UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2006
OR
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition 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.) | |
2677 Prosperity Avenue Suite 400 Fairfax, Virginia | 22031 | |
(Address of principal executive offices) | (Zip Code) |
(703) 852-4000
Registrant’s telephone number including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12-b2 of the Exchange Act).
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x
Title of Class | Number of shares outstanding on March 3, 2006 | |
Common Stock, $0.02 par value per share | 16,680,150 |
ANALEX CORPORATION
TABLE OF CONTENTS
Page No. | ||||||
Part I Financial Information: | ||||||
Item 1. | Financial Statements – Unaudited | 3 | ||||
Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005 | 3 | |||||
Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005 | 4 | |||||
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005 | 5 | |||||
6 | ||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 17 | ||||
Item 3. | Quantitative and Qualitative Disclosure about Market Risk | 24 | ||||
Item 4. | Controls and Procedures | 24 | ||||
Item 1. | Legal Proceedings | 25 | ||||
Item 1A. | Risk Factors | 25 | ||||
Item 6. | Exhibits and Reports on Form 8-K | 25 | ||||
27 |
2
Item 1.Financial Statements-Unaudited
CONDENSED CONSOLIDATED BALANCE SHEETS
As of March 31, 2006 and December 31, 2005
Unaudited
March 31, 2006 | December 31, 2005 | |||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 2,250,400 | $ | 3,459,200 | ||||
Accounts receivable, net | 33,454,400 | 31,067,500 | ||||||
Prepaid expenses and other current assets | 5,208,100 | 4,445,500 | ||||||
Property held for sale | — | 430,600 | ||||||
Total current assets | 40,912,900 | 39,402,800 | ||||||
Property and equipment, net | 2,838,500 | 2,726,000 | ||||||
Contract rights and other intangible assets, net | 9,490,400 | 10,404,800 | ||||||
Goodwill | 77,887,000 | 77,887,000 | ||||||
Other assets | 681,600 | 671,700 | ||||||
Total assets | $ | 131,810,400 | $ | 131,092,300 | ||||
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities | ||||||||
Accounts payable | $ | 2,406,300 | $ | 1,877,300 | ||||
Notes payable | 285,400 | 387,500 | ||||||
Deferred tax liability, net | 589,000 | 780,300 | ||||||
Other current liabilities | 16,091,400 | 13,918,600 | ||||||
Total current liabilities | 19,372,100 | 16,963,700 | ||||||
Notes payable – line of credit | 26,638,600 | 27,631,400 | ||||||
Series A convertible note | 6,949,700 | 6,497,700 | ||||||
Deferred tax liability | 2,501,300 | 3,677,200 | ||||||
Other long-term liabilities | 1,290,900 | 1,131,500 | ||||||
Total long-term liabilities | 37,380,500 | 38,937,800 | ||||||
Total liabilities | 56,752,600 | 55,901,500 | ||||||
Commitments and contingencies (Note 12) | — | — | ||||||
Convertible preferred stock; 17,297,884 shares issued and outstanding at March 31, 2006 and December 31, 2005 | 37,775,300 | 36,229,600 | ||||||
Shareholders’ equity | ||||||||
Common stock; $0.02 par; authorized 65,000,000 shares; issued and outstanding March 31, 2006, 16,680,150 shares and December 31, 2005, 16,340,445 shares | 333,600 | 326,800 | ||||||
Additional paid-in capital | 50,563,000 | 50,279,000 | ||||||
Warrants outstanding | 9,228,300 | 9,228,300 | ||||||
Accumulated deficit | (22,842,400 | ) | (20,872,900 | ) | ||||
Total shareholders’ equity | 37,282,500 | 38,961,200 | ||||||
Total liabilities, convertible preferred stock and shareholders’ equity | $ | 131,810,400 | $ | 131,092,300 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements
3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2006 and 2005
Unaudited
March 31, 2006 | March 31, 2005 | |||||||
Revenue | $ | 35,531,200 | $ | 26,580,100 | ||||
Operating costs and expenses | ||||||||
Cost of revenue | 29,036,600 | 21,604,700 | ||||||
Selling, general and administrative | 3,021,900 | 2,436,700 | ||||||
Amortization of intangible assets | 914,400 | 490,000 | ||||||
Depreciation | 246,700 | 79,400 | ||||||
Total operating costs and expenses | 33,219,600 | 24,610,800 | ||||||
Operating income | 2,311,600 | 1,969,300 | ||||||
Interest expense, net | (1,186,600 | ) | (763,000 | ) | ||||
Income from continuing operations before income taxes | 1,125,000 | 1,206,300 | ||||||
Provision for income taxes | (609,100 | ) | (586,500 | ) | ||||
Net income from continuing operations | 515,900 | 619,800 | ||||||
(Loss) income from discontinued operations, including disposal, net of income taxes | (159,700 | ) | 69,900 | |||||
Net income | 356,200 | 689,700 | ||||||
Dividends on convertible preferred stock | (780,000 | ) | (399,500 | ) | ||||
Accretion of convertible preferred stock | (1,545,700 | ) | (937,500 | ) | ||||
Net loss attributable to common shareholders | $ | (1,969,500 | ) | $ | (647,300 | ) | ||
Net loss attributable to common shareholders per share: | ||||||||
Continuing operations | ||||||||
Basic and diluted | $ | (0.11 | ) | $ | (0.04 | ) | ||
Discontinued operations | ||||||||
Basic and diluted | $ | (0.01 | ) | $ | 0.00 | |||
Net loss attributable to common shareholders: | ||||||||
Basic and diluted | $ | (0.12 | ) | $ | (0.04 | ) | ||
Weighted average number of shares: | ||||||||
Basic and diluted | 16,619,505 | 15,423,286 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2006 and 2005
Unaudited
March 31, 2006 | March 31, 2005 | |||||||
Reconciliation of net income to net cash provided by continuing operating activities | ||||||||
Net income | $ | 356,200 | $ | 689,700 | ||||
Net loss (income) from discontinued operations, including disposal | 159,700 | (69,900 | ) | |||||
Net income from continuing operations | 515,900 | 619,800 | ||||||
Adjustments to reconcile net income to net cash provided by continuing operating activities | ||||||||
Amortization of intangible assets and depreciation expense | 1,161,100 | 572,500 | ||||||
Amortization of debt discounts | 452,000 | 452,000 | ||||||
Amortization of deferred financing costs | 49,200 | 43,100 | ||||||
Stock-based compensation expense | 102,800 | — | ||||||
Gain on disposal of property held for sale | (13,200 | ) | — | |||||
Changes in operating assets and liabilities | ||||||||
Accounts receivable | (2,386,900 | ) | 49,700 | |||||
Prepaid expenses and other current assets | (762,600 | ) | 231,300 | |||||
Other assets | (59,100 | ) | (16,400 | ) | ||||
Accounts payable | 529,000 | (220,200 | ) | |||||
Other current liabilities | 1,548,400 | 1,097,000 | ||||||
Deferred tax liability | (697,600 | ) | — | |||||
Other long-term liabilities | 13,400 | — | ||||||
Net cash provided by continuing operating activities | 452,400 | 2,828,800 | ||||||
Cash flows from investing activities | ||||||||
Purchase of fixed assets | (191,400 | ) | (13,500 | ) | ||||
Proceeds from sale of property held for sale | 460,100 | — | ||||||
Net cash provided by (used in) investing activities | 268,700 | (13,500 | ) | |||||
Cash flows from financing activities | ||||||||
Net payments on bank and other loans | (1,094,900 | ) | (3,076,600 | ) | ||||
Proceeds from stock options and warrants exercised | — | 25,500 | ||||||
Proceeds from employee stock purchase plan | 111,100 | — | ||||||
Proceeds from ABS notes receivable | 17,600 | — | ||||||
Payments of dividends on preferred stock | (786,400 | ) | (279,800 | ) | ||||
Net cash used in financing activities | (1,752,600 | ) | (3,330,900 | ) | ||||
Net operating cash flow from discontinued operations, including disposal | (177,300 | ) | 69,900 | |||||
Net decrease in cash and cash equivalents | (1,208,800 | ) | (445,700 | ) | ||||
Cash and cash equivalents at beginning of period | 3,459,200 | 1,034,200 | ||||||
Cash and cash equivalents at end of period | $ | 2,250,400 | $ | 588,500 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
1.Business Overview
Analex Corporation (“Analex” or the “Company”) is a provider of mission-critical professional services to federal government clients. The Company is a leading provider of services in support of our nation’s security. The Company specializes in providing intelligence, systems engineering and security services in support of the nation’s security. Analex focuses on developing innovative technical approaches for the intelligence community, analyzing and supporting defense systems, designing, developing and testing aerospace systems and providing a full range of security support services to the U.S. government. The Company specializes in the following professional services:
• | Information Technology Services.Information technology services focus on design, development, test, integration and support of software and networks for business and mission critical systems. The Company develops radar, modeling and simulation and system software, all in support of collecting, testing, and analyzing data from various intelligence systems. The Company also provides the military with program management, systems engineering and software development and development of command, control, communications, computers and intelligence (“C4I”) programs. |
• | Aerospace Engineering Services.Aerospace engineering services focus on engineering associated with the development, support and operations of space launch vehicles and facilities as well as independent verification and validation services. The Company provides services in the design and testing of expendable launch vehicles for the Department of Defense (“DoD”) and intelligence community. The Company’s highly specialized expertise includes test, analysis and independent validation and verification support in areas such as structural dynamics, trajectory and performance, thermal system performance, and range safety. The Company’s solutions enable the simulation of a realistic operational environment so that satellites and related systems can be tested prior to deployment. The Company also performs verification and validation of test results to ensure the reliability of the data. |
• | Security and Intelligence Support Services.The Company’s security and intelligence support services focus on analysis support and threat assessments, counterintelligence, information, network and facilities security, technology protection and security education and training. |
These services are provided through the Company’s two strategic business units, Homeland Security Group and Systems Engineering Group.
The Homeland Security Group provides engineering, scientific, security, intelligence support and information technology services and solutions to assist in the development, implementation and support of intelligence systems. The Homeland Security Group provides these services to the intelligence community, including the National Reconnaissance Office, the Missile Defense Agency, the National Security Agency, the DoD, and major aerospace contractors, such as Lockheed Martin and Northrop Grumman.
The Systems Engineering 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.
On April 1, 2005, the Company acquired ComGlobal Systems, Inc, (“ComGlobal”) in a transaction valued at approximately $47.0 million. ComGlobal is a software engineering and information technology firm, specializing in C4I programs for the military. ComGlobal’s largest customer is the U.S. Navy’s Tomahawk Cruise Missile Program. ComGlobal is now a wholly-owned subsidiary of Analex and reported as a part of the Company’s Homeland Security Group.
During the quarter ended March 31 2006, the Company concluded that SyCom Systems, Inc. (“SyCom”), a wholly-owned subsidiary of the Company, did not fit with the Company’s long-term strategic plan and committed to a plan to dispose of this subsidiary. SyCom provides staff augmentation services, principally to a single customer and had 32 employees. The Company sold its SyCom Services subsidiary on April 1, 2006. SyCom’s results of operations are presented as a discontinued operation for all periods presented herein.
6
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
2.Basis of Presentation
The interim condensed consolidated financial statements for the Company are unaudited, but in the opinion of management, reflect all adjustments (of a normal recurring nature) 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, 2005 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 condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Form 10-K”) filed with the Securities and Exchange Commission on March 8, 2006. Certain amounts in the prior year financial statements and related notes have been reclassified to conform to the current year presentation.
3.Acquisition of ComGlobal Systems, Incorporated
Analex acquired ComGlobal on April 1, 2005. The financial consideration for the acquisition of the ComGlobal business was $47 million in cash, with no assumption of debt. Analex funded the transaction with a combination of senior debt from Bank of America, N.A. in the amount of $22 million and through the issuance of additional Series B Convertible Preferred Stock (“Series B-2”) in the amount of $25 million (see Note 11). Any remaining purchase price consideration to be recorded against goodwill is still preliminary, pending resolution of the HKSBS matter (see Note 15). The Agreement and Plan of Merger contains certain financial representations, secured by $8.0 million in escrow, which is scheduled to be released to the former shareholders of ComGlobal, net of any indemnification obligations, starting in December 2006 and continuing through April 2010.
4.Sale of Property Held for Sale
In March 2006, the Company sold land and a building it owned in Upper Marlboro, Maryland for cash proceeds of $460,100. The Company recognized a gain of $13,200 on the sale. This property was the former corporate headquarters of the Company’s Beta Analytics Incorporated subsidiary.
5.Goodwill, Contract Rights And Other Intangible Assets
The Company has recorded goodwill of $77.9 million as of March 31, 2006 and December 31, 2005. Since December 31, 2005, there were no events or conditions that the Company believes would result in an impairment of goodwill. Goodwill must be reviewed at least annually for impairment. The Company has elected to perform this review annually during the fourth quarter each calendar year.
Identifiable intangible assets, which have finite useful lives, consist of contract rights and non-compete agreements. The following table provides the details of the net carrying amounts of these intangible assets:
March 31, 2006 | December 31, 2005 | |||||||||||||||||||
Gross Carrying Value | Accumulated Amortization | Net Carrying Value | Gross Carrying Value | Accumulated Amortization | Net Carrying Value | |||||||||||||||
Amortizable intangible assets | ||||||||||||||||||||
Contract rights | $ | 14,346,300 | $ | (5,084,000 | ) | $ | 9,262,300 | $ | 14,346,300 | $ | (4,245,800 | ) | $ | 10,100,500 | ||||||
Non-compete agreements | 1,105,500 | (877,400 | ) | 228,100 | 1,105,500 | (801,200 | ) | 304,300 | ||||||||||||
Total amortizable intangible assets | $ | 15,451,800 | $ | (5,961,400 | ) | $ | 9,490,400 | $ | 15,451,800 | $ | (5,047,000 | ) | $ | 10,404,800 | ||||||
The Company amortization expense associated with identifiable intangible assets of $914,400 and $490,000 for the three months ended March 31, 2006 and 2005 respectively.
7
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
The following table provides the estimated amortization expense for the remainder of 2006 and each of the next five years ending December 31 based on the carrying amount of amortizable intangible assets existing as of March 31, 2006:
Year | Estimated Amortization Expense | ||
April 1, to December 31, 2006 | $ | 2,537,800 | |
2007 | 2,661,000 | ||
2008 | 2,004,200 | ||
2009 | 785,000 | ||
2010 | 598,000 | ||
2011 | 434,000 |
6.Other Current Liabilities
The components of other current liabilities at March 31, 2006 and December 31, 2005 were as follows:
2006 | 2005 | |||||
Payroll and related taxes | $ | 6,137,700 | $ | 6,031,800 | ||
Accrued vacation | 3,670,800 | 3,119,800 | ||||
Self-insured medical expenses | 966,200 | 890,800 | ||||
Accrued subcontractor costs | 595,300 | 937,300 | ||||
Dividends payable | 774,900 | 781,300 | ||||
Other | 3,946,500 | 2,157,600 | ||||
Total other current liabilities | $ | 16,091,400 | $ | 13,918,600 | ||
7.Debt
The Company has a $40 million revolving line of credit agreement with Bank of America, N.A. (“the Credit Facility”). The Credit Facility is subject to certain borrowing base and other requirements. As of March 31, 2006, the outstanding balance of the Credit Facility was $26.6 million and the interest rate was 7.83%. The Credit Facility has a maturity date of May 31, 2008.
The Credit Facility contains financial covenants setting forth maximum ratios for total funded debt to EBITDA and minimum ratios for fixed charge coverage. As of March 31, 2006, the Company was in compliance with these covenants. The Credit Facility also restricts the Company’s ability to dispose of certain properties; 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 certain leaseback transactions; make investments, loans or advances; engage in mergers or consolidations; and engage in certain transactions with affiliates. The Credit Facility is generally secured by the assets of the Company.
The Company also has outstanding an aggregate $10.0 million of Series A Convertible Notes issued on December 9, 2003 (see Note 11).
8
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
8.Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Net income from continuing operations | $ | 515,900 | $ | 619,800 | ||||
Dividends on convertible preferred stock | (780,000 | ) | (399,500 | ) | ||||
Accretion of convertible preferred stock | (1,545,700 | ) | (937,500 | ) | ||||
Net loss attributable to common shareholders from continuing operations | (1,809,800 | ) | (717,200 | ) | ||||
(Loss) income from discontinued operations, including disposal, net of income taxes | (159,700 | ) | 69,900 | |||||
Net loss attributable to common shareholders | (1,969,500 | ) | $ | (647,300 | ) | |||
Basic and diluted weighted average shares outstanding | 16,619,505 | 15,423,286 | ||||||
Net loss attributable to common shareholders per share | ||||||||
Continuing operations | ||||||||
Basic and diluted | $ | (0.11 | ) | $ | (0.04 | ) | ||
Discontinued operations | ||||||||
Basic and diluted | $ | (0.01 | ) | $ | 0.00 | |||
Net loss attributable to common shareholders | ||||||||
Basic and diluted | $ | (0.12 | ) | $ | (0.04 | ) | ||
Shares issuable upon the exercise of stock options, stock appreciation rights or warrants or upon conversion of the Company’s convertible preferred stock or convertible debt have been excluded from the computation of earnings per share to the extent that the inclusion of these instruments would be anti-dilutive. As of March 31, 2006, shares issuable upon conversion of such instruments are as follows:
Instrument | Common shares issuable upon conversion, exercise or vesting | Conversion or exercise price | Proceeds from conversion | |||||
Series A Convertible Preferred Stock | 6,726,457 | $ | 2.23 | $ | — | |||
Series A Common Stock Warrants | 1,345,291 | 3.28 | 4,412,556 | |||||
Series A Convertible Notes | 3,321,707 | 3.01 | — | |||||
Series A Convertible Note Warrants | 664,341 | 3.28 | 2,179,038 | |||||
Series B-1 Convertible Preferred Stock | 4,285,714 | 2.80 | — | |||||
Series B-1 Common Stock Warrants | 857,142 | 4.32 | 3,702,853 | |||||
Series B-2 Convertible Preferred Stock | 8,928,569 | 2.80 | — | |||||
Series B-2 Common Stock Warrants | 1,785,713 | 4.29 | 7,660,709 | |||||
Options issued under Incentive Stock Option Plans | 101,833 | 0.69 –1.99 | 111,722 | |||||
Options issued under Incentive Stock Option Plans | 1,148,413 | 2.20 – 2.49 | 2,606,882 | |||||
Options issued under Incentive Stock Option Plans | 1,672,500 | 2.79 – 4.49 | 5,911,175 | |||||
Unvested restricted stock awards | 150,000 | 2.80 | — | |||||
Stock Appreciation Rights issued under Incentive Stock Option Plans | 35,000 | 2.86 | — | |||||
Total | 31,022,680 | $ | 26,584,935 | |||||
9
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
As of March 31, 2005, shares issuable upon conversion of such instruments were as follows:
Instrument | Common shares issuable upon conversion or exercise | Conversion or exercise price | Proceeds from conversion | |||||
Series A Convertible Preferred Stock | 6,726,457 | $ | 2.23 | $ | — | |||
Series A Common Stock Warrants | 1,345,291 | 3.28 | 4,412,554 | |||||
Series A Convertible Notes | 3,321,707 | 3.01 | — | |||||
Series A Convertible Note Warrants | 664,341 | 3.28 | 2,179,038 | |||||
Series B-1 Convertible Preferred Stock | 4,285,714 | 2.80 | — | |||||
Series B-1 Common Stock Warrants | 857,142 | 4.32 | 3,702,853 | |||||
Warrants issued under 2000 financing agreement | 32,500 | 0.75 | 24,375 | |||||
Options issued under Incentive Stock Option Plans | 1,171,358 | 0.50-1.99 | 1,548,336 | |||||
Options issued under Incentive Stock Option Plans | 1,323,413 | 2.20-2.49 | 3,024,882 | |||||
Options issued under Incentive Stock Option Plans | 1,627,499 | 2.54-4.49 | 5,884,455 | |||||
Total | 21,355,422 | $ | 20,776,493 | |||||
9.Stock-based compensation
In May 2002, shareholders approved the Analex Corporation 2002 Stock Option Plan (“2002 Stock Option Plan”). The 2002 Stock Option Plan currently provides for the issuance of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986 and non-qualified stock options to purchase an aggregate of up to 3,000,000 shares of Common Stock. The 2002 Stock Option Plan permits the grant of options to key employees, consultants and directors of the Company. The exercise price of the incentive stock options is required to be at least equal to 100% of the fair market value of the Company’s Common Stock on the date of grant (110% of the fair market value in the case of options granted to employees who are 10% shareholders). The exercise price of the non-qualified stock options is required to be not less than the par value of a share of the Company’s common stock on the date of grant. The term of an incentive or non-qualified stock option may not exceed ten years (five years in the case of an incentive stock option granted to a 10% shareholder). The vesting for each option holder is set forth in the individual option agreements and is generally a three-year period. The 2002 Stock Option Plan honors all of the stock options outstanding under the Company’s 2000 and 1994 Stock Option Plans, as amended (the “Plan”). The Company has accelerated vesting of options for certain option holders when the exercise price of the option is more than the fair market value.
The Company’s Board of Directors approved amending and restating the Company’s Stock Option Plans (collectively, the “Plans”). These amendments allow the Plans to issue Stock Only Stock Appreciation Rights (“SOSAR”). Furthermore, the Board has authorized the Compensation Committee, commencing January 1, 2006, to permit certain option holders, on an individual basis, the right to exchange previously vested options for SOSARs under the Plan and immediately exercise such SOSARs. Any exchange of vested options for SOSARs shall be for economic value substantially equivalent to the options upon exercise. The Company shall withhold all amounts required under applicable income tax laws and regulations and deduct an equivalent number of Company common stock from the number of shares issued to such holder.
Adoption of SFAS No. 123(R)
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment,” which requires that compensation costs related to share-based payment transactions be recognized in financial statements. SFAS No. 123(R) eliminates the alternative to use the intrinsic method of accounting provided for in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” which generally resulted in no compensation expense recorded in the financial statements related to the grant of stock options to employees if certain conditions were met.
Effective January 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective method. Under this method, compensation costs for all awards granted after the date of adoption and the unvested portion of previously granted awards outstanding at the date of adoption are measured at estimated fair value and included in operating expenses over the vesting period during which an employee provides service in exchange for the award. Accordingly, prior period amounts presented herein have not been restated to reflect the adoption of SFAS No. 123(R).
10
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
Prior to the adoption of SFAS No. 123(R), the Company reported all tax benefits resulting from the exercise of stock options as operating cash flows in the consolidated statements of cash flows. In accordance with SFAS No. 123(R), for the period beginning January 1, 2006, excess tax benefits from the exercise of stock options are presented as financing cash flows. Such benefits were not considered material for the three months ended March 31, 2006 or 2005, respectively.
As a result of adopting SFAS No. 123(R), the Company recorded $102,800 of stock-based compensation expense, or approximately $82,000 after-tax This stock-based compensation expense reduced both basic and diluted earnings per share less than a penny per share for the three months ended March 31, 2006.
Stock-Based Compensation Activity
During the quarter ended March 31, 2006, the Company granted 35,000 SOSARs to certain members of the Company’s Board or Directors. The SOSARs were issued at an exercise price of $2.86 per share, the fair value of the Company’s common stock on the date of grant. The Black-Scholes option pricing model weighted-average value for the SOSARs was $1.84 per share. The SOSARs are 100 percent vested and expire ten years from the grant date. The Company recorded approximately $65,000 of stock-based compensation expense associated with these SOSAR grants.
During the quarter ended March 31, 2006, the Company also exchanged 875,725 nonqualified stock options for an equal number of SOSARs. The 875,725 SOSARs were issued on the same terms as the original options grant and were immediately exercised.
The table below summarizes stock option and SOSAR activity for the three months ended March 31, 2006:
Number of Shares | Weighted-Average Exercise Price | Aggregate Intrinsic Value | |||||||
Options and SOSARs outstanding, January 1, 2006 | 3,802,800 | $ | 2.59 | ||||||
Options and SOSARs granted | 35,000 | 2.86 | |||||||
Options and SOSARs exercised | (875,725 | ) | 1.38 | ||||||
Options cancelled and expired | (4,300 | ) | 1.38 | ||||||
Options and SOSARs outstanding, March 31, 2006 | 2,957,775 | $ | 2.95 | $ | 719,600 | ||||
Exercisable at March 31, 2006 | 2,952,775 | $ | 2.95 | $ | 719,600 | ||||
Shares reserved for equity awards at March 31, 2006 | 112,252 | ||||||||
Information with respect to stock options and SOSARs outstanding and stock options and SOSARs exercisable at March 31, 2006 was as follows:
Range of Exercise Price | Options and SOSARs Outstanding | Weighted-Average Remaining Contractual Life (Years) | Weighted-Average Exercise Price | ||||
0.69 – 1.99 | 101,833 | 3.48 | $ | 1.10 | |||
2.20 – 2.49 | 1,148,413 | 3.05 | 2.27 | ||||
2.79 – 4.49 | 1,707,500 | 8.61 | 3.53 |
11
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
Information with respect to stock options outstanding and stock options exercisable at March 31, 2005 was as follows:
Range of Exercise Price | Options Outstanding | Weighted-Average Remaining Contractual Life (Years) | Weighted-Average Exercise Price | ||||
0.50 – 1.99 | 1,171,358 | 2.04 | $ | 1.33 | |||
2.20 – 2.49 | 1,323,413 | 4.38 | 2.30 | ||||
2.54 – 4.49 | 1,627,499 | 9.19 | 3.77 |
Fair Value Determination
To determine the fair value of each option or SOSAR grant, the Company has elected to continue to use both the Black-Scholes option pricing model and straight-line amortization of compensation expense over the requisite service period of the grant. The Company will reconsider use of the Black-Scholes model if additional information becomes available in the future that indicates another model would be more appropriate, or if the fair value of the grants issued in future periods have characteristics that cannot be reasonably estimated using this model.
The Black-Scholes model uses the assumptions noted in the table below to compute a fair value of each option or SOSAR grant. The expected volatility of the Company’s shares was estimated based upon the historical volatility of the Company’s share price. The expected term was calculated based upon the simplified method for estimating expected terms as allowed under SEC Staff Accounting Bulletin (“SAB”) No. 107. The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield available on a U.S. Treasury note with a term equal to the expected term of the underlying grants. The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has not paid dividends in the past nor does it expect to pay dividends in the future.
The table below summarizes the Black-Scholes option pricing model fair value assumptions used for stock option and SOSAR awards during the following periods:
Three Months Ended March 31, 2006 | Three Months Ended March 31, 2005 | |||||||
Weighted average exercise price | $ | 2.86 | $ | 3.70 | ||||
Range of expected volatilities | 76 | % | 50 – 54 | % | ||||
Expected term | 5 years | 5 years | ||||||
Range of risk free interest rates | 4.47 | % | 3.78 – 4.18 | % | ||||
Expected dividend yield | 0.00 | % | 0.00 | % |
12
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
Pro Forma Disclosures
Under the modified prospective method, results for the three months ended March 31, 2005 were not restated to include stock option expense. The previously disclosed pro forma effects of recognizing the estimated fair value of stock-based compensation for the three months ended March 31, 2005 is presented below.
Three Months Ended March 31, 2005 | ||||
Net loss attributable to common shareholders, as reported | $ | (647,300 | ) | |
Deduct: Total stock-based compensation expense determined under fair value based method (SFAS No. 123) for all awards, net of related tax effects | (499,000 | ) | ||
Pro forma net loss attributable to common shareholders | $ | (1,146,300 | ) | |
Loss per share: | ||||
Basic and diluted, as reported | $ | (0.04 | ) | |
Basic and diluted, pro forma | $ | (0.07 | ) | |
Restricted Stock Awards
The Company awarded 150,000 shares of restricted common stock, at a weighted-average price of $2.80 per share, to three members of the Company’s senior management team as an inducement for their employment. The restricted stock will vest at the rate of 25 percent per year over 4 years starting on the employee’s first day of employment. As of March 31, 2006, none of the 150,000 shares of restricted stock has either become vested or has been forfeited.
The Company’s stock-based compensation expense related to the restricted stock award was based on the grant-date quoted market price of the Company’s common stock, which was $2.80 per share. The Company recorded approximately $29,000 of stock-based compensation expense associated with this transaction for the three months ended March 31, 2006. There was approximately $362,000 of unrecognized compensation cost related to the nonvested shares of restricted stock as of March 31, 2006. The Company estimates these costs will be fully amortized in four years.
Employee stock purchase plan
In December 1997, shareholders approved the Analex Corporation 1997 Employee Stock Purchase Plan (the “Plan”). The number of shares currently reserved for issuance under the Plan is 650,000. The purpose of the Plan is to secure for the Company and its shareholders the benefits of the incentive inherent in the ownership of Common Stock by present and future employees of the Company. The Plan is intended to comply with the terms of Section 423 of the Internal Revenue Code of 1986, as amended, and Rule 16b-3 of the Securities Exchange Act of 1934. The Plan is non-compensatory as defined by SFAS 123(R). Under the terms of the Plan, individual employees may pay up to $14,000 for the purchase of the Company’s common shares, at 95% of the determined market price. During the three months ended March 31, 2006, employees paid approximately $111,100 into this plan.
10.Concentration of Business
Almost all of the Company’s revenue is derived either directly from the U.S. government as prime contractor or indirectly as a subcontractor to other government prime contractors. Approximately 72% of the Company’s 2006 year-to-date revenue has been derived from various Department of Defense and intelligence agencies. Approximately 27% of the Company’s 2006 year-to-date revenue has been derived, directly or indirectly, from NASA.
11.Convertible Preferred Stock and Convertible Notes
Series A Convertible Preferred Stock and Convertible Notes
In December 2003, the Company issued for $15.0 million, 6,726,457 shares of Series A Convertible Preferred Stock (“Series A Preferred Stock”) and 1,345,291 Common Stock Warrants. The Series A Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Dividend expense for the Series A Preferred Stock was $0.2 million for the three months ended March 31, 2006 and 2005, respectively.
Upon issuance of the Series A Preferred Stock, the Company allocated relative fair value of approximately $3.9 million to the Common Stock Warrants and recorded a beneficial conversion charge related to the Series A Preferred Stock of approximately $11.1 million. These amounts are being recorded as accretion of Series A Preferred Stock through the earliest
13
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
redemption date of December 9, 2007. For the three months ended March 31, 2006 and 2005, the Company recorded $0.9 million, respectively, of accretion related to these charges. The unamortized discount as of March 31, 2006 and 2005 was $6.3 million and $10.1 million, respectively.
In December 2003, the Company also issued, in aggregate, $10,000,000 principal amount of Series A Secured Subordinated Convertible Promissory Notes that bear interest a 7.0% annual rate (the “Series A Convertible Notes”) convertible into 3,321,707 shares of common stock and 664,341 Common Stock Warrants.
Upon issuance of the Series A Convertible Notes, the Company allocated relative fair value of approximately $1.9 million to the Series A Convertible Note Warrants and recorded a beneficial conversion charge related to the Series A Convertible Notes of approximately $5.3 million. The discount created by these charges is being amortized to interest expense over the life of the Series A Convertible Notes. For the three months ended March 31, 2006 and 2005, the Company recognized $0.5 million, respectively, of amortization of that discount. The unamortized discount as of March 31, 2006 and 2005 was approximately $3.1 million and $4.9 million, respectively.
Series B-1 and B-2 Convertible Preferred Stock
In May 2004, the Company issued in aggregate $12.0 million principal amount of convertible secured subordinated promissory notes (“Series B-1 Notes”) and 857,142 Common Stock Warrants (the “Series B-1 Common Stock Warrants”). In September 2004, the Series B-1 Notes were converted into 3,428,571 shares of Series B Convertible Preferred Stock (“Series B-1 Preferred Stock”). The Series B-1 Common Stock Warrants will expire on May 28, 2014.
The Company had the option to obtain an additional $25.0 million through the sale of additional Series B Preferred Stock for the purpose of paying for the cost of a Company acquisition. In connection with the April 2005 acquisition of ComGlobal, the Company exercised this option and issued for $25.0 million, an additional 7,142,856 shares of Series B Convertible Preferred Stock (“Series B-2 Preferred Stock”) and 1,785,713 Common Stock Warrants (the “Series B-2 Common Stock Warrants”). The Series B-2 Common Stock Warrants will expire on April 1, 2015.
Upon issuance of the Series B-2 Preferred Stock, the Company allocated relative fair value of $2.4 million to the Common Stock Warrants and recorded a beneficial conversion charge related to the Series B-2 Preferred Stock of $8.0 million. These amounts are being recorded as accretion of Series B-2 Preferred Stock through the earliest redemption date of September 15, 2008. For the three months ended March 31, 2006 the Company recorded $0.6 million of accretion related to these charges. The unamortized discount as of March 31, 2006 was $7.9 million.
All Series B Convertible Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Dividend expense for the Series B Convertible Preferred Stock for the three months ended March 31, 2006 and 2005 was $0.6 million and $0.2 million, respectively.
Summary of Convertible Instruments
The table below provides the face value and carrying value of the convertible preferred stock as of March 31, 2006 and December 31, 2005 and the remaining periods of amortization associated with each as of March 31, 2006:
Face Value | 2006 | 2005 | Remaining Periods of Amortization | ||||||||||||||
Carrying Value | Remaining Amount to be Accreted | Carrying Value | Remaining Amount to be Accreted | ||||||||||||||
Series A Preferred Stock | $ | 15,000,000 | $ | 8,673,800 | $ | 6,323,200 | $ | 7,736,300 | $ | 7,263,700 | 1.75 years | ||||||
Series B-1 Preferred Stock | $ | 12,000,000 | $ | 12,000,000 | — | $ | 12,000,000 | — | — | ||||||||
Series B-2 Preferred Stock | $ | 25,000,000 | $ | 17,101,500 | $ | 7,898,500 | $ | 16,493,300 | 8,506,700 | 2.50 years |
14
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
The table below provides the face value and carrying value of the Series A convertible debt as of March 31, 2006 and December 31, 2005 and the remaining period of amortization as of March 31, 2006:
Face Value | 2006 | 2005 | Remaining Period of Amortization | ||||||||||||||
Carrying Value | Remaining Amount to be Accreted | Carrying Value | Remaining Amount to be Accreted | ||||||||||||||
Series A Convertible Notes | $ | 10,000,000 | $ | 6,949,700 | $ | 3,050,300 | $ | 6,497,700 | $ | 3,502,300 | 1.75 years |
12.Commitments and Contingencies
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 ranging from $1.60 to $2.20 per share, if such shares are sold within such period and if certain other conditions are satisfied. As of March 31, 2006, the maximum amount payable under the terms of the guaranteed shares 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 March 31, 2006, no amounts were accrued under the guarantee.
Cost-reimbursement contracts provide for payment of allowable incurred costs, to the extent prescribed in the contract, plus a profit component. These contracts establish an estimate of total cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed without the approval of the contracting officer. Cost-reimbursement contracts are suitable for use when uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use a fixed-price contract. Cost reimbursement contracts covered by the Federal Acquisition Regulation require an audit of actual costs and provide for upward or downward adjustments if actual recoverable costs differ from billed recoverable costs.
In February 2006 the Company entered into a lease agreement, considered an operating lease, with a property management company to lease approximately 7,000 square feet of office space to be used as the Company’s Chantilly regional office. The lease commenced on February 1, 2006 and the initial term of the lease is five years with one optional renewal period of five years. The Company took occupancy of the new facility in April 2006. Future minimum lease payments over the five-year lease term will be approximately $0.9 million.
13.Segment Reporting
Although Analex is organized into two strategic business units, the Company considers each of its government contracting units to have similar economic characteristics, provide similar types of services, and have a similar customer base. Accordingly, the Company aggregates the operations of all of its government contracting units into one reportable segment consisting of two strategic business units: the Homeland Security Group and the Systems Engineering Group. Both Homeland Security Group and Systems Engineering Group provide engineering, information technology, security, intelligence support or technical services to federal government agencies or major defense contractors.
14.Discontinued Operations
During the quarter ended March 31 2006, the Company concluded that SyCom did not fit with the Company’s long-term strategic plan and committed to a plan to dispose of this subsidiary. SyCom provides staff augmentation services, principally to a single customer and had 32 employees. SyCom’s results of operations are presented as a discontinued operation for all periods presented herein.
During the second quarter of 2004, the Company concluded that Advanced Bio-Systems, Inc. (“ABS”), a then wholly owned subsidiary of the Company did not fit with the Company’s long-term plan and decided to divest ABS. The Company disposed of ABS on November 16, 2004. Therefore, the results of operations of this business are reported as discontinued operations, net of applicable income taxes, for all periods presented. Proceeds from the sale of ABS were two non-recourse notes for $1 million. The Company collected approximately $17,000 against these notes during the three-months ended March 31, 2006, compared to $38,400 for the same period in the prior year. The Company reviewed the future viability of ABS and its underlying credit worthiness and determined a full reserve against the remaining outstanding notes was still necessary.
15
ANALEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
Unaudited
Operating results of the discontinued businesses, excluding the related disposal activity, for the three months ended March 31, 2006 and 2005 are as follows:
Three Months Ended March 31 | ||||||||
2006 | 2005 | |||||||
Revenue | $ | 892,500 | $ | 1,858,100 | ||||
(Loss) income from discontinued operations | (275,000 | ) | 74,600 | |||||
Income tax benefit (expense) | 104,500 | (23,800 | ) | |||||
(Loss) income from discontinued operations, net of tax | $ | (170,500 | ) | $ | 46,300 |
Tax rates vary between discontinued operations and the Company’s effective tax rate due to the non-deductibility of certain non-cash amortization expenses for tax purposes.
15.Litigation and Claims
The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. The Company entered into a Settlement Agreement dated July 22, 2004 with Swales. Under the terms of the Settlement Agreement, the Company paid $1,000,000 to Swales in July 2004. Included in the $1,000,000 settlement is approximately $320,000 for work performed by Swales prior to termination. This amount was billed to NASA and the Company received payment. Legal fees are expected to be approximately $290,000. The Company has received an opinion from legal counsel that the unreimbursed amount of the settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs that are reimbursable under the ELVIS contract with NASA. Therefore, the Company established a receivable of approximately $1.0 million related to the expected reimbursement of these costs. In May 2005, the Company received oral customer feedback that the costs were allowable and allocable to the contract, but the reasonableness of these costs still needed to be assessed by NASA. Based on the opinion of legal counsel and management’s assessment of relevant facts, the Company believed and continues to believe that the costs incurred are allowable, allocable and reasonable. During the quarter ended December 31, 2005, the Company met with NASA procurement personnel who indicated to us prior NASA communications with respect to allowability and allocability should not be relied upon. While the Company continues to believe that the full amounts is allowable, allocable and reasonable, and therefore should be recoverable under the ELVIS contract with NASA, the Company had concluded a reserve of $500,000 was appropriate and was therefore recorded as of December 31, 2005. The Company intends to continue to use all reasonable efforts to recover the full amount of its costs from NASA.
On April 29, 2005 the Company was served with a compliant filed by H&K Strategic Business Solutions, LLC (“HKSBS”) in Virginia Circuit Court alleging breach of contract relating to a Corporate Acquisition Agreement between the parties, dated February 10, 2004 that was later terminated by the Company on February 14, 2005. Under the complaint, HKSBS is seeking damages of $830,000 together with legal fees and expenses. The Company believes the complaint is without merit, however, the Company cannot predict the outcome of the proceeding at this time and has filed a counter-claim against HKSBS seeking reimbursement of prior retainer payments made to HKSBS of approximately $110,000, plus certain legal fees. This matter was tried in March 2006 in Fairfax County Circuit Court. Post-trial briefs were filed in April 2006. The judge hearing this matter is expected to issue a ruling in June 2006. In the event that HKSBS prevails, the Company could be held liable for up to the full amount of the damages sought; and that result could have a material adverse effect on its operating results and cash flows.
16.Subsequent Events
The Company sold its SyCom Services subsidiary on April 1, 2006. Neither the SyCom Services subsidiary nor the consideration received are material to the Company’s results of operations or financial position.
16
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Certain matters contained in the following discussion and analysis concerning our operations, cash flows, financial position, economic performance, plans, trends, strategies 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 the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements are not guarantees of future performance and subject to known and unknown risks, uncertainties, and other factors that may cause our actual results, level of activity, 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 events in the future that we may not be able to predict accurately or control. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, and as a result of many factors, including, but not limited to the following:
• | our dependence on contracts with U.S. federal government agencies, particularly clients within the Department of Defense and NASA, for substantially all of our revenue; |
• | our dependence on four material contracts, each of which accounted for a significant percentage of our revenue and operating income for the three months ended March 31, 2006; |
• | the business risks peculiar to the defense industry, including changing priorities or reductions in the U.S. Government defense budget; |
• | our ability to accurately estimate our backlog; |
• | our ability to maintain strong relationships with other contractors; |
• | our ability to recruit and retain qualified skilled employees who have the required security clearance; |
• | economic conditions, competitive environment, and timing of awards and contracts; |
• | our ability to identify future acquisition candidates and to realize the expected benefits of the acquisition; |
• | our ability to raise additional capital to fund acquisitions; |
• | our substantial debt and the restrictions imposed on us by certain debt agreements; and |
• | our ability to control indirect costs, particularly costs related to funding our self-insured health plan. |
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.
17
INTRODUCTION
This management’s discussion and analysis of financial condition and results of operations is intended to provide readers with an understanding of our past performance, our financial condition and our prospects. We will discuss and provide our analysis of the following:
• | Overview of Business |
• | Results of Operations and Related Information |
• | Liquidity and Capital Resources |
• | New Accounting Pronouncements |
OVERVIEW OF BUSINESS
We are a leading provider of mission-critical professional services to the U.S. government. We specialize in providing intelligence, systems engineering and security services in support of our nation’s security. We focus on developing innovative technical approaches for the intelligence community, analyzing and supporting defense systems, designing, developing and testing aerospace systems and providing a full range of security support services to the U.S. government. We specialize in the following professional services:
Information Technology Services.Our information technology services focus on design, development, test, integration and support of software and networks for mission critical systems. We develop radar, modeling and simulation and system software, all in support of collecting, testing, and analyzing data from various intelligence systems. We also provide the military with program management, systems engineering and software development services, including the development of command, control, communications, computers and intelligence (“C4I”) programs.
Aerospace Engineering Services.Our aerospace engineering services focus on engineering associated with the development, support and operations of space launch vehicles and facilities as well as independent verification and validation services. We provide services in the design and testing of expendable launch vehicles for the Department of Defense (“DoD”) and intelligence community. Our highly specialized expertise includes test, analysis and independent validation and verification support in areas such as structural dynamics, trajectory and performance, thermal system performance, and range safety. Our solutions enable the simulation of a realistic operational environment so that satellites and related systems can be tested prior to deployment. We also perform verification and validation of test results to ensure the reliability of the data.
Security and Intelligence Support Services.Our security and intelligence support services focus on analysis support and threat assessments, counterintelligence, information, network and facilities security, technology protection and security education and training.
We provide our services through one reportable segment, comprised of two strategic business units, our Homeland Security Group (“HSG”) and our Systems Engineering Group (“SEG”). HSG accounted for approximately 72% of our revenue for the three months ended March 31, 2006. HSG provides information technology services, aerospace engineering services and security and intelligence support services to the agencies within the intelligence community such as the National Reconnaissance Office (“NRO”), the Missile Defense Agency (“MDA”) and the National Security Agency (“NSA”). HSG also provides services to the DoD, and major aerospace contractors, such as Lockheed Martin and Northrop Grumman. We expect that our Homeland Security Group will continue to benefit from the country’s shifting priorities towards national defense and homeland security and emphasis on enhanced intelligence capabilities.
SEG accounted for approximately 28% of our revenue for the three months ended March 31, 2006. SEG provides aerospace engineering services and information technology services, including program management support, primarily to NASA and major aerospace contractors in support of the development of space-based systems. SEG also supports the operation of terrestrial assets and the launch of unmanned rockets by NASA under our Expendable Launch Vehicle Integrated Support (“ELVIS”) contract. Specific capabilities of the Systems Engineering Group include expendable launch vehicle engineering, space systems development, and ground support for space operations.
18
Our principal customer is the U.S. government. Revenue generated from contracts to federal government agencies and their prime contractors represented approximately 99% and 100% of our total revenue for the three months ended March 31, 2006 and 2005, respectively. Our principal U.S. government customer is the DoD, which, directly or through its prime contractors, accounted for approximately 72% and 59%, of our revenue for the three months ended March 31, 2006 and 2005, respectively. NASA is also a significant customer, generating 27% and 41% of our revenue for the three months ended March 31, 2006 and 2005, respectively. For the three months ended March 31, 2006 approximately 38% of our revenue and 86% of our operating income came from three prime contracts with agencies within the DoD. For the three months ended March 31, 2005 approximately 15% of our revenue and 52% of our operating income came from one prime contract with an agency within the DoD. For the three months ended March 31, 2006 and 2005 approximately 19% and 27%, respectively, of our revenue came from one prime contract with NASA, which will continue until September 2011, if the remaining contract option is exercised in 2008. We expect that federal government contracts will continue to be the source of substantially all of our revenue for the foreseeable future.
On April 1, 2005, we acquired ComGlobal Systems, Incorporated (“ComGlobal”). ComGlobal, a software engineering and information technology firm, specializes in C4I programs for the military. Its largest customer is the U.S. Navy’s Tomahawk Cruise Missile Program. ComGlobal is now a wholly-owned subsidiary of ours and is reported as a part of our Homeland Security Group.
During the first fiscal quarter of 2006, we concluded that our wholly-owned subsidiary, SyCom Systems, Inc. (“SyCom”), did not fit with our long-term strategic plan and decided to divest SyCom. SyCom provided staff augmentation services, principally to a single customer and had 32 employees. We disposed of SyCom on April 1, 2006. Therefore, the results of operations of SyCom are reported as discontinued operations, net of applicable income taxes, for all periods presented. Historically, we reported SyCom as a component of our Homeland Security Group.
We generate a majority of our revenue as a prime contractor to the federal government. Our objective is to focus on retaining and increasing the percentage of our business as a prime contractor because we believe it provides us with stronger client relationships. The following table summarizes our revenue as a prime contractor and as subcontractor as a percentage of our total revenue for the three months ended March 31:
2006 | 2005 | |||||
Prime contract revenue | 80 | % | 77 | % | ||
Subcontract revenue | 20 | % | 23 | % | ||
Total revenue | 100 | % | 100 | % | ||
19
All of our U.S. government contracts are subject to audit and various cost controls, and include standard provisions for termination at any time at the convenience of the U.S. government. Multi-year U.S. government contracts and related orders are subject to cancellation if funding for contract performance for any subsequent year becomes unavailable.
Future growth is dependent upon the strength of our target markets, our ability to identify opportunities, and our ability to successfully bid and win new contracts. Our success can be measured in part based upon the growth of our backlog. The following table summarizes our contract backlog as of March 31:
2006 | 2005 | |||||
Funded backlog | $ | 83.7 | $ | 77.0 | ||
Unfunded contract value | 279.4 | 206.0 | ||||
Total estimated backlog | $ | 363.1 | $ | 283.0 | ||
Our total backlog of approximately $363.1 million as of March 31, 2006 represented a 28% increase over the backlog as of March 31, 2005. We currently expect to recognize revenue during the remainder of fiscal 2006 of approximately 24%% from our total backlog as of March 31, 2006.
Contract profit margins are generally affected by the type of contracts we have. We can typically earn higher profits on fixed-price and time-and-material contracts than cost-plus-fee contracts. Thus, an important part of growing our operating income is to increase the amount of services delivered under fixed-price and time and material contracts The following table summarizes our historical contract mix, measured as a percentage of total revenue, for the three months ended March 31:
2006 | 2005 | |||||
Cost-plus-fee | 42 | % | 31 | % | ||
Time and material | 32 | % | 36 | % | ||
Fixed-price | 26 | % | 33 | % | ||
Total | 100 | % | 100 | % | ||
While our government clients typically determine what type of contract will be awarded to us, where we have the opportunity to influence the type of contract awarded, we will pursue time-and-material and fixed-price contracts for the reasons discussed above.
20
RESULTS OF OPERATIONS AND RELATED INFORMATION
The following tables provide comparative and common size results of operations for the three months ended March 31, 2006 and 2005, respectively, followed by our discussion and analysis of the results.
Comparison of the Three Months Ended March 31, 2006
to the Three Months Ended March 31, 2005
(dollar amounts in thousands)
March 31, 2006 | % of Revenue | March 31, 2005 | % of Revenue | % Change | |||||||||||||
Revenue | $ | 35,531 | 100.0 | % | $ | 26,580 | 100.0 | % | 33.7 | % | |||||||
Operating costs and expenses | |||||||||||||||||
Cost of revenue | 29,037 | 81.7 | 21,605 | 81.3 | 34.4 | ||||||||||||
Selling, general and administrative | 3,022 | 8.5 | 2,437 | 9.2 | 24.0 | ||||||||||||
Amortization of intangible assets | 914 | 2.6 | 490 | 1.8 | 86.5 | ||||||||||||
Depreciation | 247 | 0.7 | 79 | 0.3 | 212.7 | ||||||||||||
Total operating costs and expenses | 33,220 | 93.5 | 24,611 | 92.6 | 35.0 | ||||||||||||
Operating income | 2,311 | 6.5 | 1,969 | 7.4 | 17.4 | ||||||||||||
Other income and expense | |||||||||||||||||
Interest expense, net | (1,186 | ) | (3.3 | ) | (763 | ) | (2.9 | ) | 55.4 | ||||||||
Income from continuing operations before income taxes | 1,125 | 3.2 | 1,206 | 4.5 | (6.7 | ) | |||||||||||
Provision for income taxes | 609 | 1.7 | 586 | 2.2 | 3.9 | ||||||||||||
Income from continuing operations | 516 | 1.5 | 620 | 2.3 | (16.8 | ) | |||||||||||
(Loss) income from discontinued operations, net of tax | (170 | ) | (0.5 | ) | 46 | 0.2 | (469.6 | ) | |||||||||
Gain on disposal of discontinued operations, net of income taxes | 10 | 0.0 | 24 | 0.1 | (58.3 | ) | |||||||||||
Net income | 356 | 1.0 | 690 | 2.6 | (48.4 | ) | |||||||||||
Dividends convertible preferred stock | (780 | ) | (2.1 | ) | (400 | ) | (1.5 | ) | 95.0 | ||||||||
Accretion of convertible preferred stock | (1,546 | ) | (4.4 | ) | (937 | ) | (3.5 | ) | 65.0 | ||||||||
Net loss available to common shareholders | $ | (1,970 | ) | (5.5 | )% | $ | (647 | ) | (2.4 | )% | 204.5 | % | |||||
Revenue
Our revenue for the three months ended March 31, 2006 was $35.5 million, an increase of $9.0 million, or 33.7%, from the same period in the prior year.
Our Homeland Security Group provided $25.7 million, or 72%, of our revenue for the three months ended March 31, 2006. This represented a 64.8% total increase from the same period in the prior year and organic growth of approximately 9.0%. Contributing to this increase were the effects of our acquisition of ComGlobal in April 2005 and increased information and technology asset protection solutions we provided to certain agencies, including MDA and the Counterintelligence Field Activity (“CIFA”). In addition, we provided increased independent verification and validation services in support of launches of expendable launch vehicles by the United States Air Force and the NRO.
Our Systems Engineering Group provided $9.8 million, or 28%, of our revenue for the three months ended March 31, 2006. Systems Engineering Group revenue decreased approximately 10.7% for the three months ended March 31, 2006 compared to same period in the prior year. This decrease is attributable to decreases in NASA direct material pass-through revenue, which was unusually high in the quarter that ended March 31, 2005, and the continuing planned step-down of our Microgravity Research Development and Operations subcontract (“MRDOC”). On an annual basis, NASA will typically purchase a certain amount of direct material under our ELVIS contract. The timing of these purchases, however, is dictated by NASA and may widely fluctuate from quarter to quarter.
Cost of Revenue
Cost of revenue for the three months ended March 31, 2006 was $29.0 million, an increase of $7.4 million, or 34.4%, from the same period in the prior year. Cost of revenue, as a percentage of revenue for the three months ended March 31, 2006 was 81.7%, compared to 81.3% for the same period in the prior year. The increase in cost of revenue, as a percentage of revenue, for the three months ended March 31, 2006 was attributable primarily to an increase in personnel fringe benefit costs during the three months ended March 31, 2006 compared to the same period in the prior year. An increased number of larger medical claims during the three months ended March 31, 2006 was the primary reason attributable to the increase in fringe benefit costs.
21
Selling, General and Administrative Expenses (SG&A)
SG&A for the three months ended March 31, 2006 was $3.0 million, an increase of $0.6 million, or 24.0%, from the same period in the prior year. This increase in total costs incurred is associated with the incremental costs required to support the ComGlobal business acquired in April 2005 and the additional investment in business development made in 2006. SG&A, as a percentage of revenue was 8.5% for the three months ended March 31, 2006 compared to 9.2% for the same period in the prior year. As we acquire and integrate companies, we expect to leverage our central corporate services, reducing the ratio of SG&A to revenue. The operational efficiencies we experienced with our ComGlobal acquisition in April 2005 contributed to the decrease in SG&A as a percentage of revenue for the three months ended March 31, 2006 compared to the same period in the prior year. These efficiencies were partially offset by increased expense associated with establishing a more robust centralized business development function which we completed during the fourth fiscal quarter of 2005.
Depreciation Expense and Amortization of Intangible Assets
Depreciation expense and intangible amortization expense for the three months ended March 31, 2006 was $1.2 million, an increase of $0.6 million or 103.9% from the same period in the prior year. This increase resulted from the fixed assets and identifiable intangible assets we acquired in connection with the ComGlobal acquisition in April 2005.
Operating Income
Operating income for the three months ended March 31, 2006 was $2.3 million, an increase of $0.3 million, or 17.4%, from the same period in the prior year. Our operating margin for the three months ended March 31, 2006 was 6.5% compared to 7.4% for the same period in the prior year. The increase in depreciation and amortization expense for the three months ended March 31, 2006, related to the April 2005 ComGlobal acquisition, reduced our operating margin by approximately 1.4%. Excluding the effects of the depreciation and amortization, our operating margin for the three months ended March 31, 2006 would have increased by 0.5 points compared to the same period in the prior year. This increase was attributed primarily to the SG&A efficiencies described in the SG&A section above.
Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)
EBITDA, as defined below, for the three months ended March 31, 2006 was $3.5 million after adding depreciation and amortization expense of $1.2 million to operating income of $2.3 million. This was an increase of $0.9 million, or 36.8% from the same period in the prior year. For the three months ended March 31, 2006, EBITDA, as a percentage of revenue was 9.8% compared to 9.6% for the same period in the prior year. The increase in our EBITDA margin for the three months ended March 31, 2006, compared to the same period in the prior year, was attributed primarily to the SG&A efficiencies described in the SG&A section above.
EBITDA is 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 should not be considered as a substitute either for net income, as an indicator of our operating performance, or for cash flow, as measures of our liquidity. In addition, because all companies do not calculate EBITDA identically, our presentation of EBITDA may not be comparable to other similarly titled measures of other companies.
EBITDA is a widely used measure of operating performance. It is presented as supplemental information that we believe is useful to investors in evaluating our results because it excludes certain non-cash expenses that are not directly related to our core operating performance. EBITDA is calculated by adding net interest expense, income taxes, discontinued operations, depreciation and amortization to net income. EBITDA should not be considered as a substitute either for net income, as an indicator of our operating performance, or for cash flow, as measures of our liquidity. In addition, because all companies do not calculate EBITDA identically, our presentation of EBITDA may not be comparable to other similarly titled measures of other companies.
Interest Expense
Interest expense for the three months ended March 31, 2006 was $1.2 million, an increase of $0.4 million, or 55.4%, from the same period in the prior year. Interest expense has increased as a result of the $22 million we borrowed from our revolving line of credit in April 2005 to fund a portion of our ComGlobal acquisition.
Provision for Income Taxes
The provision for income taxes for the three months ended March 31, 2006 was $0.6 million, an increase of $23,000, or 3.9%, from the same period in the prior year. Our effective tax rate, or the ratio of income tax expense reported in relation to income from continuing operations before income taxes, was impacted significantly by the non-tax deductible interest and accretion expense associated with our convertible notes and preferred stock issued since 2003.
22
LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity needs are to finance the costs of operations pending the billing and collection of accounts receivable, to acquire capital assets, to pay the interest on our credit facility, to make quarterly dividend payments on our convertible preferred stock and to make selective strategic acquisitions.
Cash Flow
For the three months ended March 31, 2006, net cash provided by operating activities was $0.5 million, compared to $2.8 million for the same period in the prior year. This decrease in cash flow from operations was a result of funding delays that occurred during our prior quarter that ended December 31, 2005. These funding delays resulted in the delayed billing and collection of approximately $8 million of accounts receivable that remained outstanding at March 31, 2006. Since March 31, 2006, we have collected approximately $4 million of this $8 million balance. The other $4 million is accruing interest as it is past due and should be released any day by the government payment office. Accounts receivable represents our largest component of working capital. We bill most of our clients the month after services have been rendered. Our operating cash flow is primarily affected by the overall profitability of our contracts, our ability to invoice and collect from our clients in a timely manner and our ability to manage our vendor payments. We use Days Sales Outstanding, or DSO, to measure how efficiently we manage the billing and collection of our accounts receivable. For the three months ended March 31, 2006, our DSO increased to 84 days. The $8 million in delayed collections, as described above, represented 20 days of sales. We view these delays in payment as a non-recurring event precipitated by personnel changes in one of our large Government customers. We expect DSO to return to its historical level in the range of 60 days of sales.
Cash provided by investing activities was $0.3 million for the three months ended March 31, 2006, compared to $13,500 used in investing activities for the same period in the prior year. Our investing cash flow activity is affected primarily by our purchase of property and equipment. We acquired approximately $0.2 million of property and equipment during the three months ended March 31, 2006. This was offset by approximately $0.5 million we received associated the sale of property which was previously held for sale.
Cash used in financing activities was $1.8 million for the three months ended March 31, 2006, compared to $3.3 million for the same period in the prior year. Our financing cash flow activity was affected by borrowings and repayments on our revolving line of credit. For the three months ended March 31, 2006, we repaid approximately $1.0 million against our revolving line of credit, compared to approximately $3.1 million for the same period during the prior year. Financing activity cash flows were also affected by the payment of dividends on our convertible preferred stock. We paid approximately $0.8 million in dividends on our preferred stock for the three months ended March 31,2006 compared to $0.3 million for the same period in the prior year. The increase in our preferred stock dividend expense from the same period in the prior year was attributed to the $25.0 million of preferred stock we issued in April 2005 in connection with our acquisition of ComGlobal.
Credit Facility and Borrowing Capacity
We have a long-standing relationship with Bank of America, N.A. (“the Bank”). Part of our relationship with the Bank includes a $40.0 million revolving line of credit (“the Credit Facility”) used for senior acquisition financing and working capital requirements. The Credit Facility is subject to a borrowing base determined based on our outstanding accounts receivable balance and certain financial covenants setting forth maximum ratios for total funded debt to EBITDA and minimum ratios for fixed charge coverage. As of March 31, 2006 we were in compliance with these covenants. The Credit Facility has a maturity date of May 31, 2008. Interest on the Credit Facility is at the LIBOR Rate plus an applicable margin as specified the agreement. As of March 31, 2006, the outstanding balance of the Credit Facility was $26.6 million. The interest rate at March 31, 2006 was 7.83%. Borrowing availability under our Credit Facility continues to be sufficient to fund normal operations. Available borrowing capacity on our Credit Facility at March 31, 2006 was approximately $5.5 million.
The Credit Facility also restricts our ability to dispose of properties, 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 certain leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. All assets of our business generally secure the Credit Facility.
Guarantees and Commitments
Pursuant to the November 2, 2001 acquisition of the former Analex, we issued 3,572,143 shares of our 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 we guarantee 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. As of March 31, 2006, the maximum amount payable under the terms of the guaranteed shares was approximately $1.6 million. As the fair market value of our Common Stock was in excess of the guaranteed share prices as of March 31, 2006, we did not accrue any amounts under the guarantee.
23
On November 2, 2001, we issued promissory notes to certain Analex sellers totaling approximately $0.8 million with a five-year term, bearing interest at 6%. As of March 31, 2006 the outstanding balance of the promissory notes was approximately $0.1 million. We also entered into non-competition agreements with former employees totaling $0.4 million, on a discounted basis, payable over various periods with a current balance of $0.1 million at March 31, 2006.
In February 2006, we entered into a lease agreement for approximately 7,000 square feet to be used as our new Chantilly, Virginia regional office. The lease commenced on February 1, 2006 and has a term of five years with one optional renewal period of five years. Future minimum lease payments over the five-year lease term will be approximately $0.9 million.
NEW ACCOUNTING PRONOUNCEMENTS
Adoption of SFAS No. 123(R)
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment,” which requires that compensation costs related to share-based payment transactions be recognized in financial statements. SFAS No. 123(R) eliminates the alternative to use the intrinsic method of accounting provided for in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” which generally resulted in no compensation expense recorded in the financial statements related to the grant of stock options to employees if certain conditions were met.
Effective January 1, 2006, we adopted SFAS No. 123(R) using the modified prospective method. Under this method, compensation costs for all awards granted after the date of adoption and the unvested portion of previously granted awards outstanding at the date of adoption are measured at estimated fair value and included in our operating expenses over the vesting period during which an employee provides service in exchange for the award. Accordingly, prior period amounts presented herein have not been restated to reflect the adoption of SFAS No. 123(R).
Prior to the adoption of SFAS No. 123(R), we reported all tax benefits resulting from the exercise of stock options as operating cash flows in the consolidated statements of cash flows. In accordance with SFAS No. 123(R), for the period beginning January 1, 2006, excess tax benefits from the exercise of stock options are presented as financing cash flows. We did not consider such benefits material for the three months ended March 31, 2006 or 2005, respectively.
As a result of adopting SFAS No. 123(R), we recorded approximately $0.1 million of stock-based compensation expense, or approximately $82,000 after-tax, in our statement of operations for the three months ended March 31, 2006. This stock-based compensation expense reduced both our basic and diluted earnings per share by less than a penny a share for the three months ended March 31, 2006.
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 expenditures exposes the Company to variability in interest payments due to changes in interest rates. The Company does not currently use interest rate swaps or other means to reduce the interest rate exposure on these variable rate obligations. Furthermore, the Company does not hold any other type of derivative instrument.
Item 4.Controls and Procedures
The Company has established and maintains disclosure controls and procedures that are designed to ensure that material information required to be disclosed by the Company in the reports that it files under the Securities Exchange Act of 1934, as amended, is 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, as 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 in this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective, at the reasonable assurance level, as of March 31, 2006, in timely alerting them to material information relating to the Company required to be included in the Company’s periodic SEC filings.
24
The Company’s management, including its Chief Executive Officer and Chief Financial Officer, also supervised 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 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. The Company entered into a Settlement Agreement dated July 22, 2004 with Swales. Under the terms of the Settlement Agreement, the Company paid $1,000,000 to Swales in July 2004. Included in the $1,000,000 settlement is approximately $320,000 for work performed by Swales prior to termination. This amount was billed to NASA and the Company received payment. Legal fees are expected to be approximately $290,000. The Company has received an opinion from legal counsel that the unreimbursed amount of the settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs that are reimbursable under the ELVIS contract with NASA. Therefore, the Company established a receivable of approximately $1.0 million related to the expected reimbursement of these costs. In May 2005, the Company received oral customer feedback that the costs were allowable and allocable to the contract, but the reasonableness of these costs still needed to be assessed by NASA. Based on the opinion of legal counsel and management’s assessment of relevant facts, the Company believed and continues to believe that the costs incurred are allowable, allocable and reasonable. During the quarter ended December 31, 2005, the Company met with NASA procurement personnel who indicated to us prior NASA communications with respect to allowability and allocability should not be relied upon. While the Company continues to believe that the full amounts is allowable, allocable and reasonable, and therefore should be recoverable under the ELVIS contract with NASA, the Company has concluded a reserve of $500,000 is appropriate and was therefore recorded as of December 31, 2005. The Company intends to continue to use all reasonable efforts to recover the full amount of its costs from NASA.
On April 29, 2005 the Company was served with a compliant filed by H&K Strategic Business Solutions, LLC (“HKSBS”) in Virginia Circuit Court alleging breach of contract relating to a Corporate Acquisition Agreement between the parties, dated February 10, 2004 that was later terminated by the Company on February 14, 2005. Under the complaint, HKSBS is seeking damages of $830,000 together with legal fees and expenses. The Company believes the complaint is without merit, however, the Company cannot predict the outcome of the proceeding at this time and has filed a counter-claim against HKSBS seeking reimbursement of prior retainer payments made to HKSBS of approximately $110,000, plus certain legal fees. This matter was tried in March 2006 in Fairfax County Circuit Court. Post-trial briefs were filed in April 2006. The judge hearing this matter is expected to rule in June 2006. In the event that HKSBS prevails, the Company could be held liable for up to the full amount of the damages sought; and that result could have a material adverse effect on its operating results and cash flows.
Item 1A.Risk Factors
Other than with respect to the risk factors below, there have been no material changes from the risk factors disclosed in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The following risk factors were disclosed on the Form 10-K and have been revised to provide updated information as of the date of filing of this quarterly report on Form 10-Q.
We depend on contracts with U.S. federal government agencies, particularly clients within the Department of Defense and NASA, for substantially all of our revenue, and if our relationships with these agencies were impaired, our business could be materially adversely affected.
Revenue derived from U.S. federal government agencies and their prime contractors represented 99%, of our total revenue for the fiscal quarters ended March 31, 2006 and 2005, respectively. The Department of Defense, our principal U.S. government customer, accounted for approximately 72% and 59% of our revenue for the fiscal quarters ended March 31, 2006 and 2005, respectively. NASA generated 27% and 41% of our revenue for the fiscal quarters ended March 31, 2006 and 2005, respectively. Approximately 19% and 30% of our revenue for the fiscal quarters ended March 31, 2006 and 2005, respectively, came from one prime contract with NASA, which will continue until September 2011 if the remaining option is exercised in 2008. In the event that the remaining option term is not exercised, we will not be able to recognize the full value of the contract awarded. In addition, the Homeland Security Group’s contracts with three Department of Defense customers generated 38% of our revenue and 86% of our operating income for the fiscal quarter ended March 31, 2006. For the fiscal quarter ended March 31, 2005, there was one prime contract with the DoD which represented 17% of our revenue and 72% of our operating income. We expect that federal government contracts will continue to be the source of substantially all of our revenue for the foreseeable future. If we were suspended or debarred from contracting with the federal government generally, the Department of Defense, NASA or any significant agency in the intelligence community, if our reputation or relationship with government agencies were impaired, or if the government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, our business, operating results, financial condition and business prospects could be materially adversely affected.
We cannot predict the results of legal proceedings which may arise from time to time in the ordinary course of business or in relation to our acquisition activities.
From time to time we are involved in legal proceedings arising in the ordinary course of our business. We cannot predict the nature, extent and timing of such legal proceedings. Furthermore, we cannot predict whether the outcome of such legal proceedings could have a material adverse effect on our operating results or cash flows.
We were served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. We entered into a Settlement Agreement dated July 22, 2004 with Swales. Under the terms of the Settlement Agreement, we paid $1,000,000 to Swales in July 2004. Included in the $1,000,000 settlement is approximately $320,000 for work performed by Swales prior to termination. This amount was billed to NASA and we received payment. Legal fees are expected to be approximately $290,000. We have received an opinion from legal counsel that the unreimbursed amount of the settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs that are reimbursable under the ELVIS contract with NASA. Therefore, we established a receivable of approximately $1.0 million related to the expected reimbursement of these costs. In May 2005, we received oral customer feedback that the costs were allowable and allocable to the contract, but the reasonableness of these costs still needed to be assessed by NASA. Based on the opinion of legal counsel and management’s assessment of relevant facts, we believed and continue to believe that the costs incurred are allowable, allocable and reasonable. During the quarter ended December 31, 2005, we met with NASA procurement personnel who indicated to us that prior NASA communications with respect to allowability and allocability should not be relied upon. While we continue to believe that the full amount is allowable, allocable and reasonable, and therefore should be recoverable under the ELVIS contract with NASA, we have concluded that a reserve of $500,000 is appropriate as of December 31, 2005. We intend to continue to use all reasonable efforts to recover the full amount of our costs from NASA.
We were served on April 29, 2005 with a complaint filed by H&K Strategic Business Solutions, LLC (“HKSBS”) in Virginia Circuit Court alleging breach of contract and other claims relating to a Corporate Acquisition Agreement between the parties, dated February 10, 2004, which we terminated on February 14, 2005. Under the complaint, HKSBS is seeking damages of $830,000 together with legal fees and expenses. We have filed a counter-claim against HKSBS seeking reimbursement of prior retainer payments made to HKSBS of approximately $110,000, plus certain legal fees. This matter was tried during March 2006 in Fairfax County Circuit Court. Post trial briefs were filed in April 2006. The judge hearing this matter is expected to issue a ruling in June 2006. In the event that HKSBS prevails, we could be held liable for up to the full amount of the damages sought; and that result could have a material adverse effect on our operating results and cash flows.
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 Form 8-K dated January 13, 2006 and filed with the Securities and Exchange Commission on January 18, 2006 reported that the Company entered into a written agreement with Mr. Sterling E. Phillips, Jr., Chairman of the Board and Chief Executive Officer, whereby Mr. Phillips exchanged his stock option to purchase 875,725 shares of Analex Common Stock for an equal number of stock-only stock appreciation rights (“SOSARs”). Mr. Phillips exercised these SOSARs on January 13, 2006.
25
A Current Report on Form 8-K dated February 22, 2006 and filed with the Securities and Exchange Commission on February 28, 2006 reported that the Company issued a press release announcing its financial results for the fiscal year ended December 31, 2005.
A Current Report on Form 8-K dated February 22, 2006 and filed with the Securities and Exchange Commission on February 28, 2006 reported that (i) the Company has amended and restated the Analex Corporation 2000 and 2002 Stock Incentive Plan, (ii) pursuant to the Analex Corporation 2002 Stock Incentive Plan, each non-employee director automatically received stock–only stock appreciation rights covering 5,000 shares of Analex Common Stock on February 22, 2006, and (iii) the Company approved the grant of 50,000 shares of restricted stock to each Messrs. C. Wayne Grubbs, V. Joseph Broadwater and Stephen C. Matthews. The form of the Stock Appreciation Rights Agreement and the Option Exchange and Stock Appreciation Right Agreement were filed as exhibits to the filing.
26
(c) | SIGNATURES |
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: May 5, 2006
Analex Corporation
(Registrant)
By: | /s/ Sterling E. Phillips, Jr. | By: | /s/ C. Wayne Grubbs | |||
Sterling E. Phillips, Jr. | C. Wayne Grubbs | |||||
Chairman and Chief Executive Officer (Principal Executive Officer) | Senior Vice President and Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer) |
27