UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended SeptemberJune 30, 20032004
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the period from to
Commission file number 0-5404
ANALEX CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 71-0869563 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
5904 Richmond Highway
Suite 300
Alexandria, Virginia 22303
(Address of principal executive offices)
Registrant’s Telephone number including area code
(703) 329-9400
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.
Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)
Yes¨ Nox
As of November 12, 2003, 15,487,426August 11, 2004, 15,292,512 shares of the common stock of the registrant were outstanding.
Page No. | ||||||
Part I Financial Information: | ||||||
| Item 1. | Financial Statements | ||||
Consolidated Balance Sheets at | 3 | |||||
5 | ||||||
6 | ||||||
7 | ||||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | ||||
| Item 3. | Quantitative and Qualitative Disclosure About Market Risk | ||||
| Item 4. | Controls and Procedures | ||||
Part IIOther Information: | ||||||
| Item 1.Legal Proceedings | |||||
| ||||||
CONSOLIDATED BALANCE SHEETS
SEPTEMBERJUNE 30, 20032004 AND DECEMBER 31, 20022003
June 30, 2004 (unaudited) | December 31, 2003 | |||||||||||
September 30, 2003 (unaudited) | December 31, 2002 | |||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 110,700 | $ | 301,800 | $ | 1,276,900 | $ | 14,177,500 | ||||
Accounts receivable, net | 12,154,600 | 12,556,100 | 20,303,800 | 10,068,100 | ||||||||
Deferred tax asset | 556,100 | 150,000 | ||||||||||
Prepaid expenses and other | 295,200 | 270,500 | 643,300 | 483,600 | ||||||||
Current assets of business held for sale | 93,200 | 658,100 | ||||||||||
Total current assets | 12,560,500 | 13,128,400 | 22,873,300 | 25,537,300 | ||||||||
Fixed assets, net | 477,800 | 216,700 | 1,108,400 | 546,100 | ||||||||
Contract rights and other intangibles, net | 7,353,500 | 1,753,000 | ||||||||||
Goodwill | 15,534,600 | 15,534,600 | 41,648,100 | 15,281,600 | ||||||||
Contract rights and other intangibles, net | 1,418,900 | 1,770,200 | ||||||||||
Deferred finance costs | 61,100 | 75,900 | ||||||||||
Other | 441,300 | 58,400 | ||||||||||
Other assets | 874,000 | 514,100 | ||||||||||
Total other assets | 17,933,700 | 17,655,800 | 50,984,000 | 18,094,800 | ||||||||
Total assets | $ | 30,494,200 | $ | 30,784,200 | $ | 73,857,300 | $ | 43,632,100 | ||||
See Notes to Consolidated Financial Statements
ANALEX CORPORATION
CONSOLIDATED BALANCE SHEETS
SEPTEMBERJUNE 30, 20032004 AND DECEMBER 31, 20022003
September 30, 2003 (unaudited) | December 31, 2002 | |||||||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||||||
June 30, 2004 (unaudited) | December 31, 2003 | |||||||||||||||
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 1,854,500 | $ | 3,294,700 | $ | 915,700 | $ | 736,200 | ||||||||
Note payable - line of credit | 594,100 | 2,187,700 | 8,254,700 | — | ||||||||||||
Note payable - convertible note | 8,398,700 | — | ||||||||||||||
Note payable - bank term note | 700,000 | 700,000 | — | 700,000 | ||||||||||||
Notes payable - other | 1,043,400 | 1,012,100 | 953,900 | 1,487,400 | ||||||||||||
Other current liabilities | 7,306,700 | 5,258,400 | 8,870,000 | 5,387,500 | ||||||||||||
Current liabilities of business held for sale | 93,200 | 116,000 | ||||||||||||||
Total current liabilities | 11,498,700 | 12,452,900 | 27,486,200 | 8,427,100 | ||||||||||||
Note payable - bank term note | 1,516,700 | 2,041,700 | — | 1,341,700 | ||||||||||||
Notes payable - other | 1,317,300 | 2,297,200 | 651,700 | 1,209,300 | ||||||||||||
Deferred tax liability | 2,325,300 | — | ||||||||||||||
Convertible note | 3,785,500 | 2,881,400 | ||||||||||||||
Other | 59,200 | 90,600 | 17,700 | 43,800 | ||||||||||||
Total long-term liabilities | 2,893,200 | 4,429,500 | 6,780,200 | 5,476,200 | ||||||||||||
Total liabilities | 14,391,900 | 16,882,400 | 34,266,400 | 13,903,300 | ||||||||||||
Commitments and contingencies | ||||||||||||||||
Series A convertible preferred stock | 2,112,900 | 236,300 | ||||||||||||||
Shareholders’ equity: | ||||||||||||||||
Common stock $.02 par; authorized 30,000,000 shares; issued and outstanding - September 30, 2003, 14,980,569 shares and December 31, 2002, 14,427,080 shares | 299,600 | 288,500 | ||||||||||||||
Additional capital | 21,331,300 | 21,171,400 | ||||||||||||||
Deferred compensation | — | (7,700 | ) | |||||||||||||
Common stock $.02 par; authorized 65,000,000 shares; issued and outstanding - June 30, 2004, 15,292,512 shares and December 31, 2003, 13,036,666 shares | 305,900 | 260,700 | ||||||||||||||
Additional paid in capital | 38,725,200 | 28,519,100 | ||||||||||||||
Warrants outstanding | 6,482,800 | 5,762,900 | ||||||||||||||
Accumulated other comprehensive loss | (59,200 | ) | (90,600 | ) | (17,700 | ) | (43,800 | ) | ||||||||
Accumulated deficit | (5,469,400 | ) | (7,459,800 | ) | (8,018,200 | ) | (5,006,400 | ) | ||||||||
Total shareholders’ equity | 16,102,300 | 13,901,800 | 37,478,000 | 29,492,500 | ||||||||||||
Total liabilities and shareholders’ equity | $ | 30,494,200 | $ | 30,784,200 | ||||||||||||
Total liabilities, convertible preferred stock and shareholders’ equity | $ | 73,857,300 | $ | 43,632,100 | ||||||||||||
�� |
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINESIX MONTHS ENDED SEPTEMBERJUNE 30, 20032004 AND 20022003
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||
2003 (unaudited) | 2002 (unaudited) | 2003 (unaudited) | 2002 (unaudited) | (unaudited) | ||||||||||||||||||||||||||||
Revenues | $ | 16,589,800 | $ | 16,318,600 | $ | 49,823,900 | $ | 42,282,300 | $ | 22,215,200 | $ | 15,425,200 | $ | 38,846,600 | $ | 30,703,500 | ||||||||||||||||
Operating costs and expenses: | ||||||||||||||||||||||||||||||||
Costs of revenue | 14,091,000 | 13,800,100 | 41,873,900 | 36,060,100 | 17,357,200 | 12,924,600 | 31,408,600 | 25,731,500 | ||||||||||||||||||||||||
Selling, general and administrative | 1,498,700 | 1,233,000 | 4,578,800 | 3,673,600 | 2,552,500 | 1,432,800 | 4,353,900 | 2,750,500 | ||||||||||||||||||||||||
Amortization of other intangible assets | 104,200 | 92,200 | 308,700 | 232,200 | ||||||||||||||||||||||||||||
Amortization of intangible assets | 277,300 | 104,300 | 426,500 | 204,500 | ||||||||||||||||||||||||||||
Total operating costs and expenses | 15,693,900 | 15,125,300 | 46,761,400 | 39,965,900 | 20,187,000 | 14,461,700 | 36,189,000 | 28,686,500 | ||||||||||||||||||||||||
Operating income | 895,900 | 1,193,300 | 3,062,500 | 2,316,400 | 2,028,200 | 963,500 | 2,657,600 | 2,017,000 | ||||||||||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||||||||||
Interest income | 200 | 600 | 1,200 | 1,200 | 29,600 | — | 42,900 | 1,100 | ||||||||||||||||||||||||
Interest expense | (83,200 | ) | (269,700 | ) | (279,800 | ) | (780,100 | ) | (1,698,900 | ) | (84,200 | ) | (2,400,000 | ) | (196,600 | ) | ||||||||||||||||
Total other expense | (83,000 | ) | (269,100 | ) | (278,600 | ) | (778,900 | ) | ||||||||||||||||||||||||
Total other expense, net | (1,669,300 | ) | (84,200 | ) | (2,357,100 | ) | (195,500 | ) | ||||||||||||||||||||||||
Income before income taxes | 812,900 | 924,200 | 2,783,900 | 1,537,500 | ||||||||||||||||||||||||||||
Income from continuing operations before income taxes | 358,900 | 879,300 | 300,500 | 1,821,500 | ||||||||||||||||||||||||||||
Provision for income taxes | 231,900 | 10,200 | 793,400 | 23,900 | 459,500 | 250,300 | 384,700 | 518,900 | ||||||||||||||||||||||||
Net income | $ | 581,000 | $ | 914,000 | $ | 1,990,500 | $ | 1,513,600 | ||||||||||||||||||||||||
Income (loss) from continuing operations | (100,600 | ) | 629,000 | (84,200 | ) | 1,302,600 | ||||||||||||||||||||||||||
Net income per share: | ||||||||||||||||||||||||||||||||
Income (loss) from discontinued operations, net of income taxes | (50,700 | ) | 45,200 | (79,200 | ) | 107,000 | ||||||||||||||||||||||||||
Loss on disposal of discontinued operations, net of income taxes | (521,800 | ) | — | (521,800 | ) | — | ||||||||||||||||||||||||||
Net income (loss) | (673,100 | ) | 674,200 | (685,200 | ) | 1,409,600 | ||||||||||||||||||||||||||
Dividends on convertible preferred stock | (225,000 | ) | — | (450,000 | ) | — | ||||||||||||||||||||||||||
Accretion of convertible preferred stock | (939,100 | ) | — | (1,876,600 | ) | — | ||||||||||||||||||||||||||
Net income (loss) available to common shareholders | $ | (1,837,200 | ) | $ | 674,200 | $ | (3,011,800 | ) | $ | 1,409,600 | ||||||||||||||||||||||
Net income (loss) available to common shareholders per share: | ||||||||||||||||||||||||||||||||
Continuing operations | ||||||||||||||||||||||||||||||||
Basic | $ | (0.09 | ) | $ | 0.05 | $ | (0.18 | ) | $ | 0.09 | ||||||||||||||||||||||
Diluted | $ | (0.09 | ) | $ | 0.04 | $ | (0.18 | ) | $ | 0.07 | ||||||||||||||||||||||
Discontinued operations | ||||||||||||||||||||||||||||||||
Basic | $ | (0.04 | ) | $ | 0.00 | $ | (0.04 | ) | $ | 0.01 | ||||||||||||||||||||||
Diluted | $ | (0.04 | ) | $ | 0.00 | $ | (0.04 | ) | $ | 0.01 | ||||||||||||||||||||||
Net income (loss) available to common shareholders: | ||||||||||||||||||||||||||||||||
Basic | $ | 0.04 | $ | 0.06 | $ | 0.13 | $ | 0.11 | $ | (0.13 | ) | $ | 0.05 | $ | (0.22 | ) | $ | 0.10 | ||||||||||||||
Diluted | $ | 0.03 | $ | 0.05 | $ | 0.11 | $ | 0.09 | $ | (0.13 | ) | $ | 0.04 | $ | (0.22 | ) | $ | 0.08 | ||||||||||||||
Weighted average number of shares: | ||||||||||||||||||||||||||||||||
Basic | 14,971,765 | 14,238,707 | 14,750,464 | 14,408,181 | 14,049,715 | 14,577,663 | 13,547,203 | 14,511,875 | ||||||||||||||||||||||||
Diluted | 17,811,841 | 17,013,845 | 17,601,869 | 16,981,384 | 14,049,715 | 17,169,313 | 13,547,203 | 17,496,504 | ||||||||||||||||||||||||
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINESIX MONTHS ENDED SEPTEMBERJUNE 30, 20032004 AND 20022003
September 30, 2003 (unaudited) | September 30, 2002 (unaudited) | June 30 2004 | June 30 2003 | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income | $ | 1,990,500 | $ | 1,513,600 | ||||||||||||
Net income (loss) | $ | (685,200 | ) | $ | 1,409,600 | |||||||||||
Adjustments to reconcile net income to net cash from operating activities: | ||||||||||||||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||||||
Depreciation | 90,900 | 73,700 | 96,300 | 37,100 | ||||||||||||
Amortization of other intangible assets | 308,700 | 232,200 | ||||||||||||||
Non-cash interest expense | 270,700 | |||||||||||||||
Amortization of intangible assets | 426,500 | 204,500 | ||||||||||||||
Amortization of deferred financing costs | 1,762,400 | — | ||||||||||||||
Loss on disposal of discontinued operations | 521,800 | — | ||||||||||||||
Stock-based compensation expense | 7,700 | 6,100 | — | 7,700 | ||||||||||||
Write-off of patent related cost | 48,600 | — | ||||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | 401,500 | (2,947,400 | ) | |||||||||||||
Deferred tax benefit | (556,100 | ) | — | |||||||||||||
Changes in operating assets and liabilities net of effect of business combination: | ||||||||||||||||
Accounts receivable, net | (5,101,100 | ) | 366,000 | |||||||||||||
Prepaid expenses and other | (24,700 | ) | 41,200 | 962,600 | (50,600 | ) | ||||||||||
Other assets | (368,100 | ) | 57,500 | (168,900 | ) | 28,700 | ||||||||||
Accounts payable | (1,440,200 | ) | 454,500 | (88,100 | ) | (1,613,000 | ) | |||||||||
Other current liabilities | 2,048,300 | 1,954,900 | 1,506,000 | 1,936,500 | ||||||||||||
Other long-term liabilities | — | (60,000 | ) | |||||||||||||
Other long term liabilities | (10,200 | ) | — | |||||||||||||
Total adjustments | 1,072,700 | 83,400 | ||||||||||||||
Net cash provided by operating activities | 3,063,200 | 1,597,000 | ||||||||||||||
Net cash provided by (used in) operating activities | (1,334,000 | ) | 2,326,500 | |||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Property additions | (332,300 | ) | (186,200 | ) | (144,600 | ) | (197,300 | ) | ||||||||
Intangible additions | (25,700 | ) | — | — | (6,100 | ) | ||||||||||
Cash paid for BAI, net of cash acquired | (27,049,200 | ) | — | |||||||||||||
Net cash used in investing activities | (358,000 | ) | (186,200 | ) | (27,193,800 | ) | (203,400 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||||||
Proceeds from borrowings on bank and other loans | 1,829,000 | 8,300 | 6,554,700 | 1,829,000 | ||||||||||||
Proceeds from stock options and warrants exercised | 97,000 | 16,400 | 305,800 | 59,200 | ||||||||||||
Proceeds from employee stock purchase plan | 74,000 | 74,000 | 126,700 | — | ||||||||||||
Proceeds from issuance of Senior Subordinated Notes and warrants | 12,000,000 | — | ||||||||||||||
Payments on bank and other loans | (4,896,300 | ) | (1,137,200 | ) | (3,143,300 | ) | (3,744,200 | ) | ||||||||
Net cash used in financing activities | (2,896,300 | ) | (1,038,500 | ) | ||||||||||||
Net cash provided by (used in) financing activities | 15,843,900 | (1,856,000 | ) | |||||||||||||
Net cash from discontinued operations | (216,700 | ) | 323,300 | |||||||||||||
Net (decrease) increase in cash and cash equivalents | (191,100 | ) | 372,300 | (12,900,600 | ) | 590,400 | ||||||||||
Cash and cash equivalents at beginning of period | 301,800 | 83,100 | 14,177,500 | 301,800 | ||||||||||||
Cash and cash equivalents at end of period | $ | 110,700 | $ | 455,400 | $ | 1,276,900 | $ | 892,200 | ||||||||
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1.Business Groups
Analex Corporation (the “Company”) provides information technology and systems engineering services to the United States government through two groups: the Homeland Security Group, supporting intelligence systems; and the Systems Engineering Group, supporting the development of space-based systems, the operation of terrestrial assets, and the launch of unmanned rockets by NASA under the Company’s Expendable Launch Vehicle Integrated Support (“ELVIS”) contract with NASA.contract. In addition, its discontinued subsidiary, Advanced Biosystems, Inc. subsidiary (“ABS”) pursues, is engaged in biomedical research and business opportunities in the areas offor broad spectrum defenses against biological warfaretoxic agents capable of being used as bioterrorist weapons, such as anthrax and other infectious diseases.smallpox. During the second quarter of 2004, the Company decided to divest ABS. Therefore, the results of operations of ABS are reported as discontinued operations for all periods presented herein (see note 12).
The Homeland Security Group has accounted for approximately 41%48% of the Company’s 20032004 year-to-date revenue. The Homeland Security Group expects to benefit from the country’s shifting priorities and new emphasis on enhanced intelligence capabilities. This group provides engineering, scientific and information technology services and solutions to assist in the development, implementation and support of intelligence systems. Analex provides these services to various members of the Intelligenceintelligence community, including the National Reconnaissance Office, the Missile Defense Agency, the National Security Agency, the Department of Defense, and major prime contractors.aerospace contractors, such as Lockheed Martin and Northrop Grumman.
The Systems Engineering Group has accounted for approximately 52% of the Company’s 20032004 year-to-date revenues. This group provides engineering and information technology services and solutions to assist in the development of space-based systems and support operations of terrestrial assets. Capabilities include expendable launch vehicle engineering, space systems development, and ground support for space operations.
ABS has accounted for approximately 7%On May 28, 2004, Analex acquired Beta Analytics, Inc. (“BAI”). BAI is reported as a part of the Company’s 2003 year-to-date revenues. ABS pursues researchHomeland Security Group. BAI provides information and technology asset protection solutions, intelligence analysis, and security services to federal government and Department of Defense agencies. BAI’s services cover a range of life cycle protection and physical security services specifically in the areas of defenses against,information protection, physical security, intelligence threat assessment and treatments for, biological warfare agentsanalysis, technology protection, security management and other infectious diseases. ABS also provides consulting services regarding biological weapons, threats,security education and defensive strategies.training.
2.Basis of Presentation
The interim consolidated financial statements for Analex Corporation (the “Company”)the Company are unaudited, but in the opinion of management, reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of results for such periods. The results of operations for any interim period are not necessarily indicative of results for the full year. The balance sheet at December 31, 20022003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Amendment No. 2 to Annual Report on Form 10-K/A10-K for the year ended December 31, 20022003 (“20022003 Form 10-K”) filed with the Securities and Exchange Commission on November 7, 2003.March 30, 2004.
Recent Accounting Pronouncements
The Company pursues acquisitions to complement its business. In November 2002,accordance with the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21,Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company adopted EITF Issue No. 00-21 effective July 1, 2003. The implementation of EITF Issue No. 00-21 did not have a material impact on the Company’s financial position or results of operations.
In November 2002, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that upon issuance of certain guarantees, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45’s provisions for initial recognition and measurement are required to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure provisions of FIN 45 are effective for financial statements of interim or annual periods that end after December 15, 2002. As the Company has not entered into or modified any guarantees subsequent to December 31, 2002, the implementation of FIN 45 did not impact the Company’s financial position or results of operations. The Company has updated its disclosures to comply with the requirements in FIN 45.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (SFAS 150)141,Business Combinations,Accounting the direct costs associated with these acquisitions are accounted for Certain Financial Instrumentsas additional purchase consideration. Costs associated with Characteristicstransactions for which we discontinue our pursuit are expensed in the period in which the transaction is abandoned.
3.Acquisition of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristicsBeta Analytics, Inc.
Under the terms of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS 150 is effective for financial instruments entered into or modified afterStock Purchase Agreement, dated May 31, 2003, and otherwise is effective at the beginning6, 2004, Analex acquired all of the first interim period beginning after June 15, 2003. In November 2003,issued and outstanding stock of BAI for approximately (i) $27.7 million in cash, and (ii) 1,832,460 unregistered shares of Analex common stock. These shares were valued at $3.332 per share. This value was determined based on the FASB deferred the effective date of certain provisions of SFAS 150. The adoptionaverage closing stock price of the applicable provisions of SFAS has not had a significant impactCompany’s common stock for the five days prior to the Company’sacquisition. Analex financed the cash portion of the consideration for the acquisition through its cash on hand, senior debt from Bank of America, N.A. and new debt in the initial principal amount of $12 million Senior Subordinated Notes (see note 9).
Management believes that the acquisition of BAI will yield additional significant yearly revenues and operating income, enhanced attractiveness to institutional investors and an enhanced ability to compete effectively within the government services industry. Value associated with BAI’s intangible assets including contract rights and customer relationships was the primary factor contributing to a purchase price in excess of net assets acquired. These intangible assets have an estimated useful life of five years.
The acquisition of BAI, which was valued at approximately $35.2 million, was accounted for using the purchase method of accounting. Under the purchase method of accounting, the purchase price is allocated to the underlying tangible and intangible assets acquired and liabilities assumed based on their respective fair market values, with the excess recorded as goodwill. The financial statements.statements as of June 30, 2004 reflect preliminary estimates of the fair market value for the purchased
intangible assets. The allocation of the purchase price is summarized as follows:
Cash purchase price | $ | 27,726,500 | ||
Stock purchase price | 6,102,100 | |||
Transaction fees | 1,383,200 | |||
35,211,800 | ||||
Cash | 2,060,500 | |||
Accounts receivable | 5,134,600 | |||
Fixed assets | 533,300 | |||
Intangible assets | 6,028,000 | |||
Other assets | 869,800 | |||
Accounts payable | (267,600 | ) | ||
Line of credit | (1,700,000 | ) | ||
Other current liabilities | (152,600 | ) | ||
Other liabilities | (1,336,300 | ) | ||
Deferred tax liability | (2,325,000 | ) | ||
Goodwill | $ | 26,367,100 |
On November 2, 2001, to financeThe unaudited pro forma financial information reflects the acquisitionresults of Analex, the Company entered intofor the three and six months ended June 30, 2004, as if BAI had been acquired on April 1, 2004 and January 1, 2004, respectively. These combined results are not necessarily indicative of future operating results of the Company.
Three Months June 30, 2004 | Six Months June 30, 2004 | |||||||
Revenues | $ | 29,046,800 | $ | 54,002,200 | ||||
Income from continuing operations | 206,200 | 728,900 | ||||||
Net income (loss) | (366,500 | ) | 127,900 | |||||
Net loss available to common shareholders | (1,530,600 | ) | (2,198,700 | ) | ||||
Basic earnings per share available to common shareholders | $ | (0.11 | ) | $ | (0.16 | ) | ||
Diluted earnings per share available to common shareholders | $ | (0.11 | ) | $ | (0.16 | ) |
4.Debt
The Company has a Credit Agreement (“Agreement”)credit agreement with Bank of America, N.A. The Agreement originally provided (“the CompanyCredit Facility”). On May 28, 2004, in connection with the acquisition of BAI, the Credit Facility was amended and restated to provide a $4,000,000$20,000,000 revolving credit facility, (the “Credit Facility”) through November 2, 2006 and a five-year $3,500,000the remaining outstanding balance on the Company’s term loan (“Term Loan”).of $1,750,000 was consolidated into the Credit Facility. An uncommitted annual
guidance facility not to exceed an additional $20,000,000 is available to fund future acquisitions upon application by the Company and approval by Bank of America. The Credit Facility has an annual renewal occurring April 30 of each year. To fund additional working capital requirements generated by the award of the ELVIS contract, the Company negotiated an increase ofInterest on the Credit Facility. The Company now has an $8,000,000 Credit Facility. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. Interest on each of the facilitiesFacility is at the LIBOR Rate plus an applicable margin as specified in a pricing grid. As of SeptemberJune 30, 2003,2004, the Credit Facility and Term Loan balances were $594,100 and $2,216,700, respectively.outstanding balance was $8,254,700. The interest rate at SeptemberJune 30, 20032004 was 3.62%3.84% for the Credit Facility.
The Credit Facility and 4.12% for the Term Loan. The Company is subject to certaincontains financial covenants pursuant to the Agreement, includingsetting forth maximum ratios for total funded debt to EBITDA ratio,and minimum ratios for fixed charge coverage ratio, senior debt to EBITDA ratio, and net worth requirements.coverage. As of SeptemberJune 30, 2003,2004, the Company was in compliance with these covenants. The Credit Facility also restricts the Company’s ability to dispose of properties other than ABS, incur additional indebtedness, pay dividends (except to holders of the Series A and Series B Preferred Stock) or other distributions, create liens on assets, enter into sale and leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. The Credit Facility is secured by the accounts receivable and the other assets of the Company secure the Credit Facility and Term Loan.Company.
The Company’s $3.5 million Term Loan facility from Bank of America carries interest comprised of two components: floating-rate LIBOR plus a credit performance margin. In January 2002, the Company entered into an interest-rate swap agreement with Bank of America whereby its obligation to pay floating-rate LIBOR on debt, now totaling $1,900,000,$1,450,000, was swapped into a fixed rate obligation at 4.25%. The Company continues to have the obligation to pay the credit performance margin in addition to its swapped 4.25% payment obligation. The total effective interest rate on the swapped portion of the Term Loanrevolving credit facility amounted to 7.25%6.75% at SeptemberJune 30, 2003.2004.
The Company’s comprehensive incomeloss available to common shareholders for the three months ended SeptemberJune 30, 20032004 was $596,100,$1,822,000 which includes the net incomeloss available to common shareholders of $581,000$1,837,200 and other comprehensive income of $15,100$15,200 arising from the interest rate swap. The Company’s comprehensive income
loss for the ninesix months ended SeptemberJune 30, 20032004 was $2,021,900,$2,985,700, which includes the net incomeloss available to common shareholders of $1,990,500$3,011,800 and other comprehensive income of $31,400$26,100 arising from the interest rate swap.
The Company has outstanding a $10,000,000 Convertible Note issued on December 9, 2003 in connection with the Pequot Transaction (see note 8). In connection with the BAI acquisition and the Series B Financing, the Company issued $12,000,000 Senior Subordinated Notes on May 28, 2004 (see note 9).
5.Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
2003 | 2002 | 2003 | 2002 | Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||
Net income | $ | 581,000 | $ | 914,000 | $ | 1,990,500 | $ | 1,513,600 | ||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||
Income (loss) from continuing operations | (100,600 | ) | 629,000 | (84,200 | ) | 1,302,600 | ||||||||||||||||||||
Income (loss) from discontinued operations, net of income taxes | (50,700 | ) | 45,200 | (79,200 | ) | 107,000 | ||||||||||||||||||||
Loss on disposal of discontinued operations, net of income taxes | (521,800 | ) | — | (521,800 | ) | — | ||||||||||||||||||||
Income (loss) from discontinued operations, net of income taxes | (572,500 | ) | 45,200 | (601,000 | ) | 107,000 | ||||||||||||||||||||
Net income (loss) available to common shareholders | $ | (1,837,200 | ) | $ | 674,200 | $ | (3,011,800 | ) | $ | 1,409,600 | ||||||||||||||||
Weighted average shares outstanding | 14,971,765 | 14,238,707 | 14,750,464 | 14,408,181 | 14,049,715 | 14,577,663 | 13,547,203 | 14,511,875 | ||||||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||||||||||
Warrants | 1,590,539 | 1,894,427 | 1,703,315 | 1,841,337 | — | 1,560,693 | — | 1,882,978 | ||||||||||||||||||
Employee stock options | 1,249,537 | 880,711 | 1,147,300 | 731,866 | — | 1,030,957 | — | 1,101,651 | ||||||||||||||||||
Diluted weighted average shares outstanding | 17,811,841 | 17,013,845 | 17,601,079 | 16,981,384 | 14,049,715 | 17,169,313 | 13,547,203 | 17,496,504 | ||||||||||||||||||
Basic earnings per share | $ | .04 | $ | .06 | $ | .13 | $ | .11 | ||||||||||||||||||
Diluted earnings per share | $ | .03 | $ | .05 | $ | .11 | $ | .09 | ||||||||||||||||||
Net income (loss) available to common shareholders per share: | ||||||||||||||||||||||||||
Continuing operations: | ||||||||||||||||||||||||||
Basic | $ | (0.09 | ) | $ | 0.05 | $ | (0.18 | ) | $ | 0.09 | ||||||||||||||||
Diluted | $ | (0.09 | ) | $ | 0.04 | $ | (0.18 | ) | $ | 0.07 | ||||||||||||||||
Discontinued operations: | ||||||||||||||||||||||||||
Basic | $ | (0.04 | ) | $ | 0.0 | $ | (0.04 | ) | $ | 0.01 | ||||||||||||||||
Diluted | $ | (0.04 | ) | $ | 0.0 | $ | (0.04 | ) | $ | 0.01 | ||||||||||||||||
Net income (loss) available to common shareholders: | ||||||||||||||||||||||||||
Basic | $ | (0.13 | ) | $ | 0.05 | $ | (0.22 | ) | $ | 0.10 | ||||||||||||||||
Diluted | $ | (0.13 | ) | $ | 0.04 | $ | (0.22 | ) | $ | 0.08 | ||||||||||||||||
Shares issuable upon the exercise of stock options or warrants or upon conversion of debt have been excluded from the computation to the extent that their inclusion would be anti-dilutive.
6.Stock-based compensation
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS No. 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related
interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the fair market value of the Company’s stock at the date of the grant over the exercise price of the related option. The following table is a computation of the pro forma earnings had the Company adopted the disclosure provisions ofaccounted for stock option grants based on their fair value as determined under SFAS No. 148 beginning with its financial reports for the year ended December 31, 2002.123:
Three Months Ended September 30, 2003 | Three Months Ended September 30, 2002 | Nine Months Ended September 30, 2003 | Nine Months Ended September 30, 2002 | |||||||||||||||||||||||
Net income, as reported | $ | 581,000 | $ | 914,000 | $ | 1,990,500 | $ | 1,513,600 | ||||||||||||||||||
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||
Net income (loss) available to common shareholders, as reported | $ | (1,837,200 | ) | $ | 674,200 | $ | (3,011,800 | ) | $ | 1,409,600 | ||||||||||||||||
Add: Total stock-based employee compensation expense as reported under intrinsic value method (APB No. 25) for all awards, net of related tax effects | $ | — | $ | 900 | $ | 5,500 | $ | 5,800 | — | 3,100 | — | 6,900 | ||||||||||||||
Deduct: Total stock-based compensation expense determined under fair value based method (SFAS No. 123) for all awards, net of related tax effects | $ | 54,100 | $ | 62,000 | $ | 922,100 | $ | 702,500 | 200,800 | 65,200 | 715,300 | 622,300 | ||||||||||||||
Pro forma net income | $ | 526,900 | $ | 852,900 | $ | 1,073,900 | $ | 816,900 | ||||||||||||||||||
Pro forma net income (loss) available to common shareholders | $ | (2,038,000 | ) | $ | 612,100 | $ | (3,727,100 | ) | $ | 794,200 | ||||||||||||||||
Earnings per share: | ||||||||||||||||||||||||||
Basic as reported | $ | .04 | $ | .06 | $ | .13 | $ | .11 | $ | (0.13 | ) | $ | 0.05 | $ | (0.22 | ) | $ | 0.10 | ||||||||
Diluted as reported | $ | .03 | $ | .05 | $ | .11 | $ | .09 | (0.13 | ) | 0.04 | (0.22 | ) | 0.08 | ||||||||||||
Basic pro forma | $ | .04 | $ | .06 | $ | .07 | $ | .06 | ||||||||||||||||||
Diluted pro forma | $ | .03 | $ | .05 | $ | .06 | $ | .05 | ||||||||||||||||||
Basic proforma | (0.15 | ) | 0.04 | (0.28 | ) | 0.05 | ||||||||||||||||||||
Diluted proforma | (0.15 | ) | 0.04 | (0.28 | ) | 0.05 |
7.Concentration of Business
Almost all of the Company’s revenues are derived either directly from the U.S. Governmentgovernment as prime contractor or indirectly as a subcontractor to other government prime contractors. With the award of the ELVIS contract to the Company, approximately 54%Approximately 47% of the Company’s 2003 year-to-date revenues have been derived, directly and indirectly, from NASA. Approximately 46% of the Company’s 20032004 year-to-date revenues have been derived from various Department of Defense agencies. Approximately 52% of the Company’s 2004 year-to-date revenues have been derived, directly or indirectly, from NASA.
8.Pequot Transaction
On December 9, 2003, the Company consummated the transactions (the “Pequot Transaction”) contemplated by the Subordinated Note and Series A Convertible Preferred Stock Purchase Agreement by and between the Company and Pequot Private Equity Fund III, L.P., a Delaware limited partnership, and Pequot Offshore Private Equity Partners III, L.P., a Cayman Islands limited partnership (“Pequot”). The Company:
Series A Preferred Stock
The Series A Preferred Stock bears a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s Credit Facility, in additional shares of Series A Preferred Stock. Holders of Series A Preferred Stock are entitled to vote together with all other classes and series of voting stock of the Company on all actions to be taken by the stockholders of the Company. In addition, as long as 50% of the Series A Preferred Stock originally issued remains outstanding, the Company may not take numerous actions without obtaining the written consent of the holders of a majority of the Series A Preferred Stock.
The Series A Preferred Stock is convertible into common stock at any time at the election of its holders, initially at a ratio of one share of common stock for every share of Series A Preferred Stock. The Series A Preferred Stock will automatically convert into Common Stock if, any time following June 9, 2005, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the conversion price then in effect for the Series A Preferred Stock. In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into Common Stock. The Series A Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.
Upon issuance of the Series A Preferred Stock, the Company allocated relative fair value of $3,857,600 to the Preferred Warrants and recorded a beneficial conversion charge of $11,142,400. These amounts are being recorded as accretion of Series A Preferred Stock over the period to the earliest redemption date, which is December 9, 2007. For the three months and six months ended June 30, 2004, the Company recorded $0.9 million and $1.9 million, respectively, of accretion related to these charges.
Convertible Notes
The Convertible Notes mature on December 9, 2007. The Convertible Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s Credit Facility, such interest will be accrued and added to the outstanding principal.
The Convertible Notes may not be prepaid prior to June 9, 2005 without the consent of the holders of a majority of the outstanding principal amount of the Convertible Notes. Any subsequent prepayment will be made, at the option of the Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum; or by conversion of the principal into shares of Series A Preferred Stock and the payment of interest in cash or in shares of Series A Preferred Stock. Holders of the Convertible Notes may convert the outstanding principal and accrued interest on the Notes into Series A Preferred Stock at any time. The conversion price for the Convertible Notes is $3.01 per share.
The Company’s obligations under the Convertible Notes are secured by a lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. Such obligations are subordinated to the rights of the Company’s present and future senior secured lenders.
Upon issuance of the Convertible Notes, the Company allocated fair value of $1,905,300 to the Note Warrants and recorded a beneficial conversion charge of $5,327,200. The discount created by these charges is being amortized to interest expense over the life of the Convertible Notes. For the three months and six months ended June 30, 2004, the Company recognized $0.5 million and $0.9 million, respectively, of amortization of that discount. The unamortized discount as of June 30, 2004 was $4.3 million.
Warrants
The Warrants are exercisable at any time before December 9, 2013. The Preferred Warrants are exercisable to purchase one share of common stock for every five shares of common stock issued or issuable upon conversion of the Series A Preferred Stock. The Note Warrants are exercisable to purchase one share of common stock for every five shares of common stock issued or issuable upon conversion of the Convertible Notes. The initial exercise price of the Warrants is $3.28.
9.Series B Financing
Pursuant to a Stock Purchase Agreement among the Company and General Electric Pension Trust (“GEPT”), New York Life Capital Partners II, L.P. (“NYL”), Pequot Private Equity Fund III, L.P., and Pequot Offshore Private Equity Partners III, L.P., (collectively, “Pequot,” together with GEPT and NYL, collectively, the “Investors”), dated May 28, 2004 (the “Series B Purchase Agreement”), the Company:
A significant portion of the funds obtained on the First Closing Date was used to pay the cash portion of the consideration for the acquisition of BAI.
Subject to certain approval rights by the holders of the Series A Preferred Stock and the Series B Preferred Stock, the Series B Purchase Agreement also provides that the Company has an option to require the Investors to purchase up to an additional $25 million of Senior Subordinated Notes or Series B Preferred Stock, with additional Common Stock Warrants (the “Company Option”), at any one or more times on or prior to May 27, 2005 for the purpose of paying the cost of acquisition of the stock or assets of one or more other companies in each case with an acquisition value of at least $10 million.
Senior Subordinated Notes
The Senior Subordinated Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s Credit Facility, accrued and added to the outstanding principal. Upon a payment default, the interest rate on the Senior Subordinated Notes will be increased to 14% per annum during the term of the default.
The outstanding principal and accrued interest on the Senior Subordinated Notes will be automatically converted into Series B Preferred Stock upon stockholders’ approval at the annual meeting. The per share conversion price of the Senior Subordinated Notes is $3.50 (the “Series B Original Issue Price”).
If the Senior Subordinated Notes have not already converted into Series B Preferred Stock, they will mature on the “Maturity Date” which is 120 days from the date of issuance (the “Series B Issue Date”). In the event that stockholders’ approval is not obtained on or before the Maturity Date, (i) the rate of interest payable on the Senior Subordinated Notes will be increased to 14% per annum and will continue to increase 3% per annum (but in no event shall be increased above the rate of interest lawfully payable) for each calendar quarter thereafter that the Senior Subordinated Notes remain unpaid and (ii) the Company will issue to Investors additional warrants to purchase $3.5 million of the Company’s common stock, exercisable at any time following the stockholders’ approval, at an exercise price equal to the Series B conversion price.
The Company’s obligations under the Senior Subordinated Notes are secured by a second lien on substantially all of the
assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. These obligations are subordinated only to those under the Credit Facility and are senior to the existing obligations to Pequot under the Convertible Notes. The Company is subject to certain financial and operational covenants.
Upon issuance of the Senior Subordinated Notes, the Company allocated fair value of $720,000 to the Common Stock Warrants based on a preliminary independent valuation, and recorded a beneficial conversion charge of $3,720,000. The discount created by these charges is being amortized to interest expense over the life of the Senior Subordinated Notes. For the three and six months ended June 30, 2004, the Company recognized $0.8 million of amortization of that discount. The unamortized discount as of June 30, 2004 was $3.6 million.
Series B Preferred Stock
An aggregate of 3,428,571 shares of Series B Preferred Stock will be issued to the Investors upon stockholders’ approval of the conversion of the $12 million Senior Subordinated Notes into the Series B Preferred Stock. The Series B Preferred Stock will rank senior to the Company’s existing Series A Preferred Stock. The Series B Preferred Stock will bear a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s Credit Facility, in additional shares of Series B Preferred Stock.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series B Preferred Stock will be entitled to receive, in preference to holders of Series A Preferred Stock and common stock, out of the Company’s assets available for stockholder distributions, an amount per share equal to the Series B Original Issue Price plus any accrued but unpaid dividends thereon. Certain mergers, acquisitions or asset sales involving the Company are treated as a liquidation event unless the holders of 66 2/3% of the then outstanding Series B Preferred Stock and Series A Preferred Stock voting together as a class elect not to treat such transactions as liquidation events.
The Series B Preferred Stock will be convertible into common stock at any time at the election of its holders. The per share conversion price (the “Conversion Price”) of the Series B Preferred Stock will be the lowest of (i) $3.10; (ii) the price that reflects a 20% discount to the trailing average closing price of the Company’s common stock for the 20 consecutive trading days immediately preceding the date of the conversion or the Series B Issue Date, but in no event less than $2.80; and (iii) the closing price of the Company’s common stock on the day
immediately preceding the Series B Issue Date; provided that if stockholder approval for the conversion of the Senior Subordinated Notes occurs during certain uncured events of default, the Conversion Price will not be subject to the $2.80 floor price under (ii) above.
The Series B Preferred Stock will automatically convert into common stock if, any time following 18 months after the Series B Issue Date, (i) the average closing price of the common stock over the immediately preceding 20 consecutive trading day period exceeds 2.5 times the Series B Original Issue Price (as adjusted for certain dilutive equity issuances and for stock splits, stock dividends and similar events related to the Series B Preferred Stock); or (ii) with respect to any holder’s shares of Series B Preferred Stock, such holder does not accept, within 60 days of notice to such holder, the Company’s offer to purchase the Series B Preferred Stock for at least 2.5 times the Series B Original Issue Price. The Series B Preferred Stock will automatically convert into common stock upon the agreement of the holders of 75% of the then outstanding Series B Preferred Stock.
Holders of two-thirds of the Series B Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of the Series B Issue Date at the Series B Original Issue Price plus accrued but unpaid dividends.
Holders of Series B Preferred Stock will be entitled to vote together with all other classes and series of voting stock of the Company as a single class, on all actions to be taken by the stockholders of the Company. As long as at least 25% of the shares of the Series B Preferred Stock issued pursuant to the Series B Purchase Agreement remain outstanding, the Company may not take numerous specified actions (including certain changes to the Company’s Certificate of Incorporation) without first obtaining the written consent of holders of at least a majority of the then outstanding shares of Series B Preferred Stock voting separately as a class. In addition, as long as the Company Option is in effect, holders of 100% of the Series A Preferred Stock and the Series B Preferred Stock, voting together as a single class, shall have the right to veto (i) any Company Acquisition, and (ii) the issuance of any securities ranking senior to or pari passu with the Series A Preferred Stock or the Series B Preferred Stock, with respect to voting, dividend, liquidation or redemption rights, including the issuance of subordinated debt.
Common Stock Warrants
The Common Stock Warrants issued in connection with the Series B Financing will expire on May 28, 2014. They are not exercisable at the time of issuance. Upon stockholders’ approval at the annual meeting, the Common Stock Warrants will become exercisable at the option of the Investors to purchase one share of common stock for every five shares of common stock issued or issuable upon conversion of the Series B Preferred Stock that is issued or issuable upon the conversion of the principal amount of the Senior Subordinated Notes. The exercise price of the Common Stock Warrants is $4.32 per share.
10.Guarantees
Pursuant to the November 2, 2001 acquisition of the former Analex, the Company issued 3,572,143 shares of the Company’s common stock to the shareholders representing all of the outstanding equity of Analex (the “Sellers”). Of the 3,572,143 shares, 857,143 shares are subject to a provision by which the Company guarantees for a five-year period to reimburse the Sellers the difference between
the price at which they sell such shares and a guaranteed sales price. The agreement phases in portions of the total shares subjectprice ranging from $1.60 to the guarantee over a period of two years following the acquisition in increments of 25% of the total guaranteed shares covered by the agreement. Of the total shares guaranteed, 25% (214,286 shares) are guaranteed from the acquisition date through November 5, 2006, at a price of $1.60. An additional 214,286$2.20 per share, if such shares are guaranteed beginning November 5, 2002 through November 5, 2006 at a pricesold within such period and if certain other conditions are satisfied. As of $1.80. An additional 214,286 shares are guaranteed beginning May 5, 2003 through November 5, 2006 at a price of $2.00 per share, resulting in aJune 30, 2004, the maximum amount of $1,157,100 payable under the terms of the guaranteed shares as of September 30, 2003.was $1,628,600. As the fair market value of the Company’s common stock was in excess of the guaranteed share prices as of SeptemberJune 30, 2003,2004, no amounts were accrued under the guarantee. On November 5, 2003, the final portion of shares (214,286 additional shares) became guaranteed at a price of $2.20 per share. These shares will be guaranteed through November 5, 2006.
11.Segment Reporting
The Company has twoone reportable segments, ABS and Analex. Thesegment consisting of the Homeland Security Group and the Systems Engineering Group. Both Homeland Security Group have been aggregated to form the reportable segment Analex. This aggregation is due to the fact that both groups perform similar services, operate in similar regulatory environments, and have similar customers. Each of the operating segments providesSystems Engineering Group provide engineering, information technology, medical research or technical services to federal government agencies or major defense contractors. BAI is reported as part of the Homeland Security Group. In prior reporting periods, ABS was reported as a reportable segment. Results for ABS are now reported as discontinued operations.
12.Discontinued Operations
During the second quarter of 2004, the Company concluded that ABS, a wholly owned subsidiary of the Company, did not fit with the Company’s long-term plan and decided to divest ABS. The reportable segmentsCompany is in the process of disposing of ABS and intends to conclude either a sale or another form of disposition by December 31, 2004. Therefore, the results of operations of
this business are distinguished by their individual clients, prior experience and technical skills.reported as discontinued operations, net of applicable income taxes, for all periods presented in accordance with SFAS 144,Accounting for the Impairment of Disposal of Long-Lived Assets. The Company has written down the assets of ABS to the fair value of the expected proceeds to be received from the disposition of ABS.
The Company’s historical financial statements have been restated to reflect ABS as discontinued operations for the periods presented.
Operating results are measured at the net income level for each segment. The accounting policies of the reportable segmentsdiscontinued business are as follows:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||
Revenues | $ | 500,039 | $ | 1,177,700 | $ | 978,700 | $ | 2,530,600 | ||||||
Income (loss) from discontinued operations | (99,000 | ) | 63,200 | (128,900 | ) | 149,600 | ||||||||
Income tax expense (benefit) | (48,300 | ) | 18,000 | (49,700 | ) | 42,600 | ||||||||
Income (loss) from discontinued operations, net of tax | $ | (50,700 | ) | $ | 45,200 | $ | (79,200 | ) | $ | 107,000 |
Tax rates vary between discontinued operations and the same as those described in the summary of significant accounting policies contained in Note 2Company’s effective tax rate due to the 2002 Form 10-K. The Company’s corporate amounts consist primarilynon-deductibility of certain activities and assets not attributable to the reportable segments.goodwill for tax purposes.
Revenues: ABS Analex Total revenues: Net income: ABS Analex Total net income: Assets: ABS Analex Total assets: THREE MONTHS
ENDED
SEPTEMBER 30,
2003 THREE MONTHS
ENDED
SEPTEMBER 30,
2002 NINE MONTHS
ENDED
SEPTEMBER 30,
2003 NINE MONTHS
ENDED
SEPTEMBER 30,
2002 (unaudited) (unaudited) (unaudited) (unaudited) $ 712,100 $ 1,708,000 $ 3,242,700 $ 4,866,400 15,877,700 $ 14,610,600 46,581,200 37,415,900 $ 16,589,800 $ 16,318,600 $ 49,823,900 $ 42,282,300 $ (74,100 ) $ 104,200 $ 75,500 $ 310,500 655,100 809,800 1,915,000 1,203,100 $ 581,000 $ 914,000 $ 1,990,500 $ 1,513,600 $ 881,700 $ 1,928,300 $ 881,700 $ 1,928,300 29,612,500 27,075,900 29,612,500 27,075,900 $ 30,494,200 $ 29,004,200 $ 30,494,200 $ 29,004,900
The major classes of assets and liabilities for this discontinued business were as follows:
June 30, 2004 | December 31, 2003 | |||||
Accounts receivable, net | $ | 93,200 | $ | 651,300 | ||
Fixed assets, net | — | 6,800 | ||||
Total assets of business held for sale | $ | 93,200 | $ | 658,100 | ||
Accounts payable | $ | 10,400 | 40,000 | |||
Other current liabilities | 82,800 | 76,000 | ||||
Total liabilities of business held for sale | $ | 93,200 | $ | 116,000 | ||
13.Litigation and Claims
The Company was served on October 9, 2003 with a lawsuitcomplaint filed by Swales & Associates, Inc. (“Swales”) in the Maryland Circuit Court for Prince George’s County Maryland, alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract.contract with NASA. Under the complaint, Swales is seekingsought damages of $4 million. To minimize the expense, effort, uncertainty and inconvenience entailed in excess of $4.0 million. Management believes that any liability that may ultimately result fromproceeding with the resolution of this matter will not have a material adverse effect on the financial position or results of operations of the Company.
On July 18, 2003,litigation, the Company entered into a PurchaseSettlement Agreement (the “Pequot Purchase Agreement”)dated July 22, 2004 with two investment funds managed by Pequot Capital Management, Inc. (“Pequot”) pursuant to whichSwales. Under the terms of the Settlement Agreement, the Company has agreed to:paid $1,000,000 to Swales in July 2004. Legal fees incurred amounted
to Pequot 6,726,457 sharesapproximately $325,000. Based on a legal opinion from the Company’s outside counsel, the Company believes that the amount of the Company’s Series A Convertible Preferred Stock (the “Series A Preferred Stock”) for a purchase price of $2.23 per share of Series A Preferred Stock (the “Series A Purchase Price”)settlement payment, together with legal fees and an aggregate consideration of approximately $15,000,000;
expenses incurred in connection with the issuance and salelitigation, are costs that are reimbursable under the ELVIS contract with NASA. However, on July 28, 2004, the Company received from NASA a Notice of Intent to Disallow Costs. Discussions with NASA are still ongoing. Notwithstanding the Notice of Intent to Disallow Costs, the Company continues to believe that the costs of the Series A Preferred Stock, issue warrants (the “Preferred Warrants”) exercisablesettlement will be reimbursed by NASA. Therefore, no amounts have been accrued for this claim as of June 30, 2004. However, there can be no assurance that the Company will in fact be reimbursed in part or in full by NASA in the foreseeable future.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Analex specializes in developing intelligence, system engineering, technology protection, operations security, and intelligence analysis in support of our nation’s security. All of our sales are generated using written contractual arrangements. The contracts require us to purchasedeliver technical services to the intelligence community, analyze and support defense systems, design, develop and test aerospace systems according to the specifications provided by our customers. In the case of ABS, the contracts require us to develop medical defenses and treatments for infectious agents such as anthrax and smallpox used in biological warfare and terrorism.
On May 28, 2004, Analex acquired Beta Analytics, Inc. (“BAI”). BAI is reported as a part of the Homeland Security Group. BAI provides information and technology asset protection solutions, intelligence analysis, and security services to federal government and Department of Defense agencies. BAI’s services cover a range of life cycle protection and physical security services specifically in the areas of information protection, physical security, intelligence threat assessment and analysis, technology protection, security management and security education and training. We believe that our acquisition of BAI will yield additional significant yearly revenues and strong operating income, enhanced attractiveness to institutional investors and an enhanced ability to compete effectively within our industry.
During the second quarter of 2004, the Company concluded that Advanced Biosystems, Inc., (“ABS”), a wholly owned subsidiary of the Company, did not fit with the Company’s common stock (the “Common Stock”) atlong-term plan and decided to divest ABS. The Company is in the process of disposing of ABS and intends to conclude either a ratiosale or another form of one sharedisposition
by December 31, 2004. Therefore, the results of Common Stockoperations of this business are reported as discontinued operations, net of applicable income taxes, for
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Sales to U.S. federal government agencies and their prime contractors represented approximately 98% of our total net sales during the six months ended June 30, 2004 and 99% during the six months ended June 30, 2003. The Department of Defense accounted for approximately 47% and 42% of our revenues in connectionthe six months ended June 30, 2004 and 2003, respectively. NASA is our largest customer, generating 52% and 57% of our revenues for the six months ended June 30, 2004 and 2003, respectively. Approximately 19% of our revenues and 79% of our operating income for the six months ended June 30, 2004 came from one prime contract with an agency within the issuance and saleDepartment of Defense. Approximately 32% of our revenues for the Convertible Notes, issue warrants (the “Note Warrants,” and togethersix months ended June 30, 2004 came from one prime contract with NASA, which will continue until September 2011 if all options are exercised. We expect that federal government contracts will continue to be the Preferred Warrants,source of substantially all of our revenue for the “Warrants”) exercisable to purchase Common Stock at a ratio of one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Convertible Notes.
In addition,the six months ended June 30, 2004, a majority of our revenues were generated as a prime contractor to the federal government. We intend to focus on July 18, 2003,retaining and increasing the Company entered intopercentage of our business as prime contractor because it provides us with stronger client relationships.The following table shows our revenues as prime contractor and as subcontractor as a Securities Repurchase Agreement (the “Stout Repurchase Agreement”) with Company Chairman Jon M. Stout, certain memberspercentage of Mr. Stout’s immediate familyour total revenues for the following periods:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||
Prime contract revenues | 67 | % | 55 | % | 64 | % | 55 | % | ||||
Subcontract revenues | 33 | 45 | 36 | 45 | ||||||||
Total revenues | 100 | % | 100 | % | 100 | % | 100 | % |
We have one reportable segment, which is engaged in professional services related to information technology and certain entities controlled by Mr. Stoutsystems engineering for the U.S. government, primarily NASA and his family (collectively, the “Stout Parties”) pursuantDepartment of Defense. This segment consists of two business groups: the Homeland Security Group and the Systems Engineering Group. The Homeland Security Group provides information technology services, systems integration, hardware and software engineering and independent quality assurance in support of the U.S. intelligence community and Department of Defense. With BAI included as a part of the Homeland Security Group, the latter also provides information and technology asset protection
solutions, intelligence analysis, and security services to which the Company will purchase an aggregatefederal government and Department of 2,625,451 shares of Common Stock and warrants and options exercisableDefense agencies. We expect our Homeland Security Group to purchase an aggregate of 1,209,088 shares of Common Stockbenefit from the Stout Partiescountry’s shifting priorities and new emphasis on enhanced intelligence capabilities. The Systems Engineering Group provides engineering, information technology and program management support to NASA, the Department of Defense, and major aerospace contractors such as Lockheed Martin and Northrop Grumman. In previous reporting periods, ABS was disclosed as a separate segment.
Our services are provided under three types of contracts: cost-plus-fees, time-and-materials, and fixed price contracts.
The following table shows our revenues from each of these types of contracts as a percentage of our total revenue for the following periods:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||
Cost-plus-fees | 40 | % | 50 | % | 43 | % | 49 | % | ||||
Time-and-materials | 43 | 36 | 41 | 37 | ||||||||
Fixed price | 17 | 14 | 16 | 14 | ||||||||
Total | 100 | % | 100 | % | 100 | % | 100 | % |
Our objective is to grow sales organically and through acquisitions. In order to assist in accomplishing this objective, we have continued to increase our selling, general and administrative expenditures so as to increase our efforts in new business development and to provide the necessary infrastructure to support a larger organization resulting from organic growth and acquisitions.
We plan to selectively acquire companies that complement and enhance our existing businesses, and are currently reviewing potential targets. We anticipate that we will need to obtain additional financing through sale of equity and debt securities to fund our acquisitions.
The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement are requiredCompany’s backlog of orders, based on remaining contract value, believed to be closed simultaneously at a closing (the “Closing”) following approvalfirm as of June 30, 2004 was approximately $209 million. Funded backlog as of June 30, 2004 was approximately $51 million. Included in the backlog approximation are amounts from future years of government contracts under which the government has the right to exercise an option for the Company to perform services.
All of our U.S. government contracts are subject to audit and various cost controls, and include standard provisions for termination for the convenience of the Pequot Transaction by the Company’s stockholdersU.S. government. Multi-year U.S. government contracts and the satisfaction of the closing conditions providedrelated orders are subject to cancellation if funds for in the Pequot Purchase Agreement and the Stout Repurchase Agreement.contract performance for any subsequent year become unavailable.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBERJUNE 30, 20032004
TO THE THREE MONTHS ENDED SEPTEMBERJUNE 30, 20022003
REVENUES AND PERCENT OF REVENUES BY GROUP
Three Months Ended June 30 | ||||||||||||
2004 | 2003 | |||||||||||
Homeland Security Group | $ | 11,404,800 | 51 | % | $ | 6,601,200 | 43 | % | ||||
Systems Engineering Group | 10,810,400 | 49 | % | 8,824,000 | 57 | % | ||||||
Total | $ | 22,215,200 | 100 | % | $ | 15,425,200 | 100 | % |
PERCENTAGE REVENUE GROWTH QUARTER OVER QUARTER BY GROUP
2004 vs. 2003 | |||
Homeland Security Group | 73 | % | |
Systems Engineering Group | 23 | % | |
Total | 44 | % |
Revenues for the three months ended SeptemberJune 30, 20032004 were $16.6$22.2 million, an increase of $0.3$6.8 million from the $16.3$15.4 million in revenues for the three months ended SeptemberJune 30, 2002.2003. This increase is primarily due to increases in revenues in the Homeland Security Group and the Systems Engineering Group, offset by a decrease in revenues in ABS. RevenuesGroup.Revenues of the Homeland Security Group increased 8.1%72.8%, or approximately $0.5$4.8 million. This increase was primarily due to the acquisition of BAI, which contributed $3.2 million in revenues, and the remainder is due to growth in services provided to the intelligence community and related agencies. Revenues of the Systems Engineering Group increased 10.1%22.5%, or approximately $0.9$2 million, primarily due to an approximate $1.2a $1.8 million increase in revenues under the ELVIS contract, as compared to the thirdsecond quarter of 2002. This increase was2003. In addition, under the Glenn Engineering Support Services contract with NASA, revenues increased approximately $0.5 million as compared to the same period of 2003 due to additional tasking from the customer. These increases were offset by a reduction in revenues of $0.5$0.3 million due to the planned step-down in activities under the Microgravity Research Development and Operations contract with NASA related to designing and building experiments to be run on the International Space Station. In addition, ABS experienced a $1.0 million, or 58%, decline in revenues.
During the third quarter, ABS fully depleted contract funding under its primary research contract from the Defense Advanced Research Projects Agency (DARPA) resulting in a decrease in revenues and an operating loss of $0.07 million for the third quarter. Other than the DARPA contract and a small research grant with the National Institutes of Health, ABS had no other funded work during the third quarter under which to generate revenue. Thus the depletion of funding under the DARPA contract led to unrecovered costs and, consequently, an operating loss. Subsequent to the end of the third quarter, ABS was granted a contract through George Mason University with a value of $600,000 to conduct research for biological defenses. ABS also was awarded a contract with the Department of State with a value of $320,000 and is awaiting authorization to proceed. Future revenues and operating profits for ABS depend on its success in obtaining additional contracts or research grants.
Increases or decreases in the Company’s revenues are predominantly attributable to changes in the volume of services provided. As a government contractor, costs billed to the government are prescribed by the Federal Acquisition Regulation and include recovery of allowable costs such as labor, fringe benefits, overhead and general and administrative expenses plus a reasonable fee.
Costs of revenue for the quarter ended SeptemberJune 30, 20032004 were $14.1$17.4 million, an increase of $0.3$4.4 million from the same
period of the prior year. The increase is dueCosts of revenue for recently acquired BAI
accounted for $2.4 million of the increase. Growth in services provided to the costscustomers of revenue generated by growth in the Homeland Security Group and the Systems Engineering Group.Group as noted in the preceding paragraph, accounted for $0.6 million and $1.4 million of the increase, respectively. Costs of revenue as a percentage of revenues were approximately 85%78% for eachthe quarter ended June 30, 2004 and 83% for the same period of the quarters ended September 30, 2003 and 2002.2003.
Selling, general and administrative expenses totaled $1.5$2.6 million for the quarter ended SeptemberJune 30, 2003,2004, compared with $1.2$1.4 million for the same period of the prior year. The $0.3 millionThis 78% increase is primarily due to costs of $0.1 millionincreased expenses related to staffing of key business developmentmerger and marketing positions that were vacantacquisition activities which accounted for $0.6 million and investments made to expand the Company’s infrastructure and management team to accommodate an expected increase in the prior period,scope of business operations from acquisitions. These investments include upgrading our financial accounting system and additional staff members in addition to increased costs related tothe accounting, contracts, marketing and corporate insurance policies of $0.05 million.management departments.
Operating income for the three months ended SeptemberJune 30, 20032004 was $0.9$2.0 million, compared to operating income of $1.2$1.0 million for the period ended SeptemberJune 30, 2002. This $0.3 million decrease2003. The increased operating income is attributable to a declinethe growth of the Homeland Security Group of $1.4 million, of which $0.6 million is attributable to BAI, and $0.8 million is attributable to growth in operating income at ABS of approximately $0.2 million dueservices provided to depletion of contract backlogthe intelligence community and lack of new contract awards. The Company’s operating income to be derived in the future from ABS depends on its success in obtaining additional contracts or research grants.related agencies. In addition, operating income of the Systems Engineering Group decreased by $0.1increased $0.4 million due to the step-down on the Microgravity Research Developmentadditional tasking from customers. These increases are offset by an additional $0.5 million of expense related to merger and Operations contract.
Operating margin for the three months ended September 30, 2003 was 5%, compared to operating marginacquisition activities and $0.2 million of 8% for the period ended September 30, 2002. This 3% decrease is attributableadditional amortization related to the factors noted in the preceding paragraph.BAI acquisition.
Interest expense totaled $0.1$1.7 million for the quarter ended SeptemberJune 30, 2003,2004, compared with $0.1 million for the same period in the prior year. The $1.6 million increase is due to cash and non-cash interest expense related to the convertible debt issued as part of the Pequot Transaction and the Series B Financing. Cash interest payments on the convertible debt were $0.3 million and non-cash amortization recorded as interest expense was $1.3 million.
Income tax expense for the quarter ended June 30, 2004 was $0.5 million, compared with $0.3 million for the same period in the prior year. The $0.2 million decreaseCompany will experience an increase in the effective tax rate in 2004. This increase is due to the Company’s reduced bank debt, which decreased by $1.8 million from September 30, 2002 to September 30, 2003. This was duerecognition of certain amortization costs related to the Company’s continued profitability,Pequot Transaction and the Series B Financing which reduced borrowings under the credit facility, coupled with scheduled principal payments on the term note. Inare not deductible for tax purposes, in addition the termination of the guarantees associated with the Bank of America debt decreased interest expense by $0.1 million.
Income tax expense for the quarter ended September 30, 2003 was $0.2 million, compared with zero expense for the same period in the prior year. The Company’s effective income tax rate is lower than the statutory federal rate of 34%, primarily due to the reduction of a valuation allowance on the Company’s deferred tax assets. The Company’s valuation allowance is expected to be eliminated by December 31,Company consuming all net operating loss carry forwards during 2003.
In the quarter ended SeptemberJune 30, 2003,2004, the Company recorded a net incomeloss from continuing operations of approximately $0.6$0.1 million and EBITDA, as defined
below, of $1.0$2.4 million, after add-backs for interest of $0.1$1.7 million, depreciation of $0.04 million, amortization of $0.1$0.3 million, and income taxestax expense of $0.2$0.5 million. In the quarter ended September 30, 2002, the Company recorded net income of approximately $0.9 million and EBITDA of $1.3 million, after add-backs for interest of $0.3 million, depreciation of $0.02 million, amortization of $0.1 million, and income taxes of zero. EBITDA as a percent of revenuerevenues was 6.2%10.6% for the quarter ended SeptemberJune 30, 2003,2004, compared to 8.0%7.2% for the quarter ended SeptemberJune 30, 2002.2003.
EBITDA, or earnings before interest, taxes, depreciation and amortization, is considered a non-GAAP financial measure under applicable SEC rules. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with U.S. generally accepted accounting principles.
EBITDA is a widely used measure of operating performance. It is presented as supplemental information that management of the Company believes is useful to investors to evaluate the Company’s results because it excludes certain items that are not directly related to the Company’s core operating performance. EBITDA is calculated by adding back net interest expense, income taxes, depreciation and amortization to net income. EBITDA should not be considered as a substitute either for net income, as an indicator of the Company’s operating performance, or for cash flow, as measures of the Company’s liquidity. In addition, because EBITDA is not calculated identically by all companies, the Company’s presentation of EBITDA may not be comparable to other similarly titled measures of other companies.
COMPARISON OF THE NINESIX MONTHS ENDED SEPTEMBERJUNE 30, 20032004
TO THE NINESIX MONTHS ENDED SEPTEMBERJUNE 30, 20022003
REVENUES AND PERCENT OF REVENUES BY GROUP
Six Months Ended June 30 | ||||||||||||
2004 | 2003 | |||||||||||
Homeland Security Group | $ | 18,626,200 | 48 | % | $ | 13,285,300 | 43 | % | ||||
Systems Engineering Group | 20,220,400 | 52 | % | 17,418,200 | 57 | % | ||||||
Total | $ | 38,846,600 | 100 | % | $ | 30,703,500 | 100 | % |
PERCENTAGE REVENUE GROWTH SIX MONTHS OVER SIX MONTHS BY GROUP
2004 vs. 2003 | |||
Homeland Security Group | 40 | % | |
Systems Engineering Group | 16 | % | |
Total | 26.5 | % |
Revenues for the ninesix months ended SeptemberJune 30, 20032004 were $49.8$38.8 million, an increase of $7.5$8.1 million from the $42.3$30.7 million in
revenues for the ninesix months ended SeptemberJune 30, 2002.2003. This increase is primarily due to increases in revenues in the Homeland Security Group and the Systems Engineering Group, offset by a decrease in revenues in ABS.Group. Revenues of the Homeland Security Group increased 5.6%40%, or approximately $1.0$5.3 million, of which $3.2 million was attributable to the acquisition of BAI and $2.1 million was due to growth in services provided to the intelligence community and related agencies. Revenues of the Systems Engineering Group increased 44.3%16.1%, or approximately $8.0$2.8 million primarily due to an approximate $11.0a $2.3 million increase in revenues under the ELVIS contract. The increase in ELVIScontract, as compared to the first six months of 2003. In addition, under the Glenn Engineering Support Services contract with NASA, revenues was partially caused byincreased approximately $1 million as compared to the contract’s commencement datesame period of July 8, 2002. This increase
was2003 due to additional tasking from the customer. These increases were offset by a reduction ofin revenues of $3.4$0.5 million due to the planned step-down in activities under the Microgravity Research Development and Operations contract with NASA related to designing and building experiments to be run on the International Space Station. In addition, ABS experienced a $1.6 million, or 33%, decline in revenues.
During the third quarter, ABS fully depleted contract funding under its primary research contract from the Defense Advanced Research Projects Agency (DARPA) resulting in a decrease in revenues and an operating loss for the third quarter. Other than the DARPA contract and a small research grant with the National Institutes of Health, ABS had no other funded work during the third quarter which would generate revenue. Thus the depletion of funding under the DARPA contract led to unrecovered costs and, consequently, an operating loss. Subsequent to the end of the third quarter, ABS was granted a contract through George Mason University with a value of $600,000 to conduct research for biological defenses. ABS was also awarded a contract with the Department of State with a value of $320,000 and is awaiting authorization to proceed. Future revenues and operating profits for ABS depend on its success in obtaining additional contracts or research grants.
Increases or decreases in the Company’s revenues are predominantly attributable to changes in the volume of services provided. As a government contractor, costs billed to the government are prescribed by the Federal Acquisition Regulation and include recovery of allowable costs such as labor, fringe benefits, overhead and general and administrative expenses plus a reasonable fee.
Costs of revenue for the ninesix months ended SeptemberJune 30, 20032004 were $41.9$31.4 million, an increase of $5.8$5.7 million from the same period inof the prior year. The increase is largely dueCosts of revenue for the recently acquired BAI accounted for $2.4 million of the increase. Growth in services to the costscustomers of revenue generated in the Homeland Security Group and Systems Engineering Group byas noted in the ELVIS contract, which were approximately $10preceding paragraph, accounted for $1.0 million offset byand $2.2 million of the decrease in costs due to the planned step-down under the Microgravity Research Development and Operations contract of approximately $2.9 million. Decreases in costs at ABS were approximately $1.4 million due to the reduction in research and development staff.increase, respectively. Costs of revenue as a percentage of revenues were approximately 84% and 85%81% for the ninesix months ended SeptemberJune 30, 20032004 and 2002, respectively.84% for the same period of 2003.
Selling, general and administrative expenses totaled $4.6$4.4 million for the ninesix months ended SeptemberJune 30, 2003,2004, compared to $2.8 million for the same period of the prior year. This 57% increase is due to increased expenses related to merger and acquisition expenses which accounted for $0.6 million, while the remainder of the increase is attributable to investments made to expand the Company’s infrastructure and management team to accommodate an expected increase in the scope of business operations from acquisitions. These investments include upgrading our financial accounting system and additional staff members in the accounting, contracts, marketing and corporate management departments.
Operating income for the six months ended June 30, 2004 was $2.7 million, compared to operating income of $2.0 million for the period ended June 30, 2003. This $0.7 million increase is primarily attributable to growth in the Homeland Security Group of $1.3 million, of which $0.6 million is attributable to BAI and $0.7 million is attributable to growth in the services provided to the intelligence community and related agencies. In addition, operating income of the Systems Engineering Group increased $0.1 million due to additional tasking from customers. These increases are offset by an additional $0.5 million of expense related to merger and acquisition activity and $0.2 million of additional amortization related to the BAI acquisition.
Interest expense totaled $2.4 million for the six months ended June 30, 2004, compared with $3.7$0.2 million for the same period in the prior year. The $0.9$2.2 million increase is due to costscash and non-cash interest expense related to fulfillment of key business development and marketing positions of $.4 million that were vacant in the prior period, in addition to increased corporate insurance policies of $0.3 million.
Operating income for the nine months ended September 30, 2003 was $3.1 million, compared to operating income of $2.3 million for the nine months ended September 30, 2002. This $0.8 million increase is primarily attributable to the profitability of the Systems Engineering Group derived from the ELVIS contract, which was approximately $0.6 million, coupled with increased profitability of the Homeland Security Group of approximately $0.7 million due to growth noted above. This increase was offset by the reduced operating income of $0.4 million from the planned step-down on the Microgravity Research Development and Operations contract, and reduced operating income at ABS of $0.2 million due to depletion of contract backlog and lack of new contract or grant awards. The Company’s operating income to be derived in the future from ABS depends on its success in obtaining additional contracts or research grants.
Operating margin for the nine months ended September 30, 2003 was 6%, compared to operating margin of 5% for the nine months ended September 30, 2002. This 1% increase is primarily attributable to the increased profitability of the Homeland Security and Systems Engineering Groups as noted above.
Interest expense totaled $0.3 million for the nine months ended September 30, 2003, compared with $0.8 million for the same period of the prior year. The $0.5 million decrease is due to the Company’s reduced bank debt, which decreased by $1.8 million from September 30, 2002 to September 30, 2003. This was due to the Company’s continued profitability, which reduced borrowings under the credit facility, coupled with scheduled principalconvertible notes issued. Cash interest payments on the term note. In addition, the release of the guarantees associated with the Bank of America debt decreasedconvertible notes were $0.4 million and non-cash amortization recorded as interest expense by $0.1was $1.8 million.
Income tax expense for the ninesix months ended SeptemberJune 30, 20032004 was $0.8$0.4 million, compared with $0.02$0.5 million for the same period ofin the prior year. The Company’sCompany will experience an increase in the effective income tax rate in 2004. This increase is lower than the statutory federal rate of 34% primarily due to the reductionrecognition of a valuation allowance oncertain amortization costs related to the Company’s deferredPequot Transaction, which are not deductible for tax assets. The Company’s valuation allowance is expectedpurposes, in addition to be eliminated by December 31,the Company consuming all net operating loss carryforwards during 2003.
InFor the ninesix months ended SeptemberJune 30, 2003,2004, the Company recorded a net incomeloss from continuing operations of approximately $2.0$0.1 million and EBITDA, as defined below, of $3.5$3.2 million, after add-backs for interest of $0.3$2.4 million, depreciation of $0.09$0.1 million, amortization of $0.3$0.4 million, and income taxestax expense of $0.8$0.4 million. In the nine months ended September 30, 2002, the Company recorded net income of approximately $1.5 million and EBITDA of $2.6 million, after add-backs for interest of $0.8 million, depreciation of $0.07 million, amortization of $0.2 million, and income taxes of zero. EBITDA as a percent of revenue was 6.9%8.2% for the ninesix months ended
September June 30, 2003,2004, compared to 6.2%7.4% for the ninesix months ended SeptemberJune 30, 2002.
EBITDA, or earnings before interest, taxes, depreciation and amortization, is considered a non-GAAP financial measure under applicable SEC rules. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with generally accepted accounting principles.
EBITDA is a widely used measure of operating performance. It is presented as supplemental information that management of the Company believes is useful to investors to evaluate the Company’s results because it excludes certain items that are not directly related to the Company’s core operating performance. EBITDA is calculated by adding back net interest expense, income taxes, depreciation and amortization to net income. EBITDA should not be considered as a substitute either for net income, as an indicator of the Company’s operating performance, or for cash flow, as measures of the Company’s liquidity. In addition, because EBITDA is not calculated identically by all companies, the Company’s presentation of EBITDA may not be comparable to other similarly titled measures of other companies.2003.
CAPITAL RESOURCES AND LIQUIDITY
While the Company experienced decreaseda net incomeloss on a quarterly comparison to 2002, year to datea net income has increased compared tofor the same period of 2002. This continued profitability2003, the majority of the net loss can be attributed to non-cash amortization and strong cash management have allowedaccretion charges associated with the Company to reduce bank debt by $2.1 millionPequot Transaction and other notes payable by $0.9 million during 2003.Series B Financing. Borrowing availability under the Company’s Credit Facility continues to be sufficient to fund normal operations. The table below details the convertible debt and remaining amortization expense which will be recognized as interest expense.
Convertible Debt | Face Value | Carrying Value At June 30, | Remaining Amount to be Amortized | Quarterly Expenses | Remaining Period of Amortization | ||||||||||||
Cash | Non - Cash | ||||||||||||||||
Convertible Notes | $ | 10,000,000 | $ | 3,785,500 | $ | 6,570,100 | $ | 175,000 | $ | 480,000 | 3 1/2 Years | ||||||
Senior Subordinated Notes | $ | 12,000,000 | $ | 8,398,700 | $ | 3,763,100 | $ | 210,000 | $ | 2,320,000 | * | ||||||
$ | 385,000 | $ | 2,800,000 |
* | The discount on the Senior Subordinated Notes will be fully amortized during the third quarter of 2004, as the Senior Subordinated Notes will be converted into Series B Preferred Stock upon shareholders’ approval at the annual meeting on September 15, 2004. |
The table below details the Series A Preferred Stock and the associated dividends and accretion.
Preferred Stock | Face Value | Carrying Value At June 30, | Remaining Amount to be Accreted | Quarterly Dividends and Accretion | Remaining Period of Amortization | ||||||||||||
Cash | Non - Cash | ||||||||||||||||
Series A | $ | 15,000,000 | $ | 2,112,900 | $ | 12,887,100 | $ | 225,000 | $ | 937,500 | 3 1/2 Years |
For the six months ended June 30, 2004, net loss available to common shareholders of $3.0 million included $0.4 million of non-cash amortization, $1.8 million of non-cash interest accretion, and $1.9 million of non-cash preferred stock accretion. Available borrowing capacity on the Company’s Credit Facility amounted to $11.7 million. The Company had a standby financing capacity for acquisitions of $45 million, consisting of an annual guidance bank facility of $20 million and the option to draw down on a second round of Series B Preferred Stock financing of $25 million.
Working capital at SeptemberJune 30, 2003 increased2004 decreased by $0.4$21.7 million from December 31, 20022003 primarily due to the purchase of BAI which included the use of $12 million of cash from the Pequot Transaction, a decrease in tradedraw from our Credit Facility of $8.3 million and the issuance of the Senior Subordinated Notes for $12 million. In addition, accounts payable and a decreasereceivable increased $10.2 million over the prior year due to accounts receivable acquired in the Credit Facility balance.acquisition of BAI and the timing of receipt of certain accounts receivable.
Net cash used in operating activities during the six months ended June 30, 2004 was $1.3 million. Net cash provided by operating activities duringwas $2.3 million for the ninesix months ended SeptemberJune 30, 2003 was $3.12003. This $3.6 million, as compared with net cash provided decrease is due to increased accounts receivable of $1.6$5.5 million duringover the same period in 2002. This increase wasprior year due to the Company’s continued profitability.acquisition of BAI and timing of receipt of certain accounts receivable. This was offset by a decrease in cash used for accounts payable of $1.5 million, and a decrease in cash provided by other current liabilities of $0.4 million as compared to the prior year.
Net cash used in investing activities during the ninesix months ended SeptemberJune 30, 2003 was $0.42004 $27.2 million comparedin comparison to $0.2 million used duringfor the nine months ended September 30, 2002.
same period of the prior year. Net cash used in investing activities during the nine months ended September 30, 2003, and the nine months ended September 30, 2002,2004 was primarily used for fixed asset purchases and costs associated with patent development.
On November 2, 2001, to finance the acquisition of Analex,BAI, net cash used during 2003 was primarily used for the purchase of fixed assets.
The Company enteredhas a credit agreement with Bank of America, N.A. (the “Credit Facility”). On May 28, 2004, in connection
with the acquisition of BAI, the Credit Facility was amended and restated to provide a $20,000,000 revolving credit facility, and the remaining outstanding balance on the Company’s term loan of $1,750,000 was consolidated into the Credit Agreement which originally providedFacility. An uncommitted annual guidance facility not to exceed an additional $20,000,000 is available to fund future acquisitions upon application by the Company with a $4,000,000 Credit Facility through November 2, 2006 and a five-year $3,500,000 Term Loan.approval by Bank of America. The Credit Facility has an annual renewal occurring April 30 of each year. To fund additional working capital requirements generated by the award of the ELVIS contract, the Company negotiated an increase ofInterest on the Credit Facility. The Company now has an $8,000,000 Credit Facility. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. Interest on each of the facilitiesFacility is at the LIBOR Rate plus an applicable margin as specified in a pricing grid. As of June 30, 2004, the Credit Facility outstanding balance was $8,254,700. The Company is subject to certaininterest rate at June 30, 2004 was 3.84% for the Credit Facility.
The Credit Facility contains financial covenants pursuant to the Agreement, includingsetting forth maxiumum ratios for total funded debt to EBITDA ratio,and minimum ratios for fixed charge coverage ratio, senior debt to EBITDA ratio, and net worth requirements. The Company must maintain the following ratios: a Total Funded Debt to EBITDA ratiocoverage. As of no greater than 3.0 to 1.0, a Senior Debt to EBITDA ratio of no greater than 2.75 to 1.0, a Fixed Charge Coverage Ratio of no less than 1.3 to 1.0, and Net Worth equal to at least the sum of $9 million and 65% percent of net income (not to be reduced by net losses) during each fiscal quarter ending March 31, 2002 and thereafter. At SeptemberJune 30, 2003,2004, the Company was in compliance with each of these covenants. The Credit Facility also restricts the Company’s ability to dispose of properties other than ABS, incur additional indebtedness, pay dividends (except to holders of the Series A and Term Loan areSeries B Preferred Stock) or other distributions, create liens on assets, enter into sale and leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. The Credit Facility is secured by the accounts receivable and other assets of the Company.
Pursuant to the November 2, 2001 acquisition of the former Analex, the Company issued 3,572,143 shares of the Company’s Common Stockcommon stock to the shareholders representing all of the outstanding equity of Analex (the “Sellers”). Of the 3,572,143 shares, 857,143 shares are subject to a provision by which the Company guarantees for a five-year period to reimburse the Sellers the difference between the price at which they sell such shares and a guaranteed sales price. The agreement phases in portionsAs of June 30, 2004, the total shares subject to the guarantee over a period of two years following the acquisition in increments of 25% of the total guaranteed shares covered by the agreement. Of the total shares guaranteed, 25% (214,286 shares) are guaranteed from the acquisition date through November 5, 2006, at a price of $1.60. An additional 214,286 shares are guaranteed beginning November 5, 2002 through November 5, 2006 at a price of $1.80. An additional 214,286 shares are guaranteed beginning May 5, 2003 through November 5, 2006 at a price of $2.00 per share, resulting in a maximum amount of $1,157,100 payable under the terms of the guaranteed shares as of September 30, 2003.was $1,628,600. As the fair market value of the Company’s common stock was in excess of the guaranteed share prices as of SeptemberJune 30, 2003,2004, no amounts were accrued under the guarantee.
On November 5, 2003, the final portion of shares (214,286 additional shares) became guaranteed at a price of $2.20 per share. These shares will be guaranteed through November 5, 2006.
ELVIS Contract
Under the ELVIS contract, Analex provides a broad range of Expendable Launch Vehicle (ELV) support services for NASA requirements at John F. Kennedy Space Center, Florida; Cape Canaveral Air Force Station, Florida; Vandenberg Air Force Base, California; and other launch site locations. This includes management, operation and maintenance of facilities, systems and equipment, as well as specified technical and administrative capabilities.
The contract covers responsibility for furnishing engineering services; performing safety and mission assurance functions; and providing communications, data and telemetry support. In addition, at Vandenberg, Analex will also be responsible for maintenance of NASA’s administrative, launch support and spacecraft facilities, mission support planning, and customer support for payload processing activities.
The contract had a one-month phase-in period in June 2002, which is followed by a three-year, three-month basic period of performance. There are two options of three years each for a potential nine-year, four-month contract term. The contract value for the basic performance period is $55 million. The potential contract value including all priced options, is $163.8 million. However, total contract value may be increased as a result of additional task orders which may be issued under the contract as required.
With respect to the ELVIS contract, the Company is the prime contractor with two subcontractors performing various functions. Approximately 18% of the contract is expected to be performed by the subcontractors. As the prime, the Company is responsible for all aspects of work performed by the subcontractors including, but not limited to, quality of work, timeliness of performance, and cost control. The Company records all customer payments under this contract as revenues and all subcontractor invoices as contract costs.
Pequot TransactionSeries B Financing
On July 18, 2003,May 28, 2004, the Company entered intoconsummated the transaction contemplated by a Stock Purchase Agreement (the “Pequot“Series B Purchase Agreement”) with two investment funds managed by Pequot Capital Management, Inc. (“Pequot”) pursuant to whichand among the Company has agreed to:and General Electric Pension Trust (“GEPT”), New York Life Capital Partners II, L.P. (“NYL”), Pequot Private Equity Fund III, L.P., and Pequot Offshore Private Equity Partners III, L.P., (collectively, “Pequot,” together with GEPT and NYL, collectively, the
“Investors”). Pursuant to the Series B Purchase Agreement the Company:
issueissued and sellsold to Pequot 6,726,457Investors Senior Subordinated Notes in the aggregate principal amount of $12,000,000 at the time of the closing of the acquisition of BAI on May 28, 2004 (the First Closing Date). The Senior Subordinated Notes will be converted into an aggregate of 3,428,571 shares of the Company’s newly designated Series A ConvertibleB convertible preferred stock (“Series B Preferred Stock (the “Series A
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In addition, on July 18, 2003, the Company entered into a Securities Repurchase Agreement (the “Stout Repurchase Agreement”) with Company Chairman Jon M. Stout, certain members of Mr. Stout’s immediate family and certain entities controlled by Mr. Stout and his family (collectively, the “Stout Parties”) pursuant to which the Company will purchase an aggregate of 2,625,451 shares of Common Stock and warrants and options exercisable to purchase an aggregate of 1,209,088 shares of Common Stock from the Stout Parties for aggregate consideration of approximately $9.2 million. The aggregate purchase price to be paid by the Company to the Stout Parties pursuant to the Securities Repurchase Agreement is calculated by multiplying the number of shares of Common Stock to be repurchased (including those issuable under warrants and options held by the Stout Parties) by $2.63 per share, and then reducing such amount by the amount of the aggregate exercise prices of the warrants and options held by the Stout Parties. The Common Stock, warrants and options to be purchased by the Company represent all of the equity interests in the Company owned by the Stout Parties other than approximately 100,000 shares of Common Stock which Mr. Stout may use to make a gift to a specified academic institution pursuant to the terms of the Stout Repurchase Agreement and which the Company may subsequently repurchase pursuant to the Stout Repurchase Agreement if such gift is not made.
The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement are required to be closed simultaneously at a closing (the “Closing”) following approval of the Pequot Transaction by the Company’s stockholders and the satisfaction of the closing conditions provided for in
the Pequot Purchase Agreement and the Stout Repurchase Agreement. The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement are collectively referred to herein as the “Pequot Transaction.”
The proceeds from the sale of the Convertible Notes will be used to repurchase the securities from the Stout Parties and pay expenses in connection with the Pequot Transaction.
The Company anticipates using the proceeds from the sale of the Series A Preferred Stock to pay certain existing liabilities and to support all or asignificant portion of the funds obtained on the First Closing Date under the Purchase Agreement was used to pay the cash portion of the consideration for the acquisition of BAI.
Subject to certain approval rights by the holders of Series A convertible preferred stock of the Company (the “Series A Preferred Stock”) and the Series B Preferred Stock, when issued, the Series B Purchase Agreement also provides that the Company has an option to require the Investors to purchase up to an additional $25 million of Senior Subordinated Notes or Series B Preferred Stock, with additional Common Stock Warrants (the “Company Option”), at any one or more times on or prior to May 27, 2005 for the purpose of paying the cost of future acquisitions byacquisition of the Company.stock or assets of one or more other companies in each case with an acquisition value of at least $10 million.
Pequot Purchase AgreementSenior Subordinated Notes
The issuance of the Series A Preferred Stock, Convertible Notes and Warrants and the other transactions contemplated by the Pequot Purchase Agreement are subject to several closing conditions, including the approval of the Company’s stockholders.
If the Company is unable to consummate the Pequot Transaction due to a determination by the Company’s Board of Directors that consummation of such transaction conflicts with the Board’s fiduciary duties under applicable law, the Company is required to pay Pequot a fee of $750,000. If the Closing does not occur because Pequot is unable to consummate the transaction for any reason other than the Company’s failure to comply with its obligations or to satisfy the conditions to Pequot’s closing obligations, then Pequot is required to pay the Company a fee of $750,000.
Series A Preferred Stock
The Series A Preferred Stock bears a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s senior credit facility, in additional shares of Series A Preferred Stock. Holders of Series A Preferred Stock are entitled to vote together with all other classes and series of voting stock of the Company on all actions to be taken by the stockholders of the Company. In addition, as long as 50% of the Series A Preferred Stock originally issued remains outstanding, the Company may not take numerous specified actions (including mergers, certain changes to the Company’s Certificate of Incorporation and acquisitions involving aggregate consideration greater than $10,000,000) without obtaining the written consent of the holders of a majority of the Series A Preferred Stock. If the Company fails to comply with its redemption obligations with respect to the Series A Preferred Stock (discussed below), the Company may
not take such specified actions without Pequot’s consent, regardless of the amount of Series A Preferred Stock Pequot owns.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series A Preferred Stock are entitled to receive, out of the Company’s assets available for stockholder distributions and prior to distributions to junior securities (including the Common Stock), an amount equal to the Series A Purchase Price plus any accrued but unpaid dividends thereon. Certain mergers, acquisitions or asset sales involving the Company are treated as a liquidation event unless the holders of a majority of the Series A Preferred Stock elect not to treat such transactions as liquidation events.
The Series A Preferred Stock is convertible into Common Stock at any time at the election of its holders, initially at a ratio of one share of Common Stock for every share of Series A Preferred Stock. The conversion ratio is subject to adjustments for certain dilutive equity issuances and for stock splits, stock dividends and similar events. The Series A Preferred Stock will automatically convert into Common Stock if, any time following 18 months after the Closing, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the conversion price then in effect for the Series A Preferred Stock. In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into Common Stock. In addition, the Series A Preferred Stock will automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.
Holders of the Series A Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of the Closing at the Series A Purchase Price, as adjusted for stock splits, stock dividends and similar events, plus accrued but unpaid dividends. Holders of the Series A Preferred Stock and any debt or equity security of the Company convertible into Series A Preferred Stock (including the Convertible Notes) have pro rata preemptive rights with respect to private equity offerings by the Company after the Closing, subject to specified exceptions.
These and other terms and provisions of the Series A Preferred Stock are set forth in the Certificate of Designations Powers, Preferences and Rights of the Series A Preferred Stock (the “Series A Certificate of Designations”) that will form a part of the Company’s Certificate of Incorporation. The Series A Certificate of Designations will be filed with the Secretary of State of Delaware prior to the Closing.
Convertible Notes
The Convertible Notes mature on the fourth anniversary of the Closing. The ConvertibleSenior Subordinated Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s senior credit facility, accrued and added to the outstanding principal. Upon a payment default, the interest rate on the ConvertibleSenior Subordinated Notes will be increased to 11%14% per annum.annum during the term of the default.
Prior to the date which is 18 months after the Closing, the Convertible Notes may not be prepaid without the consent of the holders of a majority of the outstanding principal amount of the Convertible Notes. Any time following 18 months after the Closing, the Company, at its sole option, may prepay the Convertible Notes. Such prepayment will be made, in most circumstances at the option of the Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum or by conversion of the principal into shares of Series A Preferred Stock and the payment of interest in cash or in shares of Series A Preferred Stock. Holders of the Convertible Notes may convert theThe outstanding principal and accrued interest on the Senior Subordinated Notes will be automatically converted into Series B Preferred Stock upon stockholders’ approval at the annual
meeting. The per share conversion price of the Senior Subordinated Notes is $3.50 (the “Series B Original Issue Price”).
If the Senior Subordinated Notes have not already converted into Series B Preferred Stock, they will mature on the “Maturity Date” which is 120 days from the date of issuance (the “Series B Issue Date”). In the event that stockholders’ approval is not obtained on or before the Maturity Date, (i) the rate of interest payable on the Senior Subordinated Notes will be increased to 14% per annum and will continue to increase 3% per annum (but in no event shall be increased above the rate of interest lawfully payable) for each calendar quarter thereafter that the Senior Subordinated Notes remain unpaid and (ii) the Company will issue to Investors additional warrants to purchase $3.5 million of the Company’s Common Stock, exercisable at any time following the stockholders’ approval, at an exercise price equal to the Series B Conversion Price (as defined below).
The Company’s obligations under the Senior Subordinated Notes are secured by a second lien on all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. These obligations are subordinated only to those under the Credit Facility and are senior to the existing obligations to Pequot under the convertible debt issued pursuant to the Convertible Note and Series A Convertible Preferred Stock Purchase Agreement dated July 18, 2003 (the “Series A Purchase Agreement”). The Company is subject to certain financial and operational covenants.
Upon issuance of the Senior Subordinated Notes, the Company allocated fair value of $720,000 to the Common Stock Warrants based on a preliminary valuation, and recorded a beneficial conversion charge of $3,720,000. The discount created by these charges is being amortized to interest expense over the life of the Senior Subordinated Notes. For the three and six months ended June 30, 2004, the Company recognized $0.8 million of amortization of that discount. The unamortized discount as of June 30, 2004 was $3.6 million.
Series B Preferred Stock
An aggregate of 3,428,571 shares of Series B Preferred Stock will be issued to the Investors upon stockholders’ approval of the conversion of the $12 million Senior Subordinated Notes into the Series B Preferred Stock. The Series B Preferred Stock will rank senior to the Company’s existing Series A Preferred Stock. The Series B Preferred Stock will bear a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s Credit Facility, in additional shares of Series B Preferred Stock.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series B Preferred Stock will be entitled to receive, in preference to holders of Series A Preferred Stock and Common Stock, out of the Company’s assets available for stockholder distributions, an amount per share equal to the Series B Original Issue Price plus any accrued but unpaid dividends thereon. Certain mergers, acquisitions or asset sales involving the Company are treated as a liquidation event unless the holders of 66 2/3% of the then outstanding Series B Preferred Stock and Series A Preferred Stock voting together as a class elect not to treat such transactions as liquidation events.
The Series B Preferred Stock will be convertible into Common Stock at any time.time at the election of its holders. The per share conversion price for the Convertible Notes is 135%(the “Conversion Price”) of the Series A Purchase Price, subjectB Preferred Stock will be the lowest of (i) $3.10; (ii) the price that reflects a 20% discount to adjustmentthe trailing average closing price of the Company’s Common Stock for stock splits, stock dividendsthe 20 consecutive trading days immediately preceding the date of the conversion or the Series B Issue Date, but in no event less than $2.80; and similar events. The Company may cause(iii) the automaticclosing price of the Company’s Common Stock on the day immediately preceding the Series B Issue Date; provided that if stockholder approval for the conversion of the ConvertibleSenior Subordinated Notes occurs during certain uncured events of default, the Conversion Price will not be subject to the $2.80 floor price under (ii) above.
The Series B Preferred Stock will automatically convert into Common Stock if, any time following 18 months after the Closing,Series B Issue Date, (i) the average closing price forof the Common Stock over athe immediately preceding 20 consecutive trading day period exceeds 2.5 times the Series A PurchaseB Original Issue Price as(as adjusted for certain dilutive equity issuances and for stock splits, stock dividends and similar events.events related to the Series B Preferred Stock); or (ii) with respect to any holder’s shares of Series B Preferred Stock, such holder does not accept, within 60 days of notice to such holder, the offer to purchase the Series B Preferred Stock for at least 2.5 times the Series B Original Issue Price. The Series B Preferred Stock will automatically convert into Common Stock upon the agreement of the holders of 75% of the Series B Preferred Stock.
The termsHolders of two-thirds of the Convertible Notes provide for specified eventsSeries B Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of default, including failure to pay principalthe Series B Issue Date at the Series B Original Issue Price plus accrued but unpaid dividends.
Holders of and interest on the Notes, certain violations of financial and operational covenants and certain other events, many of which are similar to the events of default under the Company’s senior credit facility. The Company’s obligations under the Convertible NotesSeries B Preferred Stock will be secured by a lien on substantiallyentitled to vote together with all other classes and series of the assetsvoting stock of the Company and its subsidiaries and willon all actions to be guaranteedtaken by the Company’s subsidiaries. Such obligations will be subordinatedstockholders of the Company. As long as at least 25% of the shares of the Series B Preferred Stock issued pursuant to the rightsSeries B Purchase Agreement remain outstanding, the Company may not take numerous specified actions (including certain changes to the Company’s Certificate of Incorporation) without first obtaining the written consent of holders of at least a majority of the Company’s present and future senior secured lenders andthen outstanding shares of Series B Preferred Stock voting separately as a class. In addition, as long as the rights of the DOJ under the Settlement Agreement between the DOJ and the former Analex Corporation. The relative rights of the Company’s senior lenders and theCompany Option is in effect, holders of the Convertible Notes are set forth in an intercreditor agreement (the “Intercreditor Agreement”) that will become effective at the Closing.
During the time that the Convertible Notes and100% of the Series A Preferred Stock are outstanding,and the Series B Preferred Stock, voting together as a single class, shall have the right to veto (i) any Company will be subjectAcquisition, and (ii) the issuance of any securities ranking senior to financial and operational covenants specified inor pari passu with the Pequot Purchase Agreement. These financial and operational covenants will be no more restrictive thanSeries A Preferred Stock or the financial and operational covenants included inSeries B Preferred Stock, with respect to voting, dividend, liquidation or redemption rights, including the Company’s senior credit facility. Certainissuance of such covenants will continue in effect after the payment or conversion of the Convertible Notes.subordinated debt.
Common Stock Warrants
The Common Stock Warrants issued in connection with the Series B Financing will expire on May 28, 2014. They are not exercisable at anythe time beforeof issuance. Upon stockholders’ approval at the tenth anniversaryannual meeting, the Common Stock Warrants will become exercisable at the option of the Closing. The Preferred Warrants are exercisableInvestors to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Series AB Preferred Stock. The Note Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stockthat is issued or issuable upon the conversion of the Convertibleprincipal amount of the Senior Subordinated Notes. The exercise price of the Common Stock Warrants is $3.28 (representing a 47% premium to the Series A Purchase Price) subject to adjustment for stock splits, stock dividends and similar events.
Stockholders’ Voting Agreement
At the Closing, the Company, Pequot and certain stockholders of the Company who, together with Pequot, will own a majority of the voting stock of the Company upon the Closing, will enter into a Stockholders’ Voting Agreement (the “Stockholders’ Agreement”), pursuant to which Pequot and such stockholders agree to vote, or cause to be voted, all securities of the Company they own or over which they have voting control so that the number of directors of the Company will be seven (7), consisting of:
One of the directors designated by Pequot will be the “financial expert” required by Securities and Exchange Commission rules, and, to the greatest extent permitted by applicable law and regulations, at least one director designated by Pequot will be on each committee of the Board. If Pequot holds less than
specified percentages of the securities it originally purchases at the Closing, Pequot will have the right to designate two, one or no directors. If Pequot has the right to designate fewer than two directors, the above voting provisions are adjusted in the manner described in the Stockholders’ Agreement.
Immediately following the Closing, the Board will be constituted in accordance with the Stockholders’ Agreement, and will consist of four current directors, including Mr. Phillips, and three directors designated by Pequot, including Gerald Poch, Managing Director of Pequot Capital Management, Inc., the investment adviser/manager to Pequot, and Martin Hale, Principal of Pequot Capital Management, Inc. At the Closing, Mr. Stout and Shawna Stout will resign from the Board.
In certain circumstances, including the Company’s failure to redeem the Series A Preferred Stock as required or failure to pay certain amounts due under the Convertible Notes, Pequot may designate additional directors so that the Pequot directors comprise a majority of the Board. This right will terminate if the Company redeems the Series A Preferred Stock and repays the Convertible Notes.
Registration Rights
At the Closing, the Company will enter into a Registration Rights Agreement with Pequot (the “Registration Rights Agreement”), pursuant to which, within 30 days following the Closing, the Company will be required to file a registration statement on Form S-3 registering the resale of the Common Stock underlying the Series A Preferred Stock, the Convertible Notes and the Warrants. The Company will be required to keep such registration statement effective until all the Common Stock registered thereunder is sold or the holders are entitled to sell such Common Stock under Rule 144(k) under the Securities Act of 1933. The Registration Rights Agreement also provides Pequot with piggyback registration rights with respect to certain underwritten offerings initiated by the Company.
Stout Repurchase
The consummation of the transactions under the Stout Repurchase Agreement is subject to several conditions, including the approval of the Company’s stockholders of the Pequot Transaction and the receipt by the Company of an updated fairness opinion from Houlihan, Lokey, Howard & Zukin Financial Advisors, Inc. with respect to the fairness of the Pequot Transaction, including the repurchase of the Stout Parties’ securities.
At the Closing, the Registration Rights Agreement, dated as of March 30, 2000, by and among the Company, Mr. Stout, Patricia
Stout, the Stout Dynastic Trust, J. Richard Knop and certain other investors in the Company, will be terminated. In addition, the Voting Agreement, dated as of March 30, 2000, by and among Mr. Stout, Mrs. Stout, the Stout Dynastic Trust, Mr. Knop, C.W. Gilluly and certain other investors in the Company, will be terminated at the Closing.
In connection with the Closing, Mr. Stout’s employment with the Company will be terminated, and an Employment Termination Agreement between the Company and Mr. Stout (the “Stout Employment Termination Agreement”) will become effective. Pursuant to the Stout Employment Termination Agreement, at the Closing, the Company will pay Mr. Stout $280,000, representing two years’ base salary under Mr. Stout’s existing employment agreement. In addition, a Non-Competition Agreement between Mr. Stout and the Company (the “Stout Non-Competition Agreement”) will become effective at the Closing. Under the Stout Non-Competition Agreement, Mr. Stout agrees not to compete with the Company, adversely interfere with the Company’s current and prospective customers and clients or solicit or hire Company employees, consultants or service providers for a period of three (3) years following the Closing. As consideration for such non-competition and non-solicitation restrictions, and as long as Mr. Stout is in compliance with the Stout Non-Competition Agreement, the Company will pay him $50,000 every three months during the term of the agreement, for aggregate consideration of $600,000.
Amendment to Senior Credit Facility
In connection with the Closing, an amendment (the “Credit Agreement Amendment”) to the Company’s existing credit agreement with Bank of America, N.A. (“Bank of America”) will become effective. The Credit Agreement Amendment will eliminate or revise certain operational and financial covenants and revise an event of default provision. In connection with the execution of the Pequot Transaction documents, Bank of America has provided the Company with a letter (the “Bank of America Consent Letter”) consenting to the Company’s entering into the Pequot Transaction and waiving certain covenant defaults under the existing credit agreement otherwise triggered by the Pequot Transaction.
Increase in Authorized Stock
In connection with its review and approval of the Pequot Transaction, the Company’s Board of Directors has authorized an increase in the number of shares of the Company’s Common Stock and Preferred Stock authorized for issuance. This increase would result in the Company having total authorized capital stock of 100,000,000 shares, consisting of 65,000,000 shares of Common Stock and 35,000,000 shares of Preferred Stock. The increase will be reflected in a Certificate of Amendment to the Company’s
Certificate of Incorporation (the “Certificate of Amendment”) which will be presented to the Company’s stockholders for approval at the special meeting to be held to approve the Pequot Transaction.
Stockholder Approval
The Company’s stockholders will be asked to approve the Pequot Transaction and the increase in authorized capital stock at a special meeting of stockholders. In connection with the execution of the Pequot Purchase Agreement, stockholders holding approximately 48% of the Company’s Common Stock (including the Stout Parties) entered into a Voting Agreement (the “Pequot Transaction Voting Agreement”), pursuant to which these stockholders have agreed to vote in favor of the Pequot Transaction at any meeting of the Company’s stockholders or in connection with any action taken by such stockholders. The Company has scheduled the special meeting for December 9, 2003.
Summary of Terms
The description of the terms and provisions of the Pequot Purchase Agreement, the Series A Certificate of Designations, the Convertible Notes, the Warrants, the Intercreditor Agreement, the Stockholders’ Voting Agreement, the Registration Rights Agreement, the Stout Repurchase Agreement, the Stout Employment Termination Agreement, the Stout Non-Competition Agreement, the Certificate of Amendment, the Credit Agreement Amendment, the B of A Consent Letter and the Pequot Transaction Voting Agreement set forth herein do not purport to be complete and are subject to, and are qualified in their entirety by, the detailed provisions of those documents. Copies of these documents are filed as exhibits to the Current Report on Form 8-K dated July 18, 2003 and filed with the Securities and Exchange Commission on July 21, 2003. Additionally, amendments to each of the Pequot Purchase Agreement and Stout Repurchase Agreement are filed as Exhibits 10.2 and 10.3 to this Quarterly Report on Form 10Q and as Appendices Q and R to the Company’s definitive proxy statement filed with the SEC on November 7, 2003.$4.32 per share.
Forward-Looking Statements
Except for the historical informationCertain matters contained herein, the matters discussed in this 10-Qdiscussion and analysis concerning our operations, cash flows, financial position, economic performance, and financial condition, including in particular, the likelihood of our success in growing our business through acquisitions or otherwise, the realization of sales from backlog, and the sufficiency of capital to meet our working capital needs, include forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that involve a numbermay cause our actual results, level of risks and uncertainties. Thereactivity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,” “would” or similar
words. We believe that it is important to communicate our future expectations to our investors. However, there are certain important factors and risksevents in the future that could causewe may not be able to predict accurately or control. Our actual results tocould differ materially from those anticipated byin these forward-looking statements for many reasons, and as a result of many factors, including but not limited to the statements contained herein. Such factorsfollowing:
Readers of this report should not place undue reliance on these forward-looking statements, which apply only as of the date of the filing of this Form 10-Q. We assume no obligation to update any such forward-looking statements.
personnel. Other risks may be detailed from time to time in the Company’s SEC reports.Item 3.Quantitative and Qualitative Disclosure about Market Risk
Market Risks and Hedging Activities
The Company’s outstanding bank debt bears interest at variable interest rates tied to LIBOR. The use of variable-rate debt to finance operations and capital improvements exposes the Company to variability in interest payments due to changes in interest rates. The Company uses an interest rate swap to reduce the interest rate exposure on these variable rate obligations. The Company does not hold any derivatives for trading or speculative purposes.
The Company’s $3.5 million term loan facility from Bank of America carries interest comprised of two components: floating-rate LIBOR plus a credit performance margin. The Company entered into an interest-rate swap agreement with Bank of America whereby its obligation to pay floating-rate LIBOR was swapped into a fixed rate obligation at 4.25% beginning in January 2002. The Company continues to have the obligation to pay the credit performance margin in addition to its swapped 4.25% payment obligation.
Interest rate hedges that are designated as cash flow hedges hedge the future cash outflows on debt. Interest rate swaps that convert variable payments to fixed payments, interest rate caps, floors, collars and forwards are cash flow hedges. The unrealized gains/losses in the fair value of these hedges are reported on the balance sheet and included in other long-term liabilities with a corresponding adjustment to either accumulated other comprehensive income/(loss) or in earnings depending on the hedging relationship. If the hedging transaction is a cash flow hedge, then the offsetting gains/losses are reported in accumulated other comprehensive income/(loss). Over time, the unrealized gains/losses held in accumulated other comprehensive income/(loss) will be recognized in earnings consistent with when the hedged items are recognized in earnings.
Under the interest rate swap, the Company pays the bank at a fixed rate and receives variable interest at a rate approximating the variable rate of the Company’s debt, thereby creating the equivalent of a fixed rate obligation. The following table summarizes the original financial terms of the Company’s interest rate swap:
Notional Value | Variable Rate Received | Fixed Rate Paid | Effective Date | Expiration Date | Variable Rate Received | Fixed Rate | Effective | Expiration | ||||||||
$2,950,000 | LIBOR | 4.25% | 1/1/02 | 12/1/04 | LIBOR | 4.25% | 1/1/02 | 12/1/04 |
The notional value of the interest rate swap declines as the amount of the Term Loan is paid down. At SeptemberJune 30, 20032004 the notional value of the swap was $1,900,000.$1,450,000. Increases in prevailing interest rates could increase the Company’s interest payment obligations relating to variable rate debt.debt, which includes the portion of the term note not covered by the interest rate swap agreement and the Credit Facility. For example, a 100 basis points increase in interest rates would increase annual interest expense by $15,800,$68,300, based on debt levels at SeptemberJune 30, 2003.2004.
Item 4.Controls and Procedures
AsThe Company has established and maintains disclosure controls and procedures that are designed to ensure that material information required to be disclosed by Rule 13a-15(b)the Company in the reports that it files under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), Analexis recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, conductedas appropriate, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of disclosure controls and procedures as of the end of the period covered byin this report, of the effectiveness of the Company’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).report. Based onupon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’sour disclosure controls and procedures were effective, at the reasonable assurance level, as of June 30, 2004, in timely alerting them to material information relating to the end ofCompany required to be included in the period covered by this report. As required by Exchange Act Rule 13a-15(d), AnalexCompany’s periodic SEC filings.
Our management, including theour Chief Executive Officer and Chief Financial Officer, also conductedsupervised and participated in an evaluation of any changes in internal controls over financial reporting that occurred during the last fiscal quarter. That evaluation did not identify any significant changes to the Company’s internal control over financial reporting to determine whether any changes occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the quarter covered by this report.
The Company was served on October 9, 2003 with a lawsuitcomplaint filed by Swales & Associates, Inc. (“Swales”) in the Maryland Circuit Court for Prince George’s County Maryland alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. Under the complaint, Swales is seekingsought damages of $4 million. To minimize the expense, effort, uncertainty and inconvenience entailed in excessproceeding with the litigation, the Company entered into a Settlement Agreement dated July 22, 2004 with Swales.
Under the terms of $4.0 million. Managementthe Settlement Agreement, the Company paid $1,000,000 to Swales in July 2004. Legal fees incurred amounted to approximately $325,000. Based on a legal opinion from the Company’s outside counsel, the Company believes that any liability that may ultimately result from the resolution of this matter will not have a material adverse effect on the financial position or results of operationsamount of the Company.
Item 6.Exhibits and Reports on Form 8-K
(a) | Exhibits |
31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
31.2 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
(b) | Reports on Form 8-K |
A Current Report on a Form 8-K, dated July 18, 2003May 7, 2004 and filed with the Securities and Exchange Commission on July 21, 2003,May 10, 2004, reported (i) its financial results for the first quarter ended March 31, 2004; (ii) its agreement to report thatacquire Beta Analytics, Incorporated; (iii) its binding commitment letter from Pequot to provide investment capital; and (iv) its intention to divest the Company had entered into the Pequot Purchase Agreement and the Stout Repurchase Agreement relating to the Pequot Transaction.ABS subsidiary by December 31, 2004.
A Current Report on Form 8-K, dated July 24, 2003May 28, 2004 and filed with the Securities and Exchange Commission on July 24, 2003, to reportJune 1, 2004, reported the consummation of the acquisition of BAI and its Stock Purchase Agreement with certain investors in connection with the Series B Financing.
A Current Report on Form 8-K, dated June 7, 2004 and filed with the Securities and Exchange Commission on June 15, 2004 reported that the Company had issued a press release announcing second quarter 2003 financial results.has appointed Mr. Thomas L. Hewitt to the Board of Directors and that the Company has amended its Bylaws to increase the size of the Board of Directors.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.
Date: November 14, 2003August 16, 2004
Analex Corporation | ||||||||
(Registrant) | ||||||||
By: | /S/ Sterling E. Phillips, Jr. | By: | /S/ Ronald B. Alexander | |||||
Sterling E. Phillips, Jr. |
| |||||||
Chairman and Chief Executive Officer | Chief Financial Officer | |||||||
(Principal Executive Officer) |
(Principal Financial Officer and Principal Accounting Officer) |
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