELECOM-NKF, INC.
  By:
    /s/  Edmund
    Ludwig    Director and President and CEO
      OPTELECOM-NKF, INC.By

/s/  Edmund
    LudwigEdmund
    LudwigDirector and President and CEO

Date: March 30, 2006By

/s/  James
    ArmstrongJames
    ArmstrongExecutive VP, CFO, Chief Operating Officer North American
    Operations

Date: March 30, 2006By

/s/  Thomas
    OverwijnThomas
    OverwijnExecutive VP, Chief Operating Officer European Operations

Date: March 30, 2006By

/s/  Carl
    Rubbo, JrCarl
    Rubbo, Jr.Director

Date: March 30, 2006By

/s/  David
    R. LipinskiDavid
    R. LipinskiDirector

Date: March 30, 2006By

/s/  Robert
    UrsoRobert
    Urso Director

Date: March 30, 2006By

/s/  Walter
    R. Fatzinger, Jr.Walter
    R. Fatzinger, Jr.Director

Date:  March 30, 2006  49




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##### 



SCHEDULE II  OPTELECOM-NKF,
    INC.
   SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
    FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
  Balanceat


Charges to





BalanceBeginning


Costs and





at Endof Period


Expenses


Deductions


of PeriodYear Ended December 31, 2005:Reserves and allowances deducted
    from asset accounts:Obsolescence reserve for inventory

$
93,132


$
341,039


$



$
434,171Allowance for uncollectible
    accounts receivable


143,194



411,275







554,469Year Ended December 31, 2004:Reserves and allowances deducted
    from asset accounts:Obsolescence reserve for inventory

$
279,991


$
120,079


$
(306,938
)1

$
93,132Allowance for uncollectible
    accounts receivable


102,084



41,110







143,194Year Ended December 31, 2003:Reserves and allowances deducted
    from asset accounts:Obsolescence reserve for inventory


303,996



266,412



(290,417
)1


279,991Allowance for uncollectible
    accounts receivable


156,439



77,350



(131,705
)2


102,084Valuation allowance for deferred
    tax assets


1,449,630







(1,449,630
)3


   1
 2
 3
 50