Use these links to rapidly review the documentTABLE OF CONTENTS Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2009

Commission file number 0-8828

OPTELECOM-NKF, 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o    No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o    No ý

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 ý    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).Yes o    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§ 229.405 of this
chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of "large accelerated filer", "accelerated filer", and "smaller reporting company" in Rule 12b-2 of the Exchange Act: (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o (Do not check if a
smaller reporting company)

Smaller Reporting Company ý


Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o    No ý

At June 30, 2009, 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 $14,034,239 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 12, 2010, the registrant had outstanding 3,676,006 shares of Common Stock, $.03 Par Value.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2010 Annual Meeting of Shareholders are incorporated by reference into Part III.



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OPTELECOM-NKF, INC.  FISCAL YEAR 2009 FORM 10-K ANNUAL REPORT



TABLE OF CONTENTS



Item

Description

Page
NumberPART IItem 1

Business


3Item 1A

Risk Factors


8Item 1B

Unresolved Staff Comments


13Item 2

Properties


13Item 3

Legal Proceedings


13PART IIItem 4

Market for Registrant's Common Stock and Related Stockholder Matters and Issuer Purchases of Equity Securities


14Item 5

Selected Consolidated Financial Data


15Item 6

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


15Item 6A

Quantitative and Qualitative Disclosures About Market Risk


24Item 7

Financial Statements and Supplementary Data


25Item 8

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure


49Item 8A(T)

Controls and Procedures


49Item 8B

Other Information


50PART IIIItem 9

Directors, Executive Officers and Corporate Governance


50Item 10

Executive Compensation


50Item 11

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters


51Item 12

Certain Relationships and Related Transactions and Director Independence


51Item 13

Principal Accountant Fees and Services


51PART IVItem 14

Exhibits and Financial Statement Schedules


51Signatures


53


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PART I

FORWARD LOOKING STATEMENTS

Statements in this Form 10-K that are in the future tense, and all statements accompanied by terms such as
"believe," "project," "expect," "estimate," "assume," "intend," "anticipate," and variations or similar terms are intended to be "forward-looking statements" as defined by federal securities law.
Forward-looking statements are based upon assumptions, expectations, plans and projections that are believed valid when made, but that are subject to the risks and uncertainties identified below and
under the Risk Factors identified in Item 1A of this Form 10-K, that may cause actual results to differ materially from those expressed or implied in the forward-looking
statements.

The
Company intends that all forward-looking statements made will be subject to safe harbor protection of the federal securities laws pursuant to Section 27A of the Securities Act
of 1933 and Section 21E of the Securities Exchange Act of 1934.

Forward-looking
statements are based upon, among other things, the Company's assumptions with respect to:



You
should consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of predictions contained in forward-looking statements.
These forward-looking statements speak only as of the date when they are made. The Company does not undertake any obligation to update forward-looking statements to reflect events, circumstances,
changes in expectations, or the occurrence of unanticipated events after the date of those statements. In the future, the Company and its senior management may make forward-looking statements that
involve the risk factors and other matters described in this Form 10-K as well as other risk factors subsequently identified, including those in the Company's filings with the
Securities and Exchange Commission on Form 10-Q and Form 8-K.

Item 1.BUSINESS

Optelecom-NKF, Inc., manufacturer of Siqura® advanced video surveillance solutions, provides a full
range of network products based on an open technology platform that simplifies integration and installation. Our Siqura solutions offer a blend of ease of use and processing power, enabling end users
to optimize the effectiveness of their surveillance systems while reducing the total cost of ownership. Products and solutions are developed and tested for professional and mission critical
applications, such as at highway departments, airports, seaports, casinos, public transport authorities, hospitals, city

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centers,
shopping centers, military bases, and corporate and government campuses. Founded in 1972, Optelecom-NKF is committed to providing its customers with expert technical advice and
support.

The
Optelecom-NKF corporate headquarters is in Germantown, Maryland, USA, with European corporate offices in Gouda, the Netherlands, and sales or support offices covering the
Americas, France, Spain, the UK, Germany, Italy, Dubai, and Singapore.

HISTORY

Optelecom-NKF is a Delaware corporation whose business activities began in 1972 under the name Optelecom, Inc. The
Company's early business commenced with the design and delivery of specialized laser systems and fiber optic communications products for the Department of Defense and other defense related agencies 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 both commercial and government customers. We focused on providing integrated multi-media products for communicating video, audio, and other data over both copper wire and
optical network systems.

In
March 2005, we acquired NKF Electronics B.V. (NKF), a wholly owned subsidiary of Draka Holding N.V. (Draka). NKF was founded in 1981 and had accumulated extensive
expertise in fiber optic and IP/Ethernet network technologies. This expertise enabled NKF to build a broad range of communications products, ranging from fiber optic video modems and multiplexers to
Video-Over-IP network solutions. In April 2005, the Company's name was changed from Optelecom, Inc. to Optelecom-NKF, Inc. to reflect the importance
of this acquisition and new corporate structure.

The
Company has received a going concern opinion from its auditors. Its continuation as a going concern is dependent upon obtaining the financing necessary to operate its business and
pay its debt. We cannot assure you that we will be able to access any financing in sufficient amounts or at all when needed. Our inability to obtain sufficient working capital funding will have an
immediate material adverse effect upon our financial condition and our business.

ORGANIZATION, MARKETS AND PRODUCTS

The Company currently maintains its corporate headquarters in Germantown, Maryland. Our corporate structure globally integrates our
management into one functional group. We maintain operating centers in both the United States and the Netherlands under this integrated management structure, which includes research and development
(R&D), production, sales and logistics in each location.

We
are a global supplier of network video equipment, including video codecs and servers, fiber optic systems, network video recorders, Ethernet switches and video management software. We
are a customer and product focused company with a flexible philosophy based on providing companies and governments across the world with top quality solutions for traffic management and security
surveillance.

Optelecom-NKF
is committed to providing its customers with competitively priced, highly reliable, quality equipment and solutions, along with outstanding technical advice and
support. All products are developed and tested for real applications, particularly those that need to operate in challenging environmental conditions and across large distances between individual
transmission sites. We are ISO 9001:2008 certified and dedicated to the ongoing improvement of our products and processes, applying a high level of quality monitoring to increase customer
satisfaction.

We
sell our products worldwide through direct sales, commercial integrators and resellers. Management expects the primary sales channel to continue to be the commercial integrator with
an

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increasing
emphasis on developing key accounts on a direct basis. In addition, several vendors incorporate the Company's products in their product offerings allowing the Company to penetrate markets
we do not address directly.

The
Company continues to focus its resources on developing additional IP products, sales and distribution channels. Service and technical support programs are in place to attract and
maintain a large network of integration companies. The Company primarily attracts new customer contacts through participation in trade shows in both the security and traffic markets and through
business development efforts with sales representatives. Our web site (www.optelecom-nkf.com) enables the convenient and rapid dissemination
of information by our distribution channel personnel and other interested parties who gather information necessary to select our equipment.

The
Company has expanded its focus to identify prospects that have a requirement for complete IP-video solutions including the Company's video codecs, Ethernet network
equipment, network video recorders and video management software as well as a broad range of pre and post sales services such as design, detailed engineering and training. Internal training programs
have been implemented to expand the in-depth knowledge of our worldwide sales and support offices.

We
strive to continue improving our position as a producer and supplier of powerful, intelligent network video solutions by providing reliable products and services that enable customers
around the world to reduce their total cost of ownership and enhance the effectiveness of their applications. Products for these markets are classified into the two broad categories of Video over IP
and Video over Fiber. Our products are marketed and sold under the Siqura brand name.

The
Video over IP solutions product line includes video servers / codecs, IP cameras, Ethernet switches, recording and storage equipment. Also, to bring together these hardware
components, Siqura software solutions help the user consolidate a complete video network under one, easy-to-use management platform.

The
Video over Fiber product line is comprised of the MC Series and the 9000 Series. The MC Series is designed for most common fiber applications and is recognized for its exceptional
price-performance ratio. The 9000 Series is designed for the more complex and demanding Video over Fiber applications. The availability of 18 different wavelengths and the unique concept of using
"option modules" are the core elements behind the versatility of the 9000 Series. The 9000 Series is about customization: wavelength availability and system functionality facilitate a wide range of
fiber network configuration possibilities.

Video over IP solutions

Codecs/Servers for High-quality Video Compression

The Optelecom-NKF line of Siqura video codec/server portfolio ranges from cost-effective, low bandwidth compact
video servers to field-hardened, versatile codec platforms. Our single- and multi-channel codecs/servers are available in MJPEG, MPEG-4, MPEG-2 as well as H.264 video
compression formats.

Optelecom-NKF's
video codec/servers are designed with a strong focus on standardization. Its embedded Open Streaming Architecture (OSA) offers standardized streaming of video and remote
control. All streaming protocols are based on approved standards and tested with different industry vendors. A comprehensive HTTP application programming interface gives access to all controls and
allows integration with third party Video Management Systems.

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Cameras

Optelecom-NKF Siqura cameras address the requirements of today's CCTV security systems.
State-of-the-art camera technology in combination with our MPEG-4 compression algorithm results in crystal clear streaming video. The Siqura portfolio
of cameras consists of boxed cameras, fixed dome cameras, mini-dome cameras, and high-speed dome cameras. Available in both analog and IP versions, the Siqura camera line is
easily deployed, reliable, and feature rich.

Software Management Solutions

The Optelecom-NKF software suite ranges from single and multi-server Video Management Systems for small and medium video
surveillance applications to more sophisticated operator solutions (Operator Storage, Operator Office, and MX Viewer Lite) to support more system critical video
surveillance applications. The suite also includes a comprehensive development kit (MX SDK) for integration with third-party
software applications. In addition, versatile management and configuration tools are available for maintenance and service purposes. All components within the software suite interoperate seamlessly
with all Siqura components.

Network Video Recording (i-NVR)

The Siqura-NVR provides an intelligent network video storage solution designed to support the most demanding video
surveillance applications in which operational availability and reliability are key. Ranging from 8- to 64-channel configurations with full RAID-5 capability, the
Siqura-NVR offers an extended set of features for scheduled continuous recording and event-driven operations (i.e., video motion detection) in support of alarm recording, etc.
Special care has been given to selecting hardware, such as the hard drives and power supply redundancy, to ensure reliable 24/7 operation.

Video Network Equipment

Part of Optelecom-NKF's portfolio includes field-hardened network equipment consisting of Gigabit Ethernet switches, Fast Ethernet
switches, and models with built-in video encoders. The switches are both mechanically and electrically compatible with Optelecom-NKF's MC series 19-inch power supply
rack, offering cost-efficient, easy-to-maintain hybrid network solutions.

Video over Fiber Optics

MC Series

The MC series of Optelecom-NKF products is specifically designed for safety, security, and transportation applications.
With its compact design and its carefully
selected combinations of video, data, and audio channels, the MC series offers a full range of simple to install, cost-effective priced point-to-point fiber optic
video surveillance solutions.

9000 Series

The 9000 series of Optelecom-NKF products is specifically tailored to support government and transportation applications.
With its modular design and ability to utilize Coarse Wavelength Division Multiplexing (CWDM) drop and insert technology, the 9000 series offers maximum flexibility and scalability by combining any
number of video, data, and audio channels. In addition, all 9000 series system modules are supported by a remote network management capability (9900- NMS), which offers users the ability
to remotely manage optical wavelengths and overall system performance.

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Electro Optics Products

In addition to our two primary product categories of Video over IP and Video over Fiber Optics the Company operates an Electro Optics
(EO) group focused on Interferometric Fiber Optic Gyro coils and manufacturing innovative optical devices, primarily to U.S. government defense industry customers. In EO, emphasis has been placed on
fabrication of precision-wound coils of optical fiber used as the sensing elements of fiber optic gyroscopes. EO 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. EO represented 2% of the Company's revenue in 2009.

RESEARCH AND DEVELOPMENT

In recent years the Company has focused on the development of products being applied to the IP Video marketplace. These products may
permit us to increase our penetration of the markets we serve and expand into new markets. In previous years the Company increased its
research and development staffing and used these additional resources to continue expanding its existing IP product lines. Our research and development expense is classified as a component of
Engineering in our financial statements and for the years ended 2009 and 2008 was $4.1 million and $5.5 million respectively.

Although
the Company holds a limited number of patents relating to optical sensor technology and optical fiber networks, our business is not materially dependent upon ownership of any
one patent or group of patents. We do not license any patents from third parties and we assign no value to patents in our financial statements.

QUALITY MANAGEMENT SYSTEM

The Company maintains a Quality Management System fully compliant with ISO9001:2008 and maintains an ongoing certification to this
standard. In keeping with our continuous improvement objectives, we continually implement enhancements to our quality performance metrics which track internal product defects,
out-of-box failures, customer concerns, product repairs and new product introduction issues. With the goal of increasing customer satisfaction, management has continued to
stress the importance of the Quality Management System and continues to utilize numerous quality tools, including a corrective action process, internal quality control audits and senior management
reviews. Additionally, the Quality Management System provides for proper controls, conducts material review meetings, performs Mean Time Between Failure calculations to determine product reliability
and works closely with suppliers to reduce incoming material defects. The U.S. and Netherlands-based facilities synchronize quality processes by standardizing many company-wide procedures.

In
keeping with our Company's commitment to quality products and services we adhere to the following corporate quality policy: Quality is the responsibility of every
Optelecom-NKF employee and focuses on everything we do to maintain our competitive edge. Our commitment to quality includes a customer focus, individual ownership for quality, measurement
and feedback systems, maintaining an ISO 9001:2008 compliant quality management system, and continual review of our quality objectives.

MANUFACTURING

Both the US and the Netherlands-based facilities perform routine and specialized manufacturing, assembly, and product testing
functions. 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 quality inspections along with optical and electrical testing. Raw materials and supplies used in
our business include sheet metal, 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,

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availability
is presently not a significant factor in our ability to provide products. However, suppliers have generally reduced inventory levels as a result of the economic downturn which can cause
delays in the Company receiving certain components. In 2009, we continued to focus on decreasing the manufacturing defect rate, making throughput cycle-time improvements, and striving
toward work-in-progress (WIP) reductions as the result of embracing lean concepts. This progress is all part of continuous, long-term improvement efforts.

COMPETITION

We compete with other companies of roughly equal size that have similar or more resources as well as with much larger companies with
greater resources. Our competitors include many privately held companies and some public corporations. The Company historically competes in two primary market segments, traffic monitoring and security
surveillance. The competition in these markets often has established mature sales channels that allow for continued market penetration in both domestic and international markets. Management believes
that the expansion of the Company's IP product offering through its sales and distribution channels worldwide will be the basis for future development.

SEASONALITY

The Company'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 budgets. We are also impacted in areas with colder climates as some outdoor projects are planned to avoid the winter months. This seasonality has often resulted in historically
lower levels of revenue in the first half of the year when compared to revenue in the second half of the year.

EMPLOYEES

At December 31, 2009, the Company had 160 full time equivalent employees worldwide, including 48 in manufacturing, 55 in sales
and marketing, 33 in research, development and engineering, 3 in Electro Optics, and 21 in general management, quality management, finance and administration. We expect a decrease in headcount over
the next 12 months.

CORPORATE

The Company's principal executive offices are located at 12920 Cloverleaf Center Drive, Germantown, MD 20874. The Company's telephone
number is (301) 444-2200. Our home page on the Internet iswww.optelecom-nkf.com. The Company makes web site content
available for informational purposes, which is not incorporated by reference into this Form 10-K.

Item 1A.RISK FACTORS

Fluctuations in financial performance and recent losses could harm our ability to increase revenue and become profitable.

We have experienced and may continue to experience fluctuations in our quarterly and annual operating results. For the year ended
December 31, 2009, our financial performance included lower levels of revenue and gross profit compared to the year ended December 31, 2008. Our revenue declined approximately 20% during
the year while gross profit declined from $27.2 million to $20.7 million. Factors that may cause operating results to vary and negatively impact our ability to become profitable include,
but are not limited to, the shift by our customers from fiber optic to IP products, the need to transition our U.S. sales model to respond to the market shift to IP products, changing technology, new
product transitions, delays in new product introductions, competition, shortages of system components, changes in the mix of products and services sold, economic factors, and timing of planned
expenditures in facilities and research and development. The current economic

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environment
is marked by significant instability and continued economic weakness may be expected for the near future. As a result of the impact of these and other factors, we may not be able to become
profitable in the near future and 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, our business, financial condition, and operating results could be adversely affected if we do not achieve
increased revenues.

We may not be able to continue as a going concern.

Our financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. We have not made any adjustments to our financial statements as a result of the going concern modification to the report of our
independent registered public accounting firm. If we become unable to continue as a going concern, we could have to liquidate our assets, which means that we are likely to receive significantly less
for those assets than the values at which such assets are carried on our financial statements Any shortfall in the proceeds from the liquidation of our assets would directly reduce the amounts, if
any, that holders of our common stock could receive in liquidation.

There
can be no assurance that our plans will be successful, and other unforeseeable actions may become necessary. Any inability to obtain financing or raise capital may require us to
reduce the level of our operations. Such actions would have a material adverse effect on us, our business, and operations and result in charges that would be material to our business and results of
operations.

Our current capital may not provide the funds necessary for our short and long-term cash requirements and we may not be able to secure additional funding.

Our current capital resources including operating cash flows may not generate the funds needed for our short and long-term
cash requirements. Accordingly, we would be required to seek additional funding. In those circumstances, we would look to increase our debt 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 development, sales and marketing, and overhead costs or potentially be unable to make debt
payments or meet other obligations.

The current economic environment has had a negative impact on our business and we may be required to restructure our operations.

During 2009, our business experienced the effects of negative macroeconomic conditions, further aggravated by customer specific
challenges and disruptions in the financial and credit markets globally. The affects on our business is spread across our customer segments and geographies with a particular focus in the U.S.
Uncertainty around current macroeconomic and industry conditions persists, particularly the effect these conditions and a sustained lack of liquidity in the capital markets will continue to have on
the capital spending of our customers. We are uncertain of the impact this may have in future periods on the spending or financial position of our customers. We can not be certain how long these
conditions will continue and the magnitude of their effects on our business and results of operations. Consequently, these conditions have negatively affected our business and made our forecasting and
planning more difficult. We expect the near term market conditions to be challenging and we continue to seek longer term market opportunities.

During
this period of uncertainty, we plan to balance our strategy of continued product development and manage our workforce and operating costs carefully to ensure that they are aligned

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with
our business and market opportunities. To that end, during 2009 and 2008, we effected staff reductions and we continue to explore additional organizational changes and staff reductions that will
allow us to better manage our operations and reduce operating costs. These organizational changes increase the risk that objectives will not be met due to the allocation of valuable limited resources
to implement changes. Further, due to the uncertain nature of any of these undertakings, these efforts may not be successful and we may not realize anticipated benefits from these efforts.

We issued $23.1 million of senior and subordinated notes in connection with our acquisition of NKF.

In connection with the acquisition of NKF, we issued $23.1 million of senior and subordinated notes. The issuance of these notes
substantially increased our principal payment obligations and we may not have enough cash to repay the notes when due. By incurring indebtedness, the related risks that we face intensify. The degree
to which we are leveraged could materially and adversely affect our ability to successfully obtain financing for working capital or other purposes and could make us more vulnerable to industry
downturns and competitive pressures. The current economic environment is marked by limited availability of credit in the business sector and we may be required to pursue equity or other financing, if
available at all, to refinance the acquisition debt on less than favorable terms. At December 31, 2009, we have an outstanding balance of $14.7 million on this debt. The senior note of
$1.9 million was paid in full in March 2010 and the subordinated note is due in full on March 8, 2011.

Our obligations under the promissory note issued to Draka Holding N.V. in connection with the acquisition of NKF are secured by the majority of our assets.

On March 5, 2010, we entered into an amended and restated subordinated promissory note with Draka Holding N.V., pursuant
to which Draka agreed to extend the term of the note to March 8, 2011. The current principal amount under the note is €9.1 million Euros ($12.5 million at the
prevailing exchange rate on the transaction date). Our obligations under the note are secured by the assets of the Company and a pledge of 65% of the shares of Optelecom-NKF
Holding B.V., our holding company in The Netherlands. Fair value of this 65% approximates $14.0 million at December 31, 2009. We do not expect to be able to generate sufficient
cash from operations to pay the note when it becomes due. Accordingly, if we are unable to secure financing or equity to refinance the note, Draka could foreclose on its security interest and
liquidate the assets securing our obligations under the note.

The loss of one or more of our major customers could adversely affect our business, financial condition and operating results.

For the year ended December 31, 2009, approximately 20% of our revenues were accounted for by sales to five commercial
customers. This is similar to the prior year when five customers represented 29% 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 projects, our business, financial condition and operating results could be materially and
adversely affected. There can be no assurance that 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 our business, financial condition and operating results.

We face significant competition for our products and any failure to remain competitive would harm our operating results.

The markets in which we sell our products are highly competitive and characterized by rapidly changing technologies. We face
significant competition from a large number of domestic and international competitors, some of which are larger and have larger product development, research and

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sales
staffs. To remain competitive in both the current and future business climates, we believe we must maintain a substantial commitment to research and development. 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 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, or that we 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 new products could have a material adverse effect on our business, financial condition and operating results and our efforts to remain competitive.

Our management structure is globally integrated.

Our corporate structure globally integrates the management functions into one group to address the continually changing technology
trends within the industry. The Company was previously established as individually and separately-managed units at our U.S. global headquarters and European operating facilities. Global integration
includes product development, manufacturing, sales processes, finance and information technology. The challenges involved in this structure include the following:



If we fail to attract and retain key personnel, our business could suffer.

Our future depends, in part, on our ability to attract and retain key personnel. We may not be able to hire and retain personnel at
levels consistent with our existing compensation and salary structure. Our future also depends on the continued contributions of our executive management team and other key management, and technical
personnel, many of whom could be difficult to replace. The loss of service from these or other executive officers or key personnel or the inability to attract qualified personnel could have a material
adverse effect on our business.

Our common stock price is volatile, we have never paid dividends and our stock is subject to future dilution.

Our Common Stock currently trades on the NASDAQ Global 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 may in the future be, especially volatile. Announcements of technological innovations or new products of the Company or our competitors, developments or disputes concerning
proprietary rights, publicity regarding products under development by the Company 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

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operating
and product development results, may have a significant impact on the market price of our Common Stock.

We
have not paid any cash dividends since our inception and we do not anticipate paying any cash dividends in the foreseeable future. In addition, dilution will occur upon the exercise
of outstanding stock options or issuance of additional stock. Further dilution could be significant if we experience additional requirements to fund operations and decide to complete a future equity
financing.

We face a number of risks related to the ongoing financial crisis and severe tightening in the global credit markets.

The ongoing global financial crisis affecting the banking system and financial markets has resulted in a severe tightening in the
worldwide credit markets, a low level of liquidity in many financial markets and extreme volatility in credit and equity markets. This financial crisis could impact the Company's business in a number
of ways, as further discussed above and including:



We face risks related to our international operations and revenue.

Our customers are located throughout the world. In addition, with the acquisition of NKF, we have significant international operations
including manufacturing, product development, sales and customer support operations. Our operations outside North America are primarily located in the Netherlands. Our international presence exposes
us to certain risks, including the following:



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Net
revenue from International and U.S. based business accounted for 72% and 28%, respectively, of the Company's total revenue in 2009. Within the U.S. based business sales to customers
in Canada, South and Central America were 12% in 2009. We expect that revenue from customers outside the United States will continue to account for a significant portion of our total net revenue.

If we fail to manage our exposure to worldwide financial markets successfully, our operating results could suffer.

We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. We do not use
derivative financial instruments to manage these risks. A portion of our net revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, our European operations conduct
a substantial portion of their activities in other currencies, primarily Euros. A significant change in interest rates or movement in the Euro compared to the U.S. Dollar impacts our operations and
financial position.

If we are unable to generate new sales and return to profitability, our business and our financial condition and results of operations will be adversely impacted.

Our lack of profitability in certain periods may impact our ability to attract customers, employees, investors and creditors. Our
ability to sustain profitability in future periods will depend in large part on our ability to maintain current customers and generate new sales, to maintain or improve our rate of manufacturing
utilization, and to manage sales, product development, and general and administrative expenses in proportion to our revenue. We cannot be certain that we will generate profits in the future and a
failure to do so would have a material adverse effect on our business and our ability to operate. Our profitability and cash flow constraints are particularly emphasized in our U.S. operations where
our recent sales levels underscore the need to succeed with the implementation of product advancements and sales improvements and maintain cost controls.

Item 1B.UNRESOLVED STAFF COMMENTS

The Company has no unresolved comments from the Securities and Exchange Commission.

Item 2.PROPERTIES

The Company's corporate headquarters and U.S. manufacturing facility is located at 12920 Cloverleaf Center Drive, Germantown, Maryland,
where it leases 30,000 square feet of space, substantially all of which is occupied by the Company. The lease expires in August of 2013. We maintain a corporate office and manufacturing facility in
Gouda, the Netherlands where we lease approximately 36,000 feet of space, all of which we fully occupy. This lease expires in March of 2015.

The
Company also maintains office space in Spain, France, Singapore and Dubai. Management believes that our facilities, which have been specifically designed and fitted to accommodate
our requirements, are sufficient to meet our current and anticipated near-term growth needs.

Item 3.LEGAL PROCEEDINGS

None.

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Table of Contents

PART II

Item 4.MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company's Common Stock, representing its only class of publicly traded securities, is traded on the NASDAQ Global Market under the
symbol OPTC. The following are the highest and lowest closing bid prices for the Common Stock as reported by NASDAQ during each
quarter for the two years ended December 31, 2009 and 2008, respectively. These quotations may not necessarily reflect actual transactions:

Bid PriceQuarter Ended

High

LowDecember 31, 2009

$
4.22

$
1.92September 30, 2009


4.69


3.13June 30, 2009


4.89


3.07March 31, 2009


5.02


3.05December 31, 2008


6.75


3.76September 30, 2008


8.85


6.30June 30, 2008


8.96


6.60March 31, 2008


8.33


6.57


At
March 12, 2010, the closing price of our Common Stock was $2.55.

There
were 3,676,006 shares of Common Stock outstanding as of March 12, 2010, and 470 record holders as of such date. The Company has never declared or paid any cash dividends on
its Common Stock and does not expect to do so in the foreseeable future. The Company intends to use any future earnings to finance its operations or repay its debt obligations.

The
following is information on the Company's equity compensation plans as of December 31, 2009.

Plan Category

Number of Securities
to be Issued Upon
Exercise of Outstanding
A

Weighted Avergage
Exercise Price of
Outstanding Options
B

Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding
Securities Reflected in
Column A)
CEquity compensation plans approved by security holders


469,345

$
8.84


458,485Equity compensation plans not approved by security holdersTotals


469,345

$
8.84


458,485


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Item 5.SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected historic consolidated financial data for the periods and dates indicated. This information is
derived from the Company's audited consolidated financial statements. The information set forth below is qualified in its entirety by, and
should be read in conjunction with, the consolidated financial statements, the related notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations.

Year Ended December 31,

2009

2008

2007

2006

2005Revenues, net


36,177


45,165


42,503


39,484


33,865Net (loss) income


(2,396
)

(1,756
)

1,281


1,554


2,682Basic (loss) earnings per common share


(0.66
)

(0.48
)

0.37


0.45


0.83Diluted (loss) earnings per common share


(0.66
)

(0.48
)

0.37


0.44


0.80As of December 31,Total assets


41,188


47,148


49,963


46,274


38,868Long-term obligations


14,519


13,787


17,749


17,833


18,787Stockholders' equity


19,815


21,191


23,101


17,943


11,754


Item 6.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Optelecom-NKF, Inc., manufacturer of Siqura® advanced video surveillance solutions, provides a full
range of network products based on an open technology platform that simplifies integration and installation. Our Siqura solutions offer a blend of ease of use and processing power, enabling
end-users to optimize the effectiveness of their surveillance systems while reducing the total cost of ownership. All products and solutions are developed and tested for professional and
mission-critical applications, such as at highway departments, airports, seaports, casinos, public transport authorities, hospitals, city centers, shopping centers, military bases, and corporate and
government campuses.

Founded
in 1972, all Optelecom-NKF IP surveillance solutions are marketed under the Siqura® name. Our corporate headquarters is in Germantown, Maryland, USA, with
European corporate offices in Gouda, the Netherlands, and sales offices or support covering the Americas, France, Spain, the UK, Germany, Italy, Dubai, China and Singapore.

Optelecom-NKF
provides competitively priced, highly reliable, top quality equipment and solutions, along with technical advice and support. All products are developed and
tested for real
applications, particularly those that need to operate in challenging environmental conditions and across large distances between individual transmission sites. We are ISO 9001:2008 certified
and dedicated to the ongoing improvement of our products and processes, applying a high level of quality monitoring to increase customer satisfaction.

We
sell our products worldwide through direct sales, commercial integrators and resellers. Management expects the primary sales channel to continue to be commercial integrators with an
increasing emphasis on developing key accounts on a direct basis. In addition, several vendors incorporate the Company's products in their product offerings allowing the Company to penetrate markets
we do not address directly.

The
Company continues to focus its resources on developing additional IP products, sales and distribution channels. Service and technical support programs are in place to attract and
maintain a large network of integration companies. The Company primarily attracts new customer contacts through business development efforts and participation in trade shows in both the security and
traffic markets. Our web site (www.optelecom-nkf.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.

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Table of Contents

The Company has expanded its focus to identify prospects that have a requirement for complete IP-video solutions including the Company's video codecs,
Ethernet network equipment, network video recorders and video management software as well as a broad range of pre and post sales services such as design, detailed engineering and training. Internal
training programs have been implemented and additional personnel hired to expand the in-depth knowledge of our worldwide sales and support offices.

We
strive to continue improving our position as a producer and supplier of powerful, intelligent network video solutions by providing reliable and profitable products and services that
enable customers around the world to reduce their total cost of ownership and enhance the effectiveness of their applications. Products for these markets are classified into the two broad categories
of Video over IP and Video over Fiber.

Video
over IP solutions include video servers / codecs, IP cameras, Ethernet switches, recording and storage equipment. Also, to bring together all these hardware components, Siqura
software solutions, Operator Office and the Optelecom-NKF SDK, help the user consolidate a complete video network under one, easy-to-use management
platform.

The
Video over Fiber product line is comprised of the MC Series and the 9000 Series. The MC Series is designed for most common fiber applications and is recognized for its exceptional
price-performance ratio. The 9000 Series is designed for the more complex and demanding Video over Fiber applications. The availability of 18 different wavelengths (CWDM technology) and the unique
concept of using "option modules" are the core elements behind the versatility of the 9000 Series. The 9000 Series is about customization: wavelength availability and system functionality
facilitate a wide range of fiber network configuration possibilities.

In
addition to our two primary product categories of IP and Fiber Optics the Company operates an Electro Optics (EO) group focused on Interferometric Fiber Optic Gyro coils and
manufacturing innovative optical devices under contract, primarily to U.S. government defense industry customers.

Effect of Recent Market Conditions and Uncertain Macroeconomic Environment on our Business

Through the twelve months ended December 31, 2009, our financial performance included lower levels of revenue and gross profit
compared to the year ended December 31, 2008. Our revenue declined 20% during the year while gross profit declined from $27.2 million to $20.7 million resulting in a net loss of
$2.4 million. During 2009, our business experienced the effects of negative macroeconomic conditions, further aggravated by customer specific challenges and disruptions in the financial and
credit markets globally. The affects on our business are spread across our customer segments and geographies with a particular focus in the U.S.

Uncertainty
around current macroeconomic and industry conditions persists, particularly the effect these conditions and a sustained lack of liquidity in the capital markets will continue
to have on the capital spending of our customers. We are uncertain of the impact this may have in future periods on the spending or financial position of our customers. We can not be certain how long
these conditions will continue and the magnitude of their effects on our business and results of operations. Consequently, these conditions have negatively affected our business and made our
forecasting and planning more difficult. We expect the near term market conditions to be challenging and we continue to seek longer term market opportunities.

During
this period of uncertainty, we plan to balance our strategy of continued product development and manage our workforce and operating costs carefully to ensure that they are aligned
with our business and market opportunities. To that end, during 2009 and 2008, we effected staff reductions which resulted in restructuring charges of approximately $127 thousand and
$525 thousand, respectively, in severance costs.

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Table of Contents

Our
continuation as a going concern is dependent upon obtaining the financing necessary to operate the business. If we cannot find sources of additional financing to fund our working
capital needs, we will be unable to obtain sufficient capital resources to operate the business. We continue to work toward refinancing our debt obligations which come due in March 2011. However,
there is no guarantee that financing will be available for all or part of our outstanding debt. As a result, the Company announced it has authorized its investment banker, Seale & Associates,
to expand its role and conduct a broad evaluation of strategic options.

RESULTS OF OPERATIONS

Revenue for 2009 was $36.2 million, a decrease of 20% when compared to 2008. Information regarding the Company's U.S. and
international based operations is included in the following table. For the purposes of this table and the following discussion, revenue classified as U.S. based includes Canada, Central and South
America.:

2009

2008(Dollars in thousands)

U.S.

International

Total

U.S.

International

TotalRevenue

$
10,021

$
26,156

$
36,177

$
14,854

$
30,311

$
45,165Less: Cost of Goods Sold


4,653


10,816


15,469


6,471


11,467


17,938Gross Profit

$
5,368

$
15,340

$
20,708

$
8,383

$
18,844

$
27,227Less: Operating Expenses


8,420


14,042


22,462


9,627


15,147


24,774(Loss) Income from Operations

$
(3,052
)
$
1,298

$
(1,754
)
$
(1,244
)
$
3,697

$
2,453


Our
international operations include the impact from foreign currency translation. On average, the Dollar was stronger in 2009 with an average exchange rate to the Euro of 1.39 compared
to 1.47 in 2008. The result of a strengthening Dollar as it relates to our consolidated financial results is that we translated Euro and Pound Sterling sales and related expenses at proportionally
lower U.S. Dollar equivalents.

Overall,
2009 revenue from our international operations accounted for 72% of total revenue. Revenue in our European based operations decreased 14% to $26.2 million while
international operating expenses decreased 7% during the year. The result is a 65% decrease in international operating profits which totaled $1.3 million in 2009. Excluding the impact of
foreign exchange rates the international revenue decrease would have been 8% while the operating expenses would have decreased 2%. Our strongest region is Northern Europe representing almost 36% of
the Company's worldwide revenue.

Revenue
in our U.S. based operations totaled $10.0 million in 2009 representing a 33% decline from 2008. U.S. operating expenses decreased 13% during the year. The result is an
increased U.S. loss from operations in 2009 totaling $3.1 million. The U.S. business continues to be negatively impacted by a number of factors including the macro economic environment, a sales
model that is often dependent upon third party representatives and dependence on a shrinking legacy fiber optic product market. The Mid-Atlantic, Northeast and Southeast collectively
represent about 68% of the total U.S. business.

Revenue
by product category in the recent two year period was:

(Dollars in thousands)

2009

2008Fiber Optic

$
21,450

$
29,891IP Video


13,921


14,539Electro Optics


806


735Total Revenue

$
36,177

$
45,165


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The
Company continues a transition to accommodate an industry-wide shift from video transmission over fiber optics to video over IP/Ethernet based solutions. Fiber Optic
products sales in 2009 were down 28% to $21.4 million. This decline accelerated in the current period due to the market shift away from Fiber Optic and toward IP Video products and overall
weakness in the economy. In prior years, the Company has invested in IP Video products. However, in 2009 there was a decrease of 5% in IP related revenue over 2008 due to slow U.S. sales and an
overall weak macro environment.

Consolidated
gross profit was $20.7 million or 57% of revenues for the year ended December 31, 2009, compared to $27.2 million or 60% of revenues in 2008. The gross
profit percentage was at the low end of the Company's ongoing target of 57 to 59 percent. The decline in our gross profit margin was primarily from excess capacity in our manufacturing
facilities due to lower than expected sales volume. Gross profit was down $6.5 million and 24% in total as a result of the revenue decline. Excluding the impact of foreign exchange rates the
consolidated gross profit margin decreased $5.5 million. The current year decrease is directly attributable to the decline in revenues and somewhat offset by efficiency realized in our
manufacturing processes.

The
gross profit margin in our U.S. business was 54% in 2009 compared to 56% in 2008. This decline was caused by the reduced volume of sales during 2009. The gross profit margin in our
international business was 59% in 2009 compared to 62% in 2008 with the reduction also primarily driven by lower sales volume. Lower revenue levels result in relatively higher costs of goods sold as
the costs for personnel in direct labor positions and other fixed overhead costs are spread over a smaller revenue base.

Our
operating expense decreased during 2009 to $22.5 million from $24.8 million in 2008. The $2.3 million operating expense decline in 2009 includes savings from
reduction in personnel related costs totaling $1.2 million and savings from other cost reduction efforts totaling $1.1 million. The current year decrease of $2.3 million includes
a reduction of costs in the sales and marketing function totaling $354 thousand, reductions in engineering totaling $1.3 million and reductions in general and administrative costs of
$617 thousand. The decrease in operating expenses in 2009 was offset by a $127 thousand charge for severance accruals as we completed a reduction in force in the third quarter which
included sales, manufacturing, engineering and administrative personnel. The Company's actions have included changing or replacing certain U.S. sales personnel as we address a reduction in U.S.
revenue and a market shift from fiber optic to IP products. In addition, we continue to transition our U.S. sales model and reorganize our sales channels to place greater emphasis on developing and
supporting key accounts.

OTHER INCOME (EXPENSE)

Other expense declined in 2009 to $841 thousand compared to a total of $996 thousand in 2008. Substantially all of our
other expense is from interest expense and foreign exchange losses. Interest expense on notes payable was $808 thousand in 2009 compared to $858 thousand in 2008 as we paid down our bank
term debt during the year. Our foreign exchange loss in 2009 was $38 thousand compared to a loss of $262 thousand in 2008 as a result of larger foreign exchange rate fluctuations in
2008.

In
June 2008, the Company implemented a new European holding company structure in the Netherlands. The restructuring included the transfer of our Dutch operating subsidiary
(Optelecom-NKF B.V.) from the U.S. parent company to the new European holding company. Consideration for the transfer included an intercompany note receivable to the U.S. parent
and a corresponding note payable from the European holding company. The impact from the fluctuations in foreign exchange on the intercompany note payable is included in other income (expense).

Additionally,
there is an impact from the fluctuations in foreign exchange on the €7.3 million Euro-based subordinated note and related accrued
interest residing on the U.S. parent company's

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books
issued to Draka Holding, N.V. as part of the consideration during the acquisition of NKF. Prior to the aforementioned restructuring, the foreign exchange impact was included in
comprehensive income (loss) as the note was identified as a hedge against the investment in NKF. As a result of that investment being transferred to the European holding company, the impact from the
change in foreign exchange on the Subordinated Note and related accrued interest is now included in other income (expense).

INCOME TAXES

The provision for income taxes in 2009 was a $199 thousand benefit compared to $3.2 million expense in 2008. The lower
tax expense in 2009 was attributed primarily to the Company recording a full valuation allowance on our U.S. deferred tax assets in 2008. As a result of the full valuation allowance recorded against
the U.S. deferred tax assets, we no longer record income tax benefit related to U.S. operating losses and other U.S. deferred tax assets. Based on the weight of the positive and negative evidence and
the information available, management continued to conclude that it is not more likely than not that its U.S. deferred tax assets will be realized and therefore continued to record a full valuation
allowance on U.S. deferred tax assets as of December 31, 2009. These deferred tax assets are still available for tax purposes to offset potential U.S. taxable income in the future.

INCOME (LOSS) FROM OPERATIONS

Due to the factors described in Results of Operations, our income from operations in 2008 of $2.5 million declined to a loss
from operations of $1.8 million in 2009. Considering the lower impact of the valuation allowance on our U.S. deferred tax assets in 2008 our net loss was $1.8 million in 2008 compared to
a net loss of $2.4 million in 2009.

IMPACT OF INFLATION

Inflation did not have a significant effect on the operations of the Company during 2009 or 2008, and we do not expect it to have a
significant effect during 2010.

FINANCIAL CONDITION

At December 31, 2009, the Company had cash on hand of $4.2 million, including restricted cash of $1.9 million. The
cash is held primarily in our international business with the unrestricted portion totaling $2.3 million impacted by changes in foreign exchange rates. The $1.4 million decrease in cash
as compared to December 31, 2008, primarily resulted from our operational loss coupled with the continued payment on debt instruments.

Inventory
balances decreased during 2009 as the Company managed purchasing to revised sales forecasts. The following shows the composition of inventory for the past two years:

(Dollars in thousands)

2009

2008Production materials

$
2,948

$
4,164Work in process


236


745Finished goods


2,101


1,552Allowance for obsolescence


(942
)

(679
)Total inventories, net

$
4,343

$
5,782


The
total assets of the Company were $41.2 million at December 31, 2009, compared to $47.1 million at December 31, 2008, a decline of 13%. The Company had a
decline in cash of $1.4 million, a decline in accounts receivable of $2.1 million, and a decline in inventory of $1.4 million. The reduction in cash is the result of lower cash
flows from operating activities in 2009 combined with

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payment
of principal on loans during the period. The decrease in accounts receivable and inventory are attributable to the reduction in sales levels during 2009 compared to the later part of 2008
coupled with a concerted effort by the Company to decrease general levels of inventory and collect on accounts receivable to improve liquidity.

Total
liabilities at year-end 2009 were $21.4 million, a $4.6 million decline from year-end 2008. The decline is primarily driven by a reduction in
accounts payable, accrued payroll, taxes payable and debt outstanding. The decline in accounts payable is due to a reduction in purchases of production material associated with the decrease in revenue
as well as timing of payments. The reduction in accrued payroll is from the reduction in bonus and commission
payments in 2009 as a result of lower revenue over 2008. The decline in taxes payable is a result of tax payments made subsequent to year-end 2008 with limited tax owed in 2009 based on
operating losses. The decline in debt outstanding is due to principal payments on senior financing during 2009. In March 2010, we paid in full the senior note of $1.9 million. The subordinated
note of $12.8 million is due in March 2011 (see risk factors).

Our
stockholders' equity decreased from $21.2 million at December 31, 2008, to $19.8 million at December 31, 2009, a decline of 6%. This decrease is from a
net loss of $2.4 million in 2009 offset by an increase in additional paid-in capital of $784 thousand as a result of stock compensation expense and an increase in accumulated
other comprehensive income of $235 thousand from unrecognized foreign exchange gain as a result of the Euro and U.S. Dollar exchange rate at the balance sheet date.

LIQUIDITY AND CAPITAL RESOURCES

We have outstanding debt totaling $14.7 million at December 31, 2009. $1.9 million is due within three months of
December 31, 2009 and is therefore classified as current. The debt includes a senior term loan with a bank for $1.9 million with a balloon payment on February 28, 2010 and a
subordinated note and related deferred interest totaling $12.8 million due in March 2011. We also have a line of credit which expires on February 28, 2010 that has no outstanding balance
at December 31, 2009.

On
December 14, 2009, we entered into an amended financing agreement with our bank. Pursuant to the Amendment, the bank agreed to extend the term of the line of credit available
to the Company until February 28, 2010. In consideration for this extension, we agreed to a reduction in our revolving credit facilities to $500 thousand and also agreed to restrict
$1.9 million of cash as collateral for the term loan and revolving credit facilities. The cash collateral is restricted pursuant to a deposit account security agreement.

On
March 5, 2010, we entered into an amended and restated subordinated promissory note (the "Note") with Draka Holding N.V. ("Draka"), pursuant to which Draka agreed to
extend the term of the Note to March 8, 2011. The current principal amount under the Note is €9.1 million Euros ($12.5 million on March 5, 2010). In consideration
of Draka's agreement to extend the term of the Note, we agreed to pay Draka €155 thousand Euros ($222 thousand at December 31, 2009) under the Note and to make
quarterly interest payments on the Note at an annual interest rate of 10%. Additionally, we agreed that if we have cash on hand in excess of $2.5 million at the end of any calendar quarter, we
will pay such excess cash to Draka as a prepayment on the Note. Our obligations under the Note are secured by the assets of the Company and a pledge of 65% of the shares of Optelecom-NKF
Holding B.V., our holding company in The Netherlands. Fair value of the 65% approximates $14.0 million at December 31, 2009. We are permitted under the Note to obtain up to a
$750 thousand revolving line of credit that will be senior in priority to the Note and the Company's operating subsidiary in The Netherlands is permitted to obtain up to a $250 thousand
revolving line of credit. Immediately prior to the amendment and restatement of the Note, we paid in full the senior term loan and our line of credit facilities were terminated.

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Cash
on our balance sheet was $4.2 million at year-end, including restricted cash of $1.9 million. This cash is predominately in our European subsidiaries.
Approximately €1.0 million Euros ($1.4 million as of December 31, 2009) of the unrestricted cash may be unavailable to support debt requirements and global operations due
to cash collateral, legal and tax implications.

The
balance of our subordinated debt obligation totals $12.8 million at December 31, 2009. We continue to work through our options for refinancing this debt. In the current
credit environment the availability of senior and subordinated financing is constrained. Therefore, we negotiated with the current holder of the subordinated debt to extend the due date to March 2011.
The negative performance in recent periods combined with significant tightening of credit markets may make it unlikely that we will be able to finance a portion of or the full amount of debt owed in
March 2011. We are not likely to be able to generate sufficient cash to pay the debt in March 2011.

We
need to secure additional financing to meet these obligations and are working to secure such financing. However, the current economic environment is marked by limited availability of
credit in the business sector and we may be required to pursue refinancing of the debt on less than favorable terms, if we are able to refinance. Further, the current economic environment, as well as
concerns regarding future economic conditions, may continue to cause businesses and governments to defer or cancel purchases. If demand for our products continues to decline, it will adversely impact
our financial results and negatively impact our ability to secure additional financing. There can be no assurance that additional financing will be available in a timely manner or on acceptable terms
if it is available at all. If we are unable to extend or refinance the subordinated debt and default on repayment of the subordinated debt, the holder of the debt would have claims against
Optelecom-NKF, Inc. and its subsidiaries. The subordinated note is secured by 65% interest in our European holding company effective March 5, 2010. If we default on repayment
of the subordinated debt, this 65% interest in our European holding company would be available to the subordinated debt holder, subject to the rights of the senior debt. Fair value of this 65%
approximates $14.0 million at December 31, 2009. Should this collateral prove insufficient to satisfy the obligation then the debt holder may have claims against additional assets of the
holding company and the Company. Because cash payment of the subordinated note is unlikely, the debt holder may pursue claims against both the European holding company and the Company.

We
plan to finance our future working capital needs with our operating cash flow and use of senior credit on accounts receivable as needed. In the event these sources become insufficient
to meet funding needs, the Company may be required to scale back sales and marketing expenses, product research and
development costs, and overhead costs. Additionally, the Company would pursue additional debt or equity financing, and/or make dividend payments from its European operations. Dividends from
international operations could result in an increased tax liability and tax expense to the Company and such dividends are limited based on cash available from operations and legal restrictions.

As
discussed previously, we continue to work toward refinancing our debt obligations which come due in March 2011. However, there is no guarantee that financing will be available for all
or part of our outstanding debt. As a result, the Company announced that it has authorized its investment banker, Seale & Associates, to expand its role and conduct a broad evaluation of
strategic options.

NEW ACCOUNTING STANDARDS

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, Fair Value Measurements and Disclosures (Topic
820): Improving Disclosures about Fair Value Measurements.ASU 2010-06 requires new
disclosures and clarifies some existing disclosures regarding fair value measurements. ASU 2010-06 is effective in the first quarter of 2010.

In
October 2009, the FASB issued authoritative guidance altering the scope of revenue recognition guidance for software deliverables to exclude items sold that include hardware with
software that is

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essential
to the hardware's functionality. This authoritative guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal periods beginning on or
after June 15, 2010. Early adoption is permitted. The Company is still assessing the potential impact of adopting the new authoritative guidance.

In
October 2009, the FASB issued authoritative guidance related to the recognition of revenue for multiple-deliverable arrangements. Under the authoritative guidance, revenue may be
allocated to the different elements in an arrangement based on relative selling price using the best estimate of selling price if vendor-specific or other third-party evidence of value is not
available. This authoritative guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal periods beginning on or after June 15, 2010. Early
adoption is permitted. The Company is still assessing the potential impact of adopting the new authoritative guidance.

CRITICAL ACCOUNTING POLICIES

The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated
financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, income taxes, financing operations, warranty obligations, and
contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different
assumptions or conditions.

We
consider certain accounting policies related to revenue recognition, impairment of long lived assets, valuation of accounts receivable, inventory, income taxes and foreign currency
exchange to be critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is
discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed
discussion on the application of these and other accounting policies, see Notes to the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.

Revenue RecognitionRevenue from commercial sales is recognized when products are shipped and/or title passes pursuant to the terms of the agreement
with the customer, the amount from the customer is fixed, and collectability is reasonably assured. In the ordinary course of business, the Company warrants its products against defect in design,
materials, and workmanship over various time periods. Warranty reserve and allowance for product returns is established based upon management's best estimates of amounts necessary to settle future and
existing claims on products sold through the balance sheet date. Management evaluates the warranty reserve on at least a quarterly basis.

Impairment of Long Lived AssetsIn connection with our acquisition of NKF during 2005, the Company's long-lived assets increased
significantly primarily related to acquired goodwill and other intangibles. With respect to acquired goodwill and intangibles with indefinite lives that are not amortized, we are required to perform
an impairment test annually. This requires us to make certain difficult, subjective and complex judgments on a number of matters, including assumptions and estimates used to determine the fair value
of our reporting units. We measure fair value primarily on the basis of discounted expected future cash flows. Our estimates are based upon our historical experience, our current knowledge from our
commercial relationships, and available external

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information
about future trends. For long-lived assets with definite lives that are subject to amortization, we exercise judgment in assessing whether an event of impairment has occurred
by comparing the carrying value of these assets with the expected future cash flows generated by the assets. As of December 31, 2009, no such impairments have occurred.

Allowance for Doubtful AccountsThe Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers
to make required payments. The Company regularly monitors and assesses its risk of not collecting amounts owed by its customers. This evaluation is based upon an analysis of amounts current and past
due along with relevant history and facts particular to the customer such as collection history and the results of credit inquiries. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

InventoriesProduction materials are valued at the lower of cost or market applied on an actual cost basis. Work-in-process
and finished goods inventory includes direct labor, materials and overhead and are valued at the lower of cost or market, cost being determined using actual costs on a specific identification basis.
The Company writes down its inventory for estimated obsolescence or unmarketable inventory based upon assumptions about future demand and market conditions as well as historical inventory turnover. If
actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Income TaxesThe Company accounts for income taxes in accordance with the FASB's guidance which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. The FASB's guidance also requires that deferred tax assets
be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. We maintain
a full valuation allowance on our U.S, deferred tax assets and no valuation allowance on foreign deferred tax assets as we have historically been, and expect to be in the future, profitable in those
foreign jurisdictions.

Foreign Currency Effect on Cash FlowsThe Company prepares its statement of cash flows in accordance with FASB Accounting Standard Codification 230,
"Statement of Cash Flows". As such the Company computes the foreign currency impact on cash flows by first computing the statement of cash flows for its foreign subsidiaries using the functional
currency for that subsidiary followed by a translation of these foreign currency cash flows, using the current exchange rate at the time of the cash flows into U.S. dollars. The effect of exchange
rate changes on foreign cash balances is reported as a separate item in the reconciliation of the beginning and ending balances of cash and cash equivalents.

Item 6A.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

Market Risk

Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of
financial instruments. We are exposed to financial market risks, primarily related to changes in foreign currency exchange rates. We currently do not have any derivative financial instruments to
protect against adverse currency movements. We manage our exposure to market risks related to operations through regular operating and financing activities. All of the potential impacts noted are
based on a sensitivity analysis performed as of December 31, 2009. Actual results may differ materially.

Foreign Currency Risk

We are exposed to the fluctuations in foreign currency exchange rates. Such fluctuations impact the recorded values of our investments
in foreign subsidiaries in our consolidated balance sheet, and

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our
foreign currency translation adjustment, a component of other comprehensive income. For the year ended December 31, 2009, a 10% change in the spot exchange rate would have changed our
reported currency translation adjustment of $2.8 million by approximately $1.7 million. Additionally, fluctuations result in the remeasuring of non functional currency liabilities at
reported balance sheet dates. The impact from the fluctuations in foreign exchange on these liabilities is included in other income (expense).

Interest Rate Risk

At December 31, 2009, we have interest rate risk to the extent that interest rate changes expose our fixed rate
long-term debt to changes in fair value. As of December 31, 2009, we had $10.5 million of fixed rate debt. In addition, the Company accrues deferred interest on the fixed
rate debt which totals $2.2 million at December 31, 2009. This debt is denominated in Euros and results from our acquisition of NKF in March 2005. During 2009 and 2008, the interest on
this debt was 6.0%. We renegotiated the debt in March 2010 to extend the due date to March 2011, and agreed to a fixed interest rate of 10%. There is no further interest rate risk on the senior note
as we paid this off in full in March 2010.

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Item 7.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to the Consolidated Financial Statements



PageReports of Independent Registered Public Accounting Firms


26Consolidated Balance Sheets as of December 31, 2009 and
2008


28Consolidated Statements of Operations and Comprehensive Income (Loss) for the two years in the period ended
December 31, 2009


29Consolidated Statements of Stockholders' Equity for the two years in the period ended December 31,
2009


30Consolidated Statements of Cash Flows for the two years in the period ended December 31,
2009


31Notes to Consolidated Financial Statements


32SCHEDULE IISchedule of Valuation and Qualifying Accounts


55


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Stockholders
Optelecom-NKF, Inc.:

We
have audited the accompanying consolidated balance sheet of Optelecom-NKF, Inc. and subsidiaries as of December 31, 2009, and the related consolidated
statements of operations and comprehensive income (loss), stockholders' equity, and cash flows for the year ended December 31, 2009. In connection with our audit of the consolidated financial
statements, we have also audited financial statement Schedule II for the year ended December 31, 2009. These consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Optelecom-NKF, Inc. and
subsidiaries as of December 31, 2009, and the results of their operations and their cash flows for the year ended December 31, 2009, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule for the year ended December 31, 2009, when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.

The
accompanying consolidated financial statements and financial statement schedule have been prepared assuming that the Company will continue as a going concern. As discussed in
note 13 to the consolidated financial statements, the Company has suffered losses from operations, has substantial debt maturing, and its viability is dependent on the success of its future
operations and ability to obtain future financing. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are
also described in note 13. The consolidated financial statements and financial statement schedule do not include any adjustments that might result from the outcome of this uncertainty.

/s/ KPMG LLPMcLean, VA
March 30, 2010


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To
the Board of Directors and
Stockholders of Optelecom-NKF, Inc.

We
have audited the accompanying consolidated balance sheet of Optelecom-NKF, Inc. and subsidiaries (the Company) as of December 31, 2008, and the related
consolidated statement of operations and comprehensive income (loss), stockholders' equity and cash flows for the year ended December 31, 2008. Our audit of the basic financial statements
included the financial schedule listed in the index appearing under Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements and financial statement schedule based on our audit.

We
conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Optelecom-NKF, Inc. as of
December 31, 2008, and the results of
their operations and their cash flows for the year ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/
GRANT THORNTON, LLP

McLean,
Virginia
March 30, 2010

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OPTELECOM-NKF, INC.        CONSOLIDATED BALANCE SHEETS        AS OF DECEMBER 31, 2009 AND DECEMBER 31, 2008        (Dollars in Thousands, Except Share
Amounts)

December 31,
2009

December 31,
2008ASSETSCURRENT ASSETSCash and cash equivalents

$
2,344

$
5,671Restricted Cash


1,900


Accounts receivable, net of allowance for doubtful accounts of $386 and $245


8,209


10,290Inventories, net


4,343


5,782Deferred tax assetcurrent


240


205Prepaid expenses and other current assets


893


1,152Total Current Assets


17,929


23,100Property and equipment, less accumulated depreciation of $5,681 and $7,820


1,593


2,063Intangible assets, net of accumulated amortization of $3,609 and $2,870


6,609


7,180Goodwill


14,848


14,603Other assets


209


202TOTAL ASSETS

$
41,188

$
47,148LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIESCurrent portion of notes payable and interest payable


1,907


3,468Accounts payable


2,012


3,634Accrued payroll


1,225


1,841Commissions payable


55


198Accrued warranty reserve


422


410Taxes payable





931Other current liabilities


1,233


1,688Total Current Liabilities


6,854


12,170Notes payable


12,818


10,367Deferred tax liabilities


1,513


1,427Interest payable





1,744Other liabilities


188


249Total Liabilities


21,373


25,957STOCKHOLDERS' EQUITYCommon stock, $.03 par value-shares authorized, 15,000,000; issued and outstanding, 3,653,644 and 3,645,084 shares as of December 31, 2009 and
December 31, 2008, respectively


110


109Additional paid-in capital


17,036


16,252Accumulated other comprehensive income


2,769


2,534Treasury stock, 162,672 shares at cost


(1,265
)

(1,265
)Retained earnings


1,165


3,561Total stockholders' equity


19,815


21,191TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$
41,188

$
47,148


The
accompanying notes are an integral part of these consolidated financial statements.

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OPTELECOM-NKF, INC.        CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)        FOR THE YEARS ENDED DECEMBER 31,    
(Dollars in Thousands, Except Share and Per Share Amounts)

2009

2008Revenue

$
36,177

$
45,165Cost of goods sold


15,469


17,938Gross profit


20,708


27,227Operating expenses:Sales and marketing


10,745


11,099Engineering


4,740


6,013General and administrative


6,305


6,923Amortization of intangibles


672


739Total operating expenses


22,462


24,774Income (loss) from operations


(1,754
)

2,453Other expense, net


841


996Income (loss) before income taxes


(2,595
)

1,457Provision (benefit) for income taxes


(199
)

3,213Net (loss) income

$
(2,396
)
$
(1,756
)Basic (loss) income per share

$
(0.66
)
$
(0.48
)Diluted (loss) income per share

$
(0.66
)
$
(0.48
)Weighted average common shares outstandingbasic


3,647,543


3,638,783Weighted average common shares outstandingdiluted


3,647,543


3,638,783Net (loss) income

$
(2,396
)
$
(1,756
)Foreign currency translation


235


(872
)Comprehensive (loss) income

$
(2,161
)
$
(2,628
)


The
accompanying notes are an integral part of these consolidated financial statements.

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OPTELECOM-NKF, INC        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY        FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008        (Dollars in
Thousands, Except Share Amounts)

Number of
Shares

Common
Stock

Additional
Paid-in
Capital

Accumulated
Other
Comprehensive
Income

Treasury
Stock

Retained
Earnings

Total
Stockholders'
EquityBALANCE January 1, 2008


3,632,083

$
109

$
15,534

$
3,406

$
(1,265
)
$
5,317

$
23,101Common stock issued from the exercise of options


515





2











2Common stock issued from employee stock purchase plan


6,356





48











48Stock Awards


10,000





74











74Restricted stock forfeited


(3,870
)
















Stock based compensation








594











594Foreign currency translation











(872
)







(872
)Net (loss)

















(1,756
)

(1,756
)BALANCE DECEMBER 31, 2008


3,645,084


109


16,252


2,534


(1,265
)

3,561


21,191Common stock issued from employee stock purchase plan


4,875





16











16Stock Awards


10,625


1


42











43Restricted stock forfeited


(6,940
)




0











0Stock based compensation








726











726Foreign currency translation











235








235Net (Loss)

















(2,396
)

(2,396
)BALANCE DECEMBER 31, 2009


3,653,644

$
110

$
17,036

$
2,769

$
(1,265
)
$
1,165

$
19,815


The
accompanying notes are an integral part of these consolidated financial statements.

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OPTELECOM-NKF, INC.        CONSOLIDATED STATEMENTS OF CASH FLOWS        FOR THE YEARS ENDED DECEMBER 31,        (Dollars in Thousands)

2009

2008Cash Flows from Operating Activities:Net (Loss) Income

$
(2,396
)
$
(1,756
)Adjustments to reconcile net (loss)income to net cash provided by operating activities:Depreciation and amortization


1,598


1,743Accounts receivable provision


125


27Change in allowance for inventory obsolescence


254


(53
)Accrued warranty reserve


8


3Stock based compensation


769


670Deferred rent


(61
)

(7
)Deferred tax asset


30


2,299Change in assets and liabilities:Accounts and contracts receivable


2,090


(1,102
)Inventories


1,223


(628
)Prepaid expenses and other current assets


267


(86
)Other assets


(4
)

(6
)Accounts payable and other accrued expenses


(2,842
)

2,278Other liabilities


(518
)

347Net cash provided by operating activities


543


3,729Cash Flows from Investing Activities:Capital expenditures


(426
)

(550
)Net cash used in investing activities


(426
)

(550
)Cash Flows from Financing Activities:Net (decrease) increase in bank line of credit





(1,000
)Increase in restricted cash


(1,900
)

Payments on notes payable and capital leases


(1,583
)

(1,515
)Proceeds from employee stock purchase plan


17


46Proceeds from exercise of stock options





2Net cash used in financing activities


(3,466
)

(2,467
)Effect of exchange rates on cash and cash equivalents


22


(84
)Net (decrease) increase in cash and cash equivalents


(3,327
)

628Cash and cash equivalentsbeginning of period


5,671


5,043Cash and cash equivalentsend of period

$
2,344

$
5,671Supplemental Disclosures of Cash Flow Information:Cash paid during the period for interest

$
298

$
251Cash paid during the period for income taxes

$
832

$
31


The
accompanying notes are an integral part of these consolidated financial statements.

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OPTELECOM-NKF, INC.        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008        (Dollars in
Thousands, Except Share Amounts)

1. Nature of Business and Summary of Significant Accounting Policies

Nature of BusinessOptelecom-NKF, Inc. (the Company) is a Delaware corporation that was organized in 1972. The Company, developer
of Siqura® advanced video network solutions, is a global supplier of advanced video surveillance solutions, including IP cameras, video servers/codecs, network video recorders, fiber
transmission equipment, video management and video analytics software. We deliver complete solutions for traffic monitoring and security of airports, seaports, casinos, prisons, utilities, public
transit, city centers, hospitals, and
corporate campuses. The Optelecom-NKF corporate headquarters is in Germantown, Maryland, USA, with European corporate offices in Gouda, the Netherlands, and sales or support offices
covering the Americas, France, Spain, the UK, Germany, Italy, Dubai, and Singapore.

Principles of ConsolidationThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant
inter-company transactions and balances have been eliminated.

Use of EstimatesThe preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Accounts ReceivableAccounts receivable potentially subjects the Company to concentrations of credit risk. Credit is extended based on evaluation of a
customer's financial condition and, generally, collateral is not required. Accounts receivable are generally due within 30 days and are stated at amounts due from the customers net of an
allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of customers to make required payments. The Company regularly monitors and assesses its risk of not collecting amounts owed by its customers. This evaluation is based upon
an analysis of amounts current and past due along with relevant history and facts such as collection history, the results of credit inquiries and the impact of credit insurance maintained by the
Company. The Company believes that its allowance for doubtful accounts is adequate to cover any potential losses on its credit risk exposure. The Company writes off accounts receivable when they
become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

Revenue RecognitionRevenue from commercial sales is recognized when products are shipped and/or title passes pursuant to the terms of the agreement
with the customer, the amount from the customer is fixed, and collectability is reasonably assured.

Product WarrantyIn the ordinary course of business, the Company warrants its products against defect in design, materials, and workmanship over
various time periods generally ranging from one to five years. Warranty reserves and allowances for product returns are established based upon management's best estimates of amounts necessary to
settle future and existing claims on products sold

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OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

1. Nature of Business and Summary of Significant Accounting Policies (Continued)

through
the balance sheet date. The following is a summary of the Company's warranty obligation for the years ended December 31:

(Dollars in thousands)

2009

2008Balance, beginning of year

$
410

$
418Provision for warranty obligations


211


104Charges against warranty obligations


(199
)

(112
)Balance, end of year

$
422

$
410


InventoriesProduction materials are valued at the lower of cost or market applied on an actual cost basis. Work-in-process
and finished goods inventory includes direct labor, materials and overhead and are valued at the lower of cost or market, cost being determined using actual costs on a specific identification basis.
The Company writes down its inventory for estimated obsolescence or unmarketable inventory based upon assumptions about future demand and market conditions as well as historical inventory turnover. If
actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. At December 31, 2009 and 2008, the reserve for inventory
obsolescence was $942 thousand and $679 thousand, respectively.

Property, Equipment, and DepreciationProperty and equipment are recorded at cost and are depreciated using the straight-line method over
the estimated useful lives of the assets, which range from 3 to 10 years. Leasehold improvements are amortized over the terms of the respective leases or the service lives of the assets,
whichever is shorter. Expenditures for maintenance and repairs are expensed as incurred.

GoodwillGoodwill acquired in connection with business acquisitions is stated at fair value on the date of purchase. Goodwill is not amortized, but
it, as well as other intangible assets with indeterminate lives, are subject to an annual impairment test. The primary assumptions underlying the impairment test are current and forecasted
profitability and cash flow of the related business. There have been no adjustments to the carrying values of goodwill or intangible assets resulting from these impairment tests during 2009 as the
fair value of the reporting unit is in excess of its carrying value. Goodwill increased from $14.6 million at December 31, 2008, to $14.8 million at December 31, 2009. This
increase is the result of prevailing foreign exchange rates at the respective balance sheet dates.

IntangiblesIntangibles acquired in connection with business combinations are stated at their fair value on the date of purchase. The costs of
intangibles which are subject to amortization are amortized on a straight-line basis over their expected lives of three to eleven years. The recoverability of carrying values of
amortizable intangible assets is evaluated on a recurring basis whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Recovery of assets to be
held and used is measured by comparing the carrying value of these assets with the expected future cash flows generated by the assets. If the assets are considered to be impaired, the impairment is
recognized by the amount which the carrying amount of the assets exceeds their fair value. The changes in intangibles carrying value are the result of foreign exchange fluctuations and amortization.

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OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

1. Nature of Business and Summary of Significant Accounting Policies (Continued)

As
of December 31, 2009, intangible assets are comprised of the following (in thousands).

Description

Purchase
value

Amortization
Period in
Years

Accumulated
Amortization

Net valueIntangible indefinite life:Tradenames

$
2,293




$


$
2,293Intangible amortizable:Customer Relationships


7,596


11


(3,280
)

4,316Non-Compete Agreement


328


3


(328
)
$
Total Intangibles

$
10,217




$
(3,608
)
$
6,609


The
aggregate amortization expense of intangible assets was $672 thousand and $739 thousand for the years ended December 31, 2009, and 2008, respectively. It is
anticipated that amortization expense for these intangibles will be approximately $3.4 million over the next five years.

Research and Development CostsResearch and development costs are expensed as incurred and included as a component of engineering expense in the
consolidated statements of operations. The Company incurred research and development costs of $4.1 million and $5.5 million for the years ended December 31, 2009 and 2008
respectively.

Income TaxesThe Company accounts for income taxes in accordance with the FASB's guidance which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. The FASB's guidance also requires that deferred tax assets
be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.

It
is the Company's policy to classify interest and penalties related to uncertain tax positions as a component of income tax expense. For the years ended December 31, 2009 and
2008, there were no interest and penalties associated with uncertain tax provisions.

Stock-Based CompensationThe Company accounts for stock based compensation under FASB Codification 718-10 CompensationStock
Compensation which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors using a fair value based option pricing model.
Compensation expense is recognized for awards that were granted, modified, repurchased or cancelled on or after January 1, 2006. Share-based tax-affected compensation expense
recognized under this method for the years ended December 31, 2009 and 2008 was $769 thousand and $670 thousand, respectively. As of December 31, 2009, total unamortized
compensation expense related to non-vested share-based compensation was $392 thousand and is expected to be recognized over a period of 0.83 years.

Foreign Currency Translation/TransactionsThe functional currency of the Company's international operations is the local currency. The Company
translates the assets and liabilities of its foreign subsidiaries into U.S. dollars at the exchange rates in effect at the end of the year and revenue and

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OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

1. Nature of Business and Summary of Significant Accounting Policies (Continued)

expense
accounts are translated into U.S. dollars using the average exchange rate for the period. The related translation adjustments are reported as foreign currency translation in the statement of
stockholders' equity. Transaction gains and losses arising from transactions denominated in a currency other than the functional currency of the entity involved are included in the results of
operations.

Cash and Cash EquivalentsThe Company considers all liquid investments with original maturities of three months or less at the time of purchase to be
cash equivalents. The Company is exposed to a concentration of credit risk as the majority of the Company's cash resides in European banks. Government insurance affords coverage only up to
100 thousand Euros per account holder per bank. On December 14, 2009, we entered into an amended financing agreement with our bank. Pursuant to the Amendment, we agreed to a reduction in
our revolving credit facilities and also agreed to restrict $1.9 million of cash as collateral for the term loan and revolving credit facilities. The cash collateral is restricted pursuant to a
deposit account security agreement.

Fair Value of Financial InstrumentsThe carrying amounts approximate fair value of the Company's cash and short-term financial
instruments. The carrying value of the senior note approximates fair value. It is not practicable to estimate the fair value of the subordinated note, which had a carrying value of
$12.8 million, including accrued interest at December 31, 2009. At December 31, 2009, interest on this note was at 6%, but this was amended to 10% on March 5, 2010, in
accordance with the extension of the due date to March 8, 2011. We are unable to estimate the fair value of the note due to lack of available financing and because the debt is not traded.

Advertising and Promotion ExpensesCosts of advertising are expensed as incurred. Advertising and promotion expenses for the years ended
December 31, 2009 and 2008 were $924 thousand and $949 thousand, respectively.

Sales TaxThe Company presents all non-income government-assessed
taxes (sales, use, and value added taxes) collected from its customers and remitted to governmental agencies on a net basis (excluded from revenue) in its financial statements.

Concentration of CustomersFor the twelve months ended December 31, 2009, approximately 20% of our revenues were accounted for by sales to five
commercial customers. In 2008 five commercial customers represented 29% of our revenues.

Earnings Per ShareBasic earnings per share are computed using the weighted average number of common shares outstanding. Diluted earnings per share
are computed using the weighted average number of shares outstanding plus the impact of stock options using the treasury stock method, provided the options are not anti-dilutive. Options
to purchase 469 thousand and 517 thousand weighted average shares of common stock were outstanding during the years ended December 31, 2009 and 2008, respectively, but were not
included in the computation of diluted earnings per share because their inclusion would be anti-dilutive.

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OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

1. Nature of Business and Summary of Significant Accounting Policies (Continued)

The
computation of basic and diluted loss per share for the years ended December 31, 2009 and 2008, is as follows:

(Dollars in thousands, except share amounts)

2009

2008Basic (loss) income per share:Net (loss) income

$
(2,396
)
$
(1,756
)Weighted average common sharesbasic


3,647,543


3,638,783Basic (loss) income per share

$
(0.66
)
$
(0.48
)Diluted (loss) income per share:Net (loss) income

$
(2,396
)
$
(1,756
)Weighted average common sharesbasic


3,647,543


3,638,783Assumed conversion of:Stock options





Weighted average common sharesdiluted


3,647,543


3,638,783Diluted (loss) income per share

$
(0.66
)
$
(0.48
)


Subsequent Event PolicyWe have evaluated material events and transactions that have occurred after December 31, 2009, and concluded that no
subsequent events, other than those disclosed herein, have occurred that require adjustment to or disclosure in this Form 10-K.

2. Accounts and Contracts Receivable

Accounts and contracts receivable consisted of the following at December 31:

(Dollars in thousands)

2009

2008Accounts and contracts receivable

$
8,595

$
10,535Less: Allowance for doubtful accounts


(386
)

(245
)Total accounts and contract receivable, net

$
8,209

$
10,290


3. Inventories

Inventories consisted of the following at December 31:

(Dollars in thousands)

2009

2008Production materials

$
2,948

$
4,164Work in process


236


745Finished goods


2,101


1,552Allowance for obsolescence


(942
)

(679
)Total inventories, net

$
4,343

$
5,782


36

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

4. Property and Equipment

Property and equipment consisted of the following at December 31:

(Dollars in thousands)

2009

2008Laboratory equipment

$
1,751

$
3,377Office equipment


1,330


2,376Leasehold improvements


1,606


1,575Computer hardware and software


2,587


2,5557,274


9,883Less accumulated depreciation and amortization


(5,681
)

(7,820
)Property and equipment, net

$
1,593

$
2,063


Assets
under capital leases are included in the above categories and consisted of the following:

(Dollars in thousands)

2009

2008Laboratory equipment

$
85

$
85Office equipment


269


269354


354Less accumulated depreciation and amortization


(328
)

(283
)Net property and equipment under capital leases

$
26

$
71


Depreciation
and amortization expense was approximately $1.0 million for each of the years ended December 31, 2009 and 2008. Amortization expense for property and equipment
under capital leases was $45 thousand and $52 thousand for the years ended December 31, 2009 and 2008, respectively, and is reflected in depreciation and amortization expense. We
are evaluating strategic alternatives for our business. It is possible that certain actions taken as a result of this evaluation could result in impairment of long lived assets in 2010.

37

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

5. Other Intangible Assets

As of the dates indicated, other intangible assets are comprised of the following (in thousands):

December 31,2009

2008Description

Purchase
value

Accumulated
Amortization

Net value

Purchase
value

Accumulated
Amortization

Net valueGoodwill:

$
14,848

$
0

$
14,848

$
14,603

$
0

$
14,603Intangible indefinite life:Tradenames

$
2,293

$
0

$
2,293

$
2,256

$
0

$
2,256Intangible amortizable:Customer Relationships

$
7,596

$
3,280

$
4,316

$
7,471

$
2,547

$
4,924Non-Compete Agreement

$
328

$
328

$
0

$
323

$
323

$
0Total Intangibles

$
25,065

$
3,608

$
21,457

$
24,653

$
2,870

$
21,783


The
aggregate amortization expense of intangible assets was $672 thousand and $739 thousand for the years ended December 31, 2009, and 2008, respectively. Changes in
the value of goodwill and indefinite lived intangible assets from the date of acquisition to December 31, 2009, are a result of foreign exchange fluctuations.

Estimated
future aggregate annual amortization expense for intangible assets is as follows (dollars in thousands):

Year ended
December 31,2010

$
6902011


6902012


6902013


6902014


690Thereafter


866TOTAL

$
4,316


6. Income Taxes

The components of income (loss) before income taxes consisted of the following for the years ended December 31:

(Dollars in thousands)

2009

2008U.S. Operations

$
(1,758
)
$
32Non-U.S. Operations


(837
)

1,425$
(2,595
)
$
1,457


38

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

6. Income Taxes (Continued)

The
components of the (benefit) provision for income taxes for the years ended December 31 are summarized as follows:

(Dollars in thousands)

2009

2008Current Expense (Benefit)U.S. Operations

$
(10
)
$
15Non-U.S. Operations


(218
)

1,082$
(228
)
$
1,097Deferred Expense (Benefit)U.S. Operations

$


$
2,921Non-U.S. Operations


29


(805
)$
29

$
2,116Total

$
(199
)
$
3,213


The
difference between the federal income tax expense (benefit) and the amount computed applying the statutory federal income tax rate are summarized as follows for the years ended
December 31:

2009

2008United Sates Federal tax at statutory rates


34.0
%

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


(10.4
)%

(6.9
)%Valuation allowance related to net deferred tax assets


(17.6
)%

189.3
%Impact of foreign operations


9.9
%

7.9
%Business tax credits


(0.2
)%

(1.5
)%Stock option shortfalls


(8.6
)%

0.0
%Permanent differences


(0.3
)%

(1.5
)%Other


0.9
%

(0.8
)%Effective income tax rate


7.7
%

220.5
%


The
impact of foreign operations includes the foreign tax rate differential, the permanent differences related to the foreign subsidiaries and the U.S. tax impact resulting from the
restructuring of the foreign operations.

39

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

6. Income Taxes (Continued)

Deferred
income taxes reflect the net tax effects of temporary differences between the amount of assets and liabilities for income tax and financial reporting purposes. The components of
deferred income tax liabilities and assets as of December 31 are as follows (dollars in thousands):

2009

2008Deferred tax assets:Excess book depreciation

$
165

$
84Inventory


212


129Accrued vacation


70


62Deferral of rent expense


66


94Bad debt expense


7


21Tax credits


1,850


1,372Deferred compensation


185


331Unrealized foreign exchange loss


810


670Other


526


653Net operating loss


479


266Gross deferred tax asset


4,370


3,682Valuation allowance


(3,503
)

(3,045
)Deferred tax assets


867


637Deferred tax liabilities:Intangibles


(1,685
)

(1,831
)Unrealized foreign exchange gain


(407
)

Other


(47
)

(28
)Total deferred tax liabilities


(2,139
)

(1,859
)Net deferred tax assets (liabilities)

$
(1,272
)
$
(1,222
)Reported as:Current deferred income tax assets

$
241

$
205Long-term deferred income tax liabilities


(1,513
)

(1,427
)Net deferred income tax (liabilities)

$
(1,272
)
$
(1,222
)


The
exercise of stock options and certain stock grants generated an income tax deduction equal to the excess of the fair market value over the exercise price. The Company will not
recognize a deferred tax asset with respect to the excess stock compensation deductions until those deductions actually reduce our income tax liability. As such, the Company has not recorded a
deferred tax asset related to the net operating losses resulting from the exercise of these stock options in the accompanying financial statements. At such time as the Company utilizes these net
operating losses to reduce income tax payable, the tax benefit will be recorded as an increase in additional paid in capital. As of December 31, 2009, the cumulative amount of the unrecognized
tax benefit related to such option exercises and certain stock grants was $655 thousand.

40

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

6. Income Taxes (Continued)

As
of December 31, 2009 and 2008, the Company had federal and state tax-effected net operating loss carryforwards of approximately $461 thousand and
$277 thousand, respectively, for U.S. income tax purposes. These carryforwards begin to expire in the year 2028. As of December 31, 2009 and 2008, the Company had tax credit
carryforwards of approximately $1.9 million and $1.4 million, respectively, for U.S. income tax purposes. These tax credit carryforwards begin to expire in the year 2018. The use of
these net operating loss and tax credit carryforwards may be subject to limitation under the rules regarding a change of ownership as determined by the Internal Revenue Service. The effects of
potential ownership changes, if any, have not been analyzed by the Company.

As
of December 31, 2009, the Company has recorded a valuation allowance of approximately $3.5 million against the U.S. deferred tax assets. In evaluating the amount of the
valuation allowance as of December 31, 2009, we considered all available positive and negative evidence, including past operating results, the reversal of temporary differences, the forecasts
of future taxable income and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income. Based on
the weight of the positive and negative evidence and the information available, management concluded that it is not more likely than not that its U.S. deferred tax assets will be realized. The Company
established a valuation allowance of $3.2 million in 2008. The change in the valuation allowance from December 31, 2009 to December 31, 2008, was an increase of
$458 thousand related to the valuation allowance recorded against the U.S. net deferred tax assets generated during 2009.

The
Company files tax returns in the U.S. federal jurisdiction, as well as various state and foreign tax jurisdictions in which it has a subsidiary or branch operation. The tax years
2006 to 2009 remain open to examination by U.S. and state tax authorities. However, due to net operating loss and credit carryforwards, the tax authorities can recompute income from a closed year in
order to determine the net operating loss and credit carryforwards allowable in an open year. The tax years 2006 to 2009 also remain open to examination by the foreign tax authorities.

As
of January 1, 2009, the Company had a total unrecognized tax benefit of $720 thousand, of which $56 thousand related to tax positions taken in prior years that
did not meet the more-likely-than-not recognition threshold and $624 thousand related to stock compensation deductions.

The
change in the Company's unrecognized tax benefits are shown in the table below:

(In Thousands)

2009

2008Balance at January 1,

$
765

$
720Additions related to current year windfall tax benefits





45Subtractions related to changes in state tax rates on prior year windfall tax benefits


(54
)Balance at December 31,

$
711

$
765


41

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

7. Notes Payable

Notes payable consist of the following at December 31:

(Dollars in thousands)

2009

2008Senior term loan with a bank due Feb 2010

$
1,907

$
3,432Microsoft note payable


18


54Subordinated note due March 2011(1)


12,818


12,093$
14,743

$
15,579Less: Current Portion


(1,925
)

(3,468
)Total Notes Payable

$
12,818

$
12,111


(1)Includes
$2.3 and $1.7 million of deferred interest payable on the subordinated note for the years ended December 31, 2009 and 2008,
respectively.


In
June 2008, the Company implemented a new European holding company structure in the Netherlands which provides a more flexible corporate structure. The Company established a new Dutch
entity that is a subsidiary of the U.S. parent company and holds all of the Company's international subsidiaries. The new structure is intended to facilitate enhanced management of international
operations and improvements in cash management and income tax planning. The balance and interest rate on the term debt were not changed in the restructuring, however the debt is now included in the
European holding company in place of the U.S. legal entity. The Company made approximately $1.5 million USD principal payments on this loan during both 2008.

The
balance of the senior term loan at December 31, 2009, was $1.9 million. The term loan carries interest at the rate of LIBOR plus a margin that can range from 2.25% to
3.25% depending on the Company's leverage position. At the recent quarter end the interest rate on this term loan was 4.2%. There is $1.9 million of restricted cash that supports the senior
term loan.

The
June 2008 restructuring included the transfer of our Dutch operating subsidiary (Optelecom-NKF B.V.) from the U.S. parent company to the new European holding
company. Consideration for the transfer included an intercompany note receivable to the U.S. parent and a corresponding note payable from the European holding company. The intercompany note is in U.S.
Dollars and totaled $15.0 million with a balance of $8.6 million on December 31, 2009. The impact from the fluctuations in foreign exchange on the intercompany note payable is
included in Other Income (Expense), net in our Consolidated Statement of Operations.

On
March 8, 2005, the Company completed the acquisition of NKF Electronics B.V. from Draka Holding, N.V. ("Draka") and issued a Euro based Subordinated Note to Draka
for a portion of the acquisition price. The principal balance of the Subordinated Note to Draka was $10.5 million at December 31, 2009. The Subordinated Note is denominated in Euros and
the liability increased $697 thousand since issuance in March 2005 due to the impact of the exchange rate changes. The note is due in March 2011. Upon completion of the previously discussed
restructuring the impact from the change in foreign exchange rates on the Subordinated Note is included in the Other Income (Expense), net on our Consolidated Statements of Operations. Prior to the
restructuring, it was included in

42

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

7. Notes Payable (Continued)

Comprehensive
Income as it was considered to be a hedge in the net investment of our NKF subsidiary.

At
December 31, 2009, the Subordinated Note accrues interest at a rate of 6% per annum. $2.3 million of deferred interest payable has been accrued from the acquisition date
through December 31, 2009. The impact from the change in foreign exchange on the accrued interest payable is included in the Other Income (Expense), net on our Consolidated Statements of
Operations.

At
December 31, 2009, the Company had $500 thousand available on its bank line of credit and had no outstanding balance on this line of credit as of such date. At
December 31, 2008, the Company had up to $5.0 million available on its bank line of credit and had no outstanding balance. The Company terminated its bank line of credit facilities in
March 2010.

On
March 5, 2010, the Company entered into an amended and restated Subordinated Note issued to Draka (the "Note") and Draka agreed to extend the term of the Note to
March 8, 2011. The current principal amount under the Note is €9.1 million Euros ($12.5 million at March 5, 2010). In consideration of Draka's agreement to
extend the term of the Note, the Company agreed to pay Draka €155 thousand Euros ($222 thousand at December 31, 2009) under the Note and to make quarterly interest
payments on the Note at an annual interest rate of 10%. Additionally, the Company agreed that if it has cash on hand in excess of $2.5 million at the end of any calendar quarter, it will pay
such excess cash to Draka as a prepayment on the Note. The Company's obligations under the Note are secured by the assets of the Company and a pledge of 65% of the shares of Optelecom-NKF
Holding B.V., the Company's holding company in The Netherlands. Fair value of this 65% interest approximates $14.0 million at December 31, 2009. The terms of the amended and
restated Subordinated Note prohibit the Company from paying dividends to stockholders. The Company is permitted under the Note to obtain up to a $750 thousand revolving line of credit that will
be senior in priority to the Note and the Company's operating subsidiary in The Netherlands is permitted to obtain up to a $250 thousand revolving line of credit. Immediately prior to the
amendment and restatement of the Note, the Company paid in full its senior term loan and terminated line of credit.

For
the years ended December 31, 2009 and 2008, the Company recorded $808 thousand and $858 thousand respectively of interest expense.

Scheduled
maturities on notes payable are as follows for each of the next five years:

Year ended December 31, (Dollars in thousands):2010

$
1,9252011


12,818
(1)2012 and thereafter


$
14,743


(1)Includes
$2.3 million of deferred interest payable related to the Subordinated Note.


43

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

8. Commitments and Contingencies

Operating LeasesIn March 2003, the Company began to occupy its corporate office and manufacturing facility located in Germantown, Maryland. As an
inducement to enter this operating lease, the Company received certain incentives such as rent abatement. Additionally, the lease provides for scheduled rent increases. These lease incentives are
being amortized over the lease period. Rent expense is being recognized on a straight-line basis.

We
have a lease for office facilities located in the Netherlands that expires in March 2015, in France that expires in June 2012, in Dubai that expires December 2012, in Singapore that
expires December 2010 and Spain which expires in April 2011.

As
of December 31, 2009, future net minimum rental payments required under capital and operating leases that have initial or remaining non-cancelable terms in excess
of one year are as follows:

Year ended December 31, (Dollars in thousands):

Operating

Capital

Total2010

$
1,404,130

$


$
1,404,1302011


1,289,193





1,289,1932012


1,213,434





1,213,4342013


980,066





980,0662014


568,736





568,736Thereafter


142,184





142,184Gross Payments

$
5,597,743

$


$
5,597,743Less Amounts Representing Interst








Net Minimum Rental Payments

$
5,597,743

$


$
5,597,743


Rent
expense was $1.2 million and $1.1 million for the years ended December 31, 2009 and 2008, respectively.

Legal ProceedingsOptelecom-NKF is not involved in legal proceedings or litigation at this time.

9. Restructuring Charge

In September of 2009, the Company recorded pre-tax severance charges of approximately $127 thousand related to a reduction in force in the U.S. and Europe as a result
of a review of its operations. The majority of these charges were paid out in 2009. During the fourth quarter of 2008, the Company adopted a restructuring plan ("2008 Restructuring"), and recorded a
restructuring charge of $525 thousand for severance related costs. The Company paid this accrual out in its entirety in 2009. The Company included both the 2009 and 2008 severance charges in
engineering, sales and general and administrative expenses.

10. Stockholders' Equity

Common StockDuring 2008 proceeds from the exercise of stock options for the purchase of 500 shares of common stock were $2 thousand. There
were no exercises of stock options during 2009.

44

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

10. Stockholders' Equity (Continued)

Stock Purchase PlanThe Company's Stock Purchase Plan is intended to give employees a convenient means of purchasing shares of Common Stock through
payroll deductions. Each participating employee's contributions will be used to purchase shares for the employee's share account as promptly as practicable after each calendar quarter. The cost per
share will be 15% of the lower of the closing price of the Company's Common Stock as reported by NASDAQ on the first or the last day of the calendar quarter. The Company has reserved 200,000 shares of
Common Stock for issuance under the Stock Purchase Plan. As of December 31, 2009, 89,996 shares have been issued under the Stock Purchase Plan.

Director's Stock CompensationAs of July 1, 2006, each non-employee Director is granted 625 shares of restricted common stock at
the closing price on the first day of each calendar quarter. The Company issued 10,625 and 10,000 shares of common stock to directors in 2009 and 2008, respectively.

Stock OptionsThe Company has two stock-based compensation plans; the 2001 Nonqualified Director Stock Option Plan ("2001 Plan") and the
Optelecom-NKF, Inc. 2008 Stock Incentive Plan ("2008 Plan").

The
2001 Plan provides for up to 178,500 shares available for grant. The plan provides for the grant of stock options and restricted stock. Options under this plan are granted to
non-employee directors at fair market value on the date of the grant are exercisable upon grant and expire five years thereafter. Restricted stock under this plan is restricted from sale
for a period of two years. There were 70,798 awards available for future grant at December 31, 2009.

Effective
June 1, 2008, the Company adopted the 2008 Plan (the "2008 Plan"), which replaced the Optelecom, Inc. 2002 Stock Option Plan (the "2002 Plan"). Awards under the
2008 Plan are available only to employees. The 2008 Plan provides for the grant of up to 500,000 shares of common stock to participants, plus 70,000 remaining shares carried over from the 2002 Plan.
The 2008 Plan provides for the grant of stock options, restricted stock, restricted stock units, or performance awards. The exercise price of each option is the market value of the stock at the grant
date. Options issued in 2009 and 2008 are 100% exercisable two years from the grant date. Options expire between five and ten years from the date of grant and, in most cases, upon termination of
employment.

It
is the practice of the Company to satisfy awards and options granted under these plans through the issuance of new shares. During the years ended December 31, 2009 and 2008,
the Company recognized compensation expense of $726 thousand and $670 thousand, respectively. In each of the periods described above, compensation expense related to these plans was
recorded in the Consolidated Statements of Operations. At the years ended December 31, 2009 and 2008, the Company had $17 thousand and $21 thousand of share-based compensation
expense capitalized in inventory. The Company did not realize any income tax benefits from stock-based payment plans during the year ended December 31, 2009, as discussed in Note 6.

The
Company recognizes the fair value of service based options as stock compensation expense on a straight line basis over the requisite service period. The fair value of each stock
option award was

45

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

10. Stockholders' Equity (Continued)

estimated
on the date of grant using a Black Scholes option-pricing model based on the following weighted average assumptions:

3/9/2009

6/5/2008

3/5/2008Expected Dividend yield


0.00
%

0.00
%

0.00
%Expected volatility


65.29
%

52.00
%

56.00
%Risk-free interest rate


2.30
%

2.52
%

2.19
%Expected term


7.00


7.00


3.26


A
summary of the status of the Company's aggregate stock option awards under its Plans during the years ended December 31, 2009 and 2008 is presented below:

Shares

Weighted-
Average
Exercise Price

Weighted-
Average
Remaining
Contractual
Term (Years)

Aggregate
Intrinsic
Value (in
thousands)Outstanding, December 31, 2008


541,043

$
9.73


3.53

$
Granted


63,449


3.10Excercised





Forfeited


(8,144
)

5.90Expired


(127,003
)

9.93Outstanding, December 31, 2009


469,345

$
8.84


4.16

$
Vested and expected to vest,December 31, 2009


466,048

$
8.86


4.13

$
Excercisable, December 31, 2009


290,858

$
10.15


1.75

$



The
following table summarizes information about all stock options outstanding at December 31, 2009.

Range of Exercise Prices

Number
Outstanding

Weighted-
Average
Remaining Life
in Years

Weighted-
Average
Exercise Price

Number
Exercisable

Weighted
Average
Exercise
Price$3.10 to $6.96


78,671


7.76

$
4.02


9,000

$
3.10$6.97 to $11.98


328,935


3.87


8.88


220,119


9.13$11.99 to $18.65


54,489


1.14


13.92


54,489


13.92$18.67 to $27.77


7,250


1.26


21.66


7,250


21.66469,345


4.16

$
8.84


290,858

$
10.15


The
weighted average fair values of each stock option granted by the Company during the years ended December 31, 2009 and 2008 was $1.99 and $4.37, respectively. The total
intrinsic value on the date of exercise of stock option awards exercised during the year ended December 31, 2008 was

46

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Table of Contents

OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

10. Stockholders' Equity (Continued)

$2 thousand.
There were no stock option awards exercised during the year ended December 31, 2009. The total fair value of awards that vested during the years ended December 31,
2009 and 2008 was $393 thousand and $106 thousand, respectively. As of December 31, 2009, there was $204 thousand of total unrecognized compensation cost related to stock
option awards granted under the plans. The weighted-average period over which the compensation expense for these awards is expected to be recognized is 0.64 years.

Restricted
Stock UnitsA restricted stock unit is a stock award that entitles the holder to receive shares of the Company's common stock as the unit vests. The Company's
outstanding restricted stock unit awards are subject to service-based vesting conditions. Awards subject to service-based conditions typically cliff vest at the end of two years. The Company
recognizes the fair value of service based awards as stock compensation expense on a straight line basis over the requisite service period. The fair value of each restricted stock unit award is the
closing price of the Company's Common Stock as reported by NASDAQ as of the date of issuance.

The
following table is a summary of the Company's restricted stock unit activity for the periods indicated:

Restricted Stock
Units Outstanding

Weighted
Average Grant
Date Fair Value
Per shareBalance as of December 31, 2008


86,108


8.91Granted


97,579


3.10Vested


(82,643
)

7.99Forfeited


(474
)

8.36Balance as of December 31, 2009


100,570


4.03


The
total fair value of restricted stock units that vested and were converted into common stock during fiscal 2009 and 2008 was $661 thousand and $116 thousand, respectively.

11. Employee Benefit Plans

The Company sponsors a 401(k) defined contribution plan in which most U.S. employees are eligible to participate. The Company matches employee contributions to the plan up to a maximum
of 2.5%. Total matching contributions were $124 thousand for each of the years ended December 31, 2009 and 2008.

In
the Netherlands, pension contributions from employer and employees are subject to the Taxation of Pensions Act approved by Parliament in 1999 as well as the Pension and Savings Fund
Act. For the years ended December 31, 2009, and 2008, the Company made total contributions (mandatory and voluntary) of $1.1 million each year.

In
December 2007 the Company amended its Employment Agreement with Edmund Ludwig, its former Chief Executive Officer. The amended employment agreement increased the amount
Mr. Ludwig would receive if he terminated his employment by retirement in accordance with the

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OPTELECOM-NKF, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

(Dollars in Thousands, Except Share Amounts)

11. Employee Benefit Plans (Continued)

Employment
Agreement. Mr. Ludwig retired on December 31, 2009, and is entitled to a retirement payment of $672 thousand that was fully accrued at December 31, 2009. In
December 2009, the Compensation Committee of the Board of Directors of the Company approved amendments to two restricted stock grants previously awarded to Edmund Ludwig, Chairman of the Board. These
restricted stock grants were made in June 2008 for 2,467 shares and March 2009 for 14,839 shares and were each subject to a two year vesting period. Due to Mr. Ludwig's retirement as an
employee, the Compensation Committee approved amendments to the Grants to provide they will fully vest effective upon Mr. Ludwig's retirement.

12. Quarterly Information (UnauditedSee accompanying accountant's report)

The following unaudited information sets forth our results of operations on a quarterly basis for the two years ended December 31, 2009 and 2008:

(Amounts in thousands except per share data)

March 31

June 30,

September 30,

December 31,2009:Revenue

$
8,587

$
10,010

$
8,307

$
9,273Gross profit


4,715


6,049


4,593


5,351Operating (loss) income


(949
)

258


(957
)

(106
)Net (loss) income


(766
)

(127
)

(1,269
)

(234
)(Loss) earnings per share-basic

$
(0.21
)
$
(0.03
)
$
(0.35
)
$
(0.06
)(Loss) earnings per share-diluted

$
(0.21
)
$
(0.03
)
$
(0.35
)
$
(0.06
)2008:Revenue

$
10,535

$
11,338

$
11,541

$
11,751Gross profit


6,459


6,670


7,209


6,889Operating income (loss)


512


(111
)

879


1,173Net income (loss)


148


25


1,029


(2,958
)Earnings (loss) per share-basic

$
0.04

$
0.01

$
0.28

$
(0.81
)Earnings (loss) per share-diluted

$
0.04

$
0.01

$
0.28

$
(0.81
)


13. Liquidity

Through the twelve months ended December 31, 2009, our financial performance included lower levels of revenue and operating cash flows and increased operating losses compared to the year
ended December 31, 2008. The principal amount due in March 2011 on our subordinated note is €9.1 million Euros ($12.5 million on March 5, 2010). Prior to the
maturity date, management intends to attempt to repay this debt from the proceeds of new debt and/or equity financings, or seek additional extensions of the maturity date from the current lender.
However, there can be no assurance that adequate additional financing will be available to the Company to repay the subordinated debt or that the current lender will be willing to provide additional
extensions of the maturity date, and therefore that we will be able to continue as a going concern.

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Item 8.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

Item 8A(T).CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed with the objective of providing reasonable assurance that information
required to be disclosed in our reports filed under the Securities and Exchange Act of 1934, or the Exchange Act, such as this Annual Report on Form 10-K is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management
recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required
to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As
of December 31, 2009, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act
Rules 13a-15(e) and 15d-15(e). This type of evaluation is performed on a quarterly basis so that conclusions of management, including our Chief Executive Officer and
Chief Financial Officer, concerning the effectiveness of the disclosure controls can be reported in our periodic reports on Form 10-Q and Form 10-K. The overall
goals of these evaluation activities are to monitor our disclosure controls and to modify them as necessary. We intend to maintain the disclosure controls as dynamic systems that we adjust as
circumstances merit. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance
level as of the end of the period covered by this report.

Management's Report on Internal Control over Financial Reporting

Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer
and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, and includes those policies and procedures that:



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Internal
control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over
financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial
reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely
basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process
safeguards to reduce, though not eliminate, this risk. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.

Management
has used the framework set forth in the report entitled "Internal ControlIntegrated Framework" published by the Committee of Sponsoring Organizations of the
Treadway Commission to evaluate the effectiveness of the Company's internal control over financial reporting. Management has concluded that the Company's internal control over financial reporting was
effective as of the end of the most recent fiscal year.

This
annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was
not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules
of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.

Changes in Internal Control over Financial Reporting

There has been no change in our internal controls over financial reporting during our most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

Item 8B.OTHER INFORMATION

None.

PART III

Item 9.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Sections
entitled "Election of Directors", "Security Ownership of Beneficial Owners, Management, and Directors" and "The Board of Directors and its Committees" and is incorporated herein by reference.

We
have adopted a Code of Ethics that applies to all of our directors and employees including, our principal executive officer and principal financial officer and all of our employees
performing financial
and accounting functions. Our Code of Ethics is posted to our websitewww.optelecom-nkf.comunder the "Corporate Governance" section. We
intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an amendment to, or waiver from, a provision of our Code of Ethics by posting such
information on our website at the location specified above as necessary.

Item 10.EXECUTIVE COMPENSATION

The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Section titled
"Executive Compensation" and is incorporated herein by reference.

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Table of Contents

Item 11.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Section
entitled "Security Ownership of Beneficial Owners, Management and Directors" and is incorporated herein by reference.

Item 12.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Sections
titled "Certain Relationships and Related Transactions" and "The Board of Directors and its Committees" and is incorporated by reference herein.

Item 13.PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information called for by this Item is set forth in the Company's Proxy Statement for the 2010 Annual Meeting in the Section
entitled "Independent Public Accountants' Fees" and is incorporated herein by reference.

PART IV

Item 14.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 28 through 31 hereof, and the reports thereon of KPMG LLP and Grant Thornton LLP appearing on pages 26 and 27
respectively, hereof.(2
)

Financial Statement ScheduleSchedule II for the years ended December 31, 2009 and 2008 and the reports thereon of KPMG LLP and Grant Thornton LLP appearing in Exhibit 23.1 and 23.2, respectively. 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
)

Exhibits3.1

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

Subordinated Promissory Note dated March 8, 2005 (incorporated by reference from Form 8-K filed March 11, 2005)10.2

Amended and Restated Financing and Security Agreement dated June 25, 2008, by and among Optelecom-NKF, Inc., Optelecom UK Limited, Optelecom-NKF Limited NKF , B.V., Optelecom-NKF Holding B.V. and
Optelecom-NKF, S,.L., as Obligors and Manufacturers and Traders Trust Company, Lender (incorporated by reference Form 10-Q filed August 13, 2008).


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Table of Contents

Number

Description10.3

Employment Agreement of David Patterson (incorporated by reference from Form 8-K filed February 9, 2009)10.4

Employment Agreement of Steven Tamburo (incorporated by reference from Form 8-K filed December 22, 2008)10.5

Employment Agreement of Thomas Overwijn (incorporated by reference from Form 10-K filed March 27, 2008)10.6

Employee Stock Purchase Plan (incorporated by reference from Exhibit A to the Proxy Statement on Form 14A filed April 4, 2000)10.7

2001 Directors' Stock Option Plan (incorporated by reference from Exhibit D of the Proxy Statement on Form 14A file March 31, 2006)10.8

2008 Stock Incentive Plan (incorporated by reference from Exhibit A to the Proxy Statement on Form 14A filed March 27, 2008)10.9

Adoption of 2010 Incentive Plan (incorporated by reference from Form 8-K filed December 17, 2009)10.10

Facility lease by and among Optelecom-NKF Inc., and Guardian Realty Mgt (incorporated by reference from Form 10-Q filed May 15, 2006)21

List of Subsidiaries, filed herewith23.1

Consent of KPMG LLPIndependent Registered Public Accounting Firm, filed herewith23.2

Consent of Grant Thornton LLPIndependent Registered Public Accounting Firm, filed herewith31.1

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith31.2

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith32

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


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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.

OPTELECOM-NKF, INC.By:

/s/ DAVID PATTERSON David Patterson President and CEO


Date:
March 30, 2010

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

OPTELECOM-NKF, INC.By

/s/ DAVID PATTERSON David Patterson President and CEO

Date: March 30, 2010By

/s/ THOMAS OVERWIJN Thomas Overwijn Director and Executive VP,
Chief Operating Officer

Date: March 30, 2010By

/s/ STEVEN TAMBURO Steven Tamburo Executive VP and CFO

Date: March 30, 2010By

/s/ EDMUND LUDWIG Edmund Ludwig Chairman of the Board

Date: March 30, 2010By

/s/ DAVID LIPINSKI David Lipinski Director

Date: March 30, 2010


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OPTELECOM-NKF, INC.By

/s/ CARL RUBBO, JR. Carl Rubbo, Jr. Director

Date: March 30, 2010By

/s/ WALTER FATZINGER, JR. Walter Fatzinger, Jr. Director

Date: March 30, 2010By

/s/ JOHN MARCELLO John Marcello Director

Date: March 30, 2010By

/s/ SANDRA BUSHUE Sandra Bushue Director

Date: March 30, 2010


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Schedule II

OPTELECOM-NKF, INC.    SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS    FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008

Balance at
Beginning of
Period

Charges to
Costs and
Expenses

Deductions

Balance at End
of Period(Dollars in thousands)Year ended December 31, 2008Reserves and allowances deducted from asset accounts:Obsolescence reserve for inventory

$
750

$


$
(71
)
$
679Allowance for uncollectible accounts receivable


249





(4
)

245Valuation allowance for deferred tax assets





3,396





3,396Year ended December 31, 2009Reserves and allowances deducted from asset accounts:Obsolescence reserve for inventory

$
679

$
389

$
(126
)
$
942Allowance for uncollectible accounts receivable


245


275


(134
)

386Valuation allowance for deferred tax assets


3,396


107





3,503


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