UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934
For the Year Ended December 31, 20032005
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 Number) |
2677 Prosperity Avenue, Suite 400
Fairfax, Virginia 22031
(Address of principal executive offices)
5904 Richmond Highway, Suite 300
Alexandria, Virginia 22303
(AddressFormer address of principal executive offices)
Registrant’s telephone number including area code
(703) 329-9400852-4000
Securities registered pursuant to Section 12(b) of the Act:
Title of Class | Name of exchange on which registered: | |
Common Stock, par value $0.02 per share | ||
| American Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes ¨ No 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
The aggregate market value of the common stockCommon Stock of the registrant held by non-affiliates of the registrant (based upon the closing price of the common stockCommon Stock on the American Stock Exchange on June 30, 2003)2005) was approximately $23,965,092.$56,965,518.
As of March 25, 2004, 13,061,1758, 2006, 16,640,004 shares of the common stockCommon Stock of the registrant were outstanding.
Documents incorporated by reference: Portions of the registrant’s Proxy Statement to be filed in connection with the registrant’s 2006 Annual Meeting of Stockholders are incorporated by reference in Part III of the Annual Report pursuant to General Instruction G(3) to Form 10-K.
PART I
Item 1. Business |
Introduction
Analex Corporation (“Analex” orGENERAL OVERVIEW
We are a leading provider of mission-critical professional services to the “Company”) specializesU.S. government. We specialize in providing information technology,intelligence, systems engineering and bio-defensesecurity services and solutions in support of our 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 developing medical defensesproviding a full range of security support and treatments for infectious agents used in biological warfare and terrorism.
Name Change
Pursuantengineering services to shareholders’ approval obtained at the Company’s annual shareholder meeting held on May 21, 2002, Hadron, Inc. changed its name on July 1, 2002, to Analex Corporation by merging Hadron, Inc. into its wholly owned subsidiary Analex Corporation. Hadron acquired Analex on November 5, 2001. Hadron’s name was changed to Analex to improve marketing effectiveness and take advantage of Analex’s broader name recognition in both the intelligence and aerospace systems engineering market segments. Under the resulting corporate structure, Analex Corporation has two wholly owned subsidiaries, SyCom Services, Inc. (“SyCom”) and Advanced Biosystems, Inc. (“ABS”).
Operations
The Company has two reportable segments: Analex, which is engaged in professional services related to information technology and systems engineering for the U.S. government, primarily NASA and the Department of Defense; and Advanced Biosystems (ABS), which is engaged in biomedical research for broad-spectrum defenses against toxic agents capable of being used as bioterrorist weapons, such as anthrax and smallpox. The segments are distinguishedgovernment. We provide these services through one reportable segment represented by their individual clients, past experience and technical skills.
The Analex segment consists of two strategic business groups: theunits, our Homeland Security Group and theour Systems Engineering Group. The Homeland Security Group provides information technology services, systems integration, hardware and software engineering and independent quality assurance in support of the U.S. intelligence community and Department of Defense. The Systems Engineering Group provides engineering, information technology and program management support to NASA, the Department of Defense, and major aerospace contractors such as Lockheed Martin and Northrop Grumman.
Financial information on each segment is included inItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Analex Segment
Homeland Security Group. Since 1964, the Company has provided hardware and software engineering, systems integration, information technology solutions and independent quality assurance to support the requirements of the U.S. intelligence community. The Homeland Security Group’s role in the support of the intelligence community brings specialized skills to a broad set of technical requirements. In the area of intelligence, reconnaissance and surveillance, it provides solutions that enable the simulation of a realistic operational environment so that satellites and related systems can be tested prior to deployment. Homeland Security performs verification and validation of test results to ensure the reliability of the data and also develops radar, modeling and simulation, and system software, all in support of testing, collecting, and analyzing data from various intelligence systems.
The Homeland Security Group is an independent expert in the design and testing of expendable launch vehicles for the Department of Defense and intelligence community. Its highly specialized expertise provides test analysis and independent validation and verification support in areas such as structural dynamics, trajectory and performance, thermal system performance, and range safety.
Homeland Security provides independent validation and verification services to the United States Air Force and the National Reconnaissance Office in support of launches of expendable launch vehicles. The Company’s contribution to the success and reliability of these launches has earned two prestigious awards: the Defense Department’s David Packard Excellence in Acquisition Award, and the National Reconnaissance Office’s Gold Medal Award.
Homeland Security supports other intelligence agencies such as the National Security Agency by providing software development, systems integration, configuration management and network administration services. A substantial majority of the Company’s operating income, 72% in 2003, is derived from one contract within this group.
Systems Engineering Group. The Systems Engineering Group provides sophisticated professional services to NASA, the Defense Department and major aerospace contractors such as Lockheed Martin and Northrop Grumman. The Company provides engineering and information technology services to assist in the development of space systems and support operations of terrestrial assets. These systems include expendable launch vehicles, satellites, space-based experiments, and components and payloads associated with the International Space Station. The Company also supports Northrop Grumman in development of sophisticated airborne electronic sensors and systems.
On May 29, 2002, the Company announced that it had been awarded a $164 million Expendable Launch Vehicle Integrated Support (ELVIS) prime contract by NASA. The ELVIS contract was effective July 1, 2002 and has a nine-year and four-month period of performance if all option terms are exercised. Under the ELVIS contract, Analex will provide a broad range of expendable launch vehicle support services for NASA requirements at John F. Kennedy Space Center, Florida; Cape Canaveral Air Force Station, Florida; Vandenberg Air Force Base, California; and other locations. Under the contract, Analex is responsible for engineering services, performing safety and mission assurance functions, and providing communications, computing and telemetry support. In October 2003, Analex Corporation was named Small Business Prime Contractor of the Year by NASA’s Kennedy Space Center based on the Company’s outstanding performance on the ELVIS contract.
Under the ELVIS contract, the Company is the prime contractor with three subcontractors performing various functions. Approximately 27% of the contract is expected to be performed by the subcontractors. As the prime contractor, the Company is responsible for all aspects of work performed by the subcontractors including, but not limited to, quality of work, timeliness of performance, and cost control. The Company records all customer payments under this contract as revenues and all subcontractor invoices as contract costs. Approximately 30% of the Company’s revenues in 2003 are derived from the ELVIS contract.
The Systems Engineering Group provides a broad range of aerospace engineering services to support the programs of NASA Glenn Research Center in Cleveland, Ohio. These support services include development of next generation launch vehicles, engineering design and development of aerospace systems, engineering support for research and technology development, engineering support for operations of experimental systems, and project management support.
Under the Company’s Microgravity Research Development and Operations Contract with Northrop Grumman, Systems Engineering also supports NASA Glenn Research Center in development of an automated laboratory environment to be installed aboard the International Space Station to enable research in the performance of fluids and combustion in the near-zero gravity of space. The Company participates in the design,
development, manufacturing, test and delivery of the fluids and combustion facility and associated subsystems. The contract ends in November 2007, however, upon our completion of contract-defined deliverables, our effort on this contract will end. At this time, we anticipate completion in the latter part of 2004.
Advanced Biosystems Segment
The Company’s role in bio-defense began in 1999 when it established its Advanced Biosystems (ABS) subsidiary. Since then, an elite group of biologists, immunologists and other researchers have conducted research to develop effective medical defenses and treatments for anthrax, smallpox and other biological warfare agents. Some of these researchers are also on the faculty of George Mason University and also provide research services to that University’s National Center for Biodefense.
ABS scientists have advised Congress, members of the Bush administration, Department of Defense officials and senior members of the medical community on strategies for bio-defense. ABS also provides training on biological warfare agents, their effects, and defensive strategies to improve preparedness. ABS has been awarded almost $12 million in contracts with the Defense Advanced Research Projects Agency (“DARPA”). ABS has filed patent applications with respect to novel scientific and research insights into pathogenic processes and the effects of experimental agents in interrupting toxic pathways, but none of these patent applications have yet been reviewed by the Patent and Trademark Office.
Parties such as ABS that are interested in performing federally-funded research apply for available research grants and are selected on the basis of expertise, past research activity and research plans. The grants mandate that contract researchers submit regular reports on the progress of their research. Award grantees submit invoices and are paid on a regular basis, usually monthly, for their actual costs incurred in performing research, up to the total amount of the grant. As with any government contract, these research grants are terminable at the convenience of the government at any time. Moreover, it is possible that Congress or the government agencies that administer government research programs will decide to scale back programs or terminate them. In certain cases with respect to on-going programs of research, there are opportunities to receive additional grants upon the achievement of stated research objectives.
Under the Defense Federal Acquisition Regulations and the Federal Acquisition Regulation, ABS owns any intellectual property developed under its DARPA and NIH contracts, respectively, subject to a non-exclusive, royalty free license to the U.S. Government. Although ABS has not yet developed technologies or products that would be subject to federal regulations, any technologies or products which ABS may develop may be subject to the regulatory processes of the Federal Drug Administration or other governmental agencies.
Government Procurement and Significant Customers
TheOur principal customer for the Company’s services is the U.S. government. The Company’s sales to the U.S. government and its prime contractors represented approximately 98% of total net sales during the Company’s twelve months ended December 31, 2003, 2002, 2001 and are expected to continue to account for a substantial portion of the Company’s revenues for the foreseeable future.
TheOur principal U.S. government customer is the Department of Defense (“DoD”), which, directly or through its prime contractors, accounted forrepresented approximately 44%69%, 52%55%, and 64%42%, of our revenue for the Company’s revenues in the twelve monthsyears ended December 31, 2005, 2004, and 2003, 2002,respectively. The National Aeronautical and 2001, respectively. With the acquisition of the former Analex Corporation in November 2001, NASA becameSpace Administration (“NASA”) is also a significant customer, generating 53%30%, 44%, and 45% of revenues for the twelve months ended December 31, 2003 and 2002. Approximately 30%57% of our revenue for fiscal year 2003 came from one prime contract with NASA, which has a potential nine-year and four-month contract term if all options are exercised. In addition, the Homeland Security Group’s contract with one Department of Defense customer generated 17% of the Company’s revenues and 72% of the Company’s operating income for the twelve monthsyears ended December 31, 2003.
During2005, 2004 and 2003, the Company derived revenues from subcontracts with Northrop Grumman and QSS Group, Inc., which in the aggregate comprised 18% and 15%, respectively, of the Company’s total revenues for the year. Approximately 57% of the Company’s revenues were generated as a prime contractor to the federal government and approximately 43% of the Company’s revenues were generated as a subcontractor to a prime contractor to the federal government during the year ended December 31, 2003.respectively.
The Company’sOur contracts with the U.S. government are subject to the availability of funds through annual appropriations, may be terminated by the government for its convenience at any time, and generally do not require the purchase of a fixed quantity of services or products. Reductions in U.S. government defense or other spending could adversely affect the Company’sour operating results. While the Company is not aware of present or anticipated reductions in U.S. government spending on specific programs or contracts, there can be no assurance that such reductions will not occur or that decreases in U.S. government defense spending in general will not have an adverse effect on the Company’s revenues in the future. Contracts with the U.S. government are subject to audit by the Defense Contract Audit Agency.Agency (“DCAA”).
GOVERNMENT CONTRACTING INDUSTRY BACKGROUND
The Companypreponderance of our technology and professional services business with the DoD and NASA is obtained through competitive procurement and follow-on services related to existing business. In certain instances, however, we are awarded contracts because of our technical expertise, special professional competency or proprietary knowledge in specific subject areas.
There are currently three widely used contract methods in federal procurement, single award/defined statement of work contracts, indefinite delivery/indefinite quantity (“ID/IQ”) contracts and General Services Administration (“GSA”) schedule contracts:
Single award/defined statement of work contracts. Under this contract method, which can take a year or more to complete, an agency solicits, qualifies, and then requests proposals from interested contractors. The agency then evaluates the bids and typically awards the contract to a single contractor for a specified service. Historically, single award/defined statement of work contracts were the most prevalent type of contract award used by federal government clients; however, the use of this type of contract is known to have been declining for the past several years.
Indefinite delivery/indefinite quantity (“ID/IQ”) contracts. Under this contract method, a federal government agency can form preferred provider relationships with one or more contractors. These umbrella contracts outline the basic terms and conditions under which federal government agencies may order services. ID/IQ contracts are typically managed by one agency, the sponsoring agency, and may be either for the use of a specific agency or available for use by any agency of the federal government. Contractors within the industry compete to be pre-selected to perform work under an ID/IQ contract. An ordering agency then issues delivery orders for services to be performed under the contract. If the ID/IQ contract has a single prime contractor, only that contractor may be awarded delivery orders. If the contract has multiple
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prime contractors, the award of the delivery order typically will be competitively determined among the pre-selected contractors.
GSA schedule contracts. GSA schedule contracts are listings of services and products, along with their respective prices, offered by federal government contractors. The GSA maintains the schedules for use by any federal agency or other authorized entity, including state and local governments. In order for a contractor to enter into a contract with the GSA and be listed on a GSA schedule, the contractor must be pre-qualified and selected by the GSA. When an agency selects services under a GSA schedule contract, the user agency, or the GSA on its behalf, will typically conduct a competitive process, limited to qualified GSA schedule contractors.
Due to the lower contract procurement costs, reduced procurement time, and increased flexibility associated with ID/IQ contracts and GSA schedule contracts, these vehicles have been utilized more frequently in the last several years.
KEY FACTORS DRIVING INDUSTRY GROWTH
There are several key factors which we believe will continue to drive the growth in the U.S. federal technology services market and our business in particular:
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OUR APPROACH
We provide the following professional services for our federal government clients.
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 and 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 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 these services through one reportable segment consisting of two strategic business units, the Homeland Security Group and the Systems Engineering Group.
Homeland Security Group (“HSG”)
Our HSG provides various information technology solutions and services to our customers in the military and intelligence communities. Specific information technology solutions and services we provide include:
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We provide various aerospace engineering services to our military and intelligence community customers including independent validation and verification services to both the United States Air Force (“USAF”) and the National Reconnaissance Office (“NRO”) in support of launches of expendable launch vehicles.
We provide security and intelligence services to the Missile Defense Agency (“MDA”) including an effective partnership with the Ballistic Missile Defense System (“BMDS”) program. Specific services include security to protect the enterprise; serving as the foreign disclosure authority for the MDA to manage international security operations; responsibility for the management and execution of counterintelligence programs; operation security services in support of BMDS worldwide; managing the MDA Sensitive Compartmented Information (“SCI”) security operations and all internal security programs; and operating and maintaining the Security Operations Center/Access Control Center. In support of the U.S. Army, we established and operate the Army Research and Technology Protection Center (“ARTPC”) under the Deputy Chief of Staff for Intelligence as the single Army focal point for the integration of technology and acquisition program protection.
Systems Engineering Group (“SEG”)
Our SEG provides information technology and aerospace engineering services to various NASA programs. We provide engineering and information technology services to assist in the development of space launch systems and support operations of terrestrial assets. We also assist in the launch of expendable launch vehicles and satellites, and assist in the design and construction of space-based experiments, components and payloads associated with the International Space Station.
Our Expendable Launch Vehicle Integrated Support (“ELVIS”) contract with NASA was effective July 1, 2002 and has a nine-year and four-month period of performance if all option terms are exercised. In October 2005, NASA’s Kennedy Space Center exercised the first of two possible contract options. The performance period for this $65 million option is from October 1, 2005 through September 30, 2008. During this three-year option, we will provide ground services and flight technical support in the areas of engineering; safety and mission assurance; facilities; payloads; launch vehicle/payload integration; launch operations; systems management and business services. We will continue to provide these services for NASA at the John F. Kennedy Space Center and Cape Canaveral Air Force Station, Florida, and also at the Vandenberg Air Force Base, California. In 2005, the ELVIS contract generated $28.0 million in revenue, or 20% of our total revenue for the year. In February 2006, we were awarded an additional $32.7 million in new tasks under our ELVIS contract.
We also provide information technology and aeronautical engineering services supporting the programs of the NASA Glenn Research Center in Cleveland, Ohio under the Glenn Engineering and Scientific Services (“GESS”) subcontract with QSS Corporation. These support services include development of next generation launch vehicles, engineering design and development of aerospace systems, engineering support to research and technology development, engineering support to operations of experimental systems, and project management support. In 2005, the GESS contract generated $11.5 million in revenue, or 8.2% of our total revenue for the year. The contract is scheduled to end in April 2006. We are currently a subcontractor to a small-business prime contractor on this contract that will not qualify as a small business for the recompetition. We plan to participate in a follow-on recompetition with another small-business prime contractor for the follow-on recompetition of the contract in 2006.
Under our Microgravity Research Development and Operations Contract (“MRDOC”) subcontract with Zin Technologies, we support the NASA Glenn Research Center in development of an automated laboratory environment to be installed aboard the International Space Station to enable research in the performance of fluids and combustion in the near-zero gravity of space. We participate in the design, development, manufacturing, test and delivery of the fluids and combustion facility and associated subsystems. Following a contract modification received in February 2006, the MRDOC contract is scheduled to continue at a modest level through November 2006. However, activity under this contract has been declining for the past two years since funding for additional
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experimentation facilities for the International Space Station has not been forthcoming. In 2005, the MRDOC contract generated $2.2 million in revenue, or 1.6% of our total revenue for the year.
CORE STRENGTHS
Our core strengths include our management team and the technical expertise and capabilities of our professional staff, our past proven track record, our knowledge of the government contracting industry and processes, and our work as a prime contractor.
Management Team
Our senior executive management team has a diversified background with experiences and has taken leadership positions, in the U.S. defense, space and intelligence communities and with larger federal government contractors. This team also has significant experience acquiring companies and successfully integrating companies after they have been acquired.
Technical Expertise of Professional Staff
We have approximately 1,100 professional staff, approximately 800 of whom are cleared. Many of our skilled engineers hold advanced degrees and have background in and experiences with the defense and intelligence communities. Our employees include individuals who are members of the board of directors of the American Institute of Aeronautics and Astronautics, the Institute of Validation Technology and the Colorado Space Business Roundtable, among other professional and business organizations. Our employees also write for peer-reviewed journals and give national presentations on engineering methodologies and management techniques. In addition, we are a member of the Institute of Electrical and Electronics Engineers, the American Management Association, the Regulatory Affairs Professionals Society and the Colorado Medical Device Association, among others.
Past proven track record
We have received numerous awards and recognition including our being named a “Deloitte Virginia Fast 50 Company” in 2005 and 2004 and winning the NASA Kennedy Space Center’s “Prime Contractor of the Year” award in 2003 and “Small Business Contractor of the Year” award in 2005. In addition, since 1995 we have been the recipients of nine different industry and customer awards for excellence in the areas of customer service and project performance.
Knowledge of government contract processes
We have been a contractor or subcontractor with the Department of DefenseDoD continuously since 1973 with periodic renewals. During this time, neither the Company nor its subsidiaries1973. While we have not experienced any material adjustment of profits under its contracts. However,our contracts since current management has been involved with the Company, no assurance can be given that the Department of DefenseDoD or other customers will not seek and obtain an adjustment of profits in the future. All U.S. government contracts contain clauses that allow for the termination of contracts at the convenience of the U.S. government.
Our executives and employees have backgrounds within the U.S. military, various federal government agencies and government contractors. These experiences help us understand the government contracting industry and the requirements to successfully compete and operate.
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Work as prime contractor
Approximately 73% of our revenue was generated as a prime contractor to the federal government and approximately 27% of our revenue was generated as a subcontractor to a prime contractor to the federal government during the year ended December 31, 2005. We intend 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 preponderancefollowing table shows our revenue as a prime contractor and as a subcontractor as a percentage of our total revenue for the following years ended December 31,:
2005 | 2004 | 2003 | |||||||
Prime contract revenue | 73 | % | 68 | % | 57 | % | |||
Subcontract revenue | 27 | % | 32 | % | 43 | % | |||
Total revenue | 100 | % | 100 | % | 100 | % | |||
OUR GROWTH STRATEGY
The two components of our strategy for growth are organic new business development and completing strategically targeted acquisitions.
Organic New Business Development
Leverage Our Longstanding Client Relationships to Cross-Sell Our Broad Range of Services
We plan to continue expanding the volume and scope of the Company’s technicalservices we provide to our existing clients. We believe our high level of client satisfaction and deep knowledge of our clients’ business processes enhance our ability to cross-sell our broad range of professional services businessincluding, but not limited to, information technology, engineering and integration, advanced scientific research, systems and mission assurance, program acquisition and advisory services, and program and personnel security management.
Expand Our Client Base
We believe that the federal government’s increasing reliance on outsourcing and the increased emphasis on national security and homeland security have increased our market opportunity. We have a longstanding heritage of supporting the federal government in the areas of information technology, systems engineering, security and program management support. We intend to leverage this broad experience to expand our client base to include organizations within the federal government for which we have not historically worked. In addition, we intend to continue strategic hiring to expand the breadth of our expertise into new areas of the federal government or new technologies.
Pursue Strategic Acquisitions
Our industry remains fragmented and we believe industry consolidation will continue. We will continue to selectively review acquisition candidates with the Department of Defensecomplementary skills and other governmental agencies is obtained through competitive procurementmarket focus to enhance our internal growth and through follow-on services relatedstrategically position ourselves to existing business. In certain instances, however, the Company acquires such service contracts because of special professional competency or proprietary knowledge in specific subjectcapitalize on anticipated high growth areas.
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Government ContractsEXISTING CONTRACT PROFILES
DirectAs of December 31, 2005, we had more than 200 active contract engagements, each employing one of three types of price structures: cost-plus-fee, time and indirect contracts with government defensematerial, and intelligence agencies comprise the majorityfixed-price. The following table summarizes our revenue from each type of the Company’s business base. During 2003, 51%contract as a percentage of the Company’s contracts were cost-reimbursement, 33% were time-and-materials, and 16% were firm fixed-price. Followingour total revenue for each year ended December 31,
2005 | 2004 | 2003 | |||||||
Cost-plus-fee | 42 | % | 42 | % | 51 | % | |||
Time and material | 34 | % | 39 | % | 33 | % | |||
Fixed-price | 24 | % | 19 | % | 16 | % | |||
Total | 100 | % | 100 | % | 100 | % | |||
The following are briefsummary descriptions of theour various types of contracts the Company receives from the government.contract types:
Cost-reimbursementCost-plus-fee contracts. Cost-plus-fee 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 contractorwe may not exceed without the approval of the contracting officer. Cost-reimbursementCost-plus-fee 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-reimbursementCost-plus-fee 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. If our costs exceed the ceiling or are not allowable under the terms of the contract or applicable regulations, we may not be able to recover those costs. Approximately 47% of our current cost-plus-fee contracts contain ceilings on various categories of expenses. Therefore, if we incur expenses in excess of these ceilings, we will not be fully reimbursed by the government.
Time-and-materials (T&M)Time and material (“T&M”) contracts. T&M contracts provide for acquiring services on the basis of direct labor hours at specified fixed hourly rates. A T&M contractcontracts may also provide for acquiring materials, including, if appropriate, material handling costs. Profit margins on T&M contracts fluctuate based on the difference between negotiated billing rates and actual labor and overhead costs directly charged or allocated to such contracts. We assume the risk that a contract’s costs of performance may exceed the negotiated hourly rates.
Firm fixed-priceFixed-price contracts. Fixed-price contracts provide for delivery of products or services for a price that is negotiated in advance on the basis of the contractor’s cost experience. The price is not subject to any adjustment unless there is a change in the scope of work. Profit margins increase to the extent that costs are below the contracted amounts. If the costs exceed the estimates, profit margins decrease and a loss may be realized on the contract.
CLIENTS
Revenue derived from the U.S. government and its prime contractors represented approximately 99%, 100%, and 99% of our total revenue for the years ended December 31, 2005, 2004, 2003, respectively. The U.S. Government is expected to continue to account for substantially all of our revenue for the foreseeable future.
Our federal government clients typically exercise independent contracting authority, and even offices or divisions within an agency or department may directly, or through a prime contractor, use our services as a separate client so long as that client has independent decision-making and contracting authority within its organization. We consider each office or division within an agency or department, which directly or through a prime contractor, engages us, to be a separate client.
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Approximately 20% of our revenue for fiscal year 2005 came from one prime contract from NASA, which has a potential nine-year and four-month total contract term if all options are exercised. In addition, the Homeland Security Group’s contract with one Department of Defense customer generated 11% of the Company’s revenue and 44% of the Company’s operating income for the year ended December 31, 2005.
Contract BacklogBACKLOG
We define backlog to include funded and unfunded orders for services under existing signed contracts, assuming the exercise of all priced options relating to those contracts. We define funded backlog to be the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing authority, less the amount of revenue we have previously recognized.
The Company’sfollowing table summarizes our funded backlog, of orders, based on remainingour unfunded contract value, believedvalues and our total estimated backlog (in millions) for each year ended December 31,:
2005 | 2004 | 2003 | |||||||
Funded backlog | $ | 50.8 | $ | 57.0 | $ | 19.3 | |||
Unfunded contract value | 240.9 | 135.0 | 151.7 | ||||||
Total estimated backlog | $ | 291.7 | $ | 192.0 | $ | 171.0 | |||
We currently expect to be firm as of December 31, 2003 wasrecognize approximately $171$120.0 million of which approximately $170.4 million was attributable to the Analex segment and $0.6 million was attributable to the ABS segment. The portion of therevenue during 2006 from our total backlog expected to be realized within 2004 is $56 million. Funded backlog as of December 31, 2003 was approximately $19.3 million, of which approximately $0.6 million was attributable to the ABS segment. We expect to consume all of the funded backlog during 2004.2005. Included in the backlog approximationestimate are amounts from future years of government contracts under which the government has the right, but not the obligation, to exercise an option for the Companyus to perform services.
CompetitionCOMPETITION
In general, the industry in which the Company operateswe operate includes a large number of competitors of varying sizes. Competition within the information technology and government contracting arenas is intense. The Company maintainsWe maintain a primary commitment to itsour current direct and indirect government clients, while we are also intensifying itsour business development efforts to win additional government clients. The Company isWe are continuing efforts to diversify itsour defense and intelligence client base.base by offering a broad-range of services such as information technology, engineering and integration, advanced scientific research, systems and mission assurance, program acquisition and advisory services, and program and personnel security management.
The Analex segmentWe generally competescompete against federal systems integrators such as Booz Allen Hamilton, Lockheed Martin, Northrop Grumman, Anteon International Corporation, CACI International Inc., Computer Sciences Corporation, and Science Applications International Corporation, among others, including a varietynumber of small and medium sized, privately-held government contractors offering information technology and systems engineering services to the U.S. government. In addition, the Systems Engineering Group competeswe compete against large aerospace contractors such as Boeing and Lockheed Martin and other small and medium sized privately held firms in the provision of launch related services. Selection isContract awards are based primarily on a combination of the price of services and evaluation of technical capability, as well as past performance, quality of service and responsiveness to client requirements.
Within the Analex segment, the Company believes that the Homeland Security Group has a competitive advantage in its skilled engineers and customer relationships within the intelligence community and in its expertise and experience with independent verification and validation of space launch vehicles. However, larger government contractors can provide a breadth of professional offerings that the smaller Homeland Security Group may not be able to match. The Company also believes that the Systems Engineering Group has a competitive advantage in space launch support, especially in the expendable launch vehicle support segment, arising from the Company’s work on the ELVIS contract. Given the Company’s size, larger government contractors operating in this business area may be able to provide a breadth of service offerings beyond the Company’s capabilities.
The ABS segment’s main competition comes from individual research professionals and research groups at academic institutions seeking government funded research work. ABS competes for research grants on the basis of scientific expertise, past research activity and past performance under previous research grants. In the event that any technologies or products are developed based on ABS’ research, ABS will likely compete against a variety of large and small biotechnology and pharmaceutical businesses.
EmployeesEMPLOYEES
As of December 31, 2003, the Company (including its subsidiaries)2005, we employed approximately 5521,100 people including full time, part timefull-time, part-time and casual employees. Of the 5521,100 employees, 48 are members of unions, and we believe employee relations are believed by management to be generally good. In October 2002,On November 1, 2005, the Company entered into a three-yearrenewed its Collective Bargaining Agreement with the International Brotherhood of Teamsters now representing approximately 3738 employees on the NASA ELVIS contract at Vandenberg Air Force Base in California. In February 2003, the Company entered into a three-yearThe renewal extends this Collective Bargaining Agreement
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through November 1, 2009. In February 2006, we renewed our Collective Bargaining Agreement for three years with the International Brotherhood of Electrical Workers now representing approximately 1110 employees on the NASA ELVIS contract at the Kennedy Space Center in Florida.
General InformationGENERAL INFORMATION
Raw materials, patents, licenses, trademarks, franchises and concessions are not material to the operation of the Company’s businessour operations. We did not engage in significant internally sponsored research and the Company’s business is not seasonal. The Company derivesdevelopment. We typically experience lower staff utilization rates in our fiscal third and fourth quarters. These lower utilization rates are primarily attributable to our employees taking seasonal leave. We derive no revenuesrevenue from foreign operations.
Recent DevelopmentsRECENT DEVELOPMENTS
On March 4, 2003,April 1, 2005, we acquired ComGlobal Systems, Inc, 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 Analex began trading on the American Stock Exchange under the symbol “NLX”.and reported as a part of our Homeland Security Group.
On July 18, 2003, the Company entered into a Subordinated Note and Series A Convertible Preferred Stock Purchase Agreement (together with the First Amendment thereto dated September 30, 2003 and the Second Amendment thereto dated November 4, 2003, the “Pequot Purchase Agreement”) with Pequot Private Equity Fund III, L.P., a Delaware limited partnership, and Pequot Offshore Private Equity Partners III, L.P., a Cayman Islands limited partnership (“Pequot”). Details of the terms of the securities sold to Pequot pursuant to the Pequot Purchase Agreement are contained inItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Accounting treatment of these securities is discussed inItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.AVAILABLE INFORMATION
Available Information
The Company filesWe file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials the Company fileswe file with the SEC at the SEC’s Public Reference Room at 450 Fifth100 F Street, NW,NE, Room 1580, Washington, DC 20549. The public may also obtain information on the operation offrom the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC, including the Company. The Companyus. We also providesprovide a link to certain of itsour most recent filings with the SEC at the Company’sour Internet site at http://www.analex.com. The information contained on the Company’sour Internet site is not part of this Annual Report.
Item 2. Properties
The Company owns no real property. As of December 31, 2003, the Company leased a total of 68,373 square feet of office space at various locations in Virginia, Maryland, Colorado and Ohio. These leases expire between December 2004 and September 2006. (See Note 13 of the Notes to Consolidated Financial Statements.)
Item 3. Legal Proceedings
The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. in the Maryland Circuit Court for Prince George’s County alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. Management believes that the allegation is without merit and is vigorously contesting the complaint. Management believes and will assert that it validly exercised its contractual right to terminate the subcontract for Analex’s convenience and that termination of Swales occurred only after NASA was informed of Swales’ cost overruns and negotiations with Swales failed to yield an acceptable alternative. The Company will assert that Swales entered into the subcontract after it had hired incumbent ELVIS personnel at cost-prohibitive rates, knowing that its actual costs would greatly exceed the subcontract’s funding limitations. Under the complaint, Swales is seeking damages in excess of $4.0 million. Management believes that any liability that may ultimately result from the resolution of this matter will not have a material adverse effect on the financial position or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company held a Special Meeting of Stockholders on December 9, 2003.
(b) At the Special Meeting, the Company’s stockholders approved (i) the Pequot Transaction and (ii) amendments to the Company’s Certificate of Incorporation to increase the Company’s authorized capital stock from 35,000,000 shares, consisting of 30,000,000 shares of Common Stock and 5,000,000 shares of preferred stock, par value $0.02 per share (“Preferred Stock”), to 100,000,000 shares consisting of 65,000,000 shares of Common Stock and 35,000,000 shares of Preferred Stock.
The following votes were cast with respect to each of the matters voted on at the Special Meeting:
For | Against | Abstentions and Brokers Non-votes | ||||
The Pequot Transaction | 9,187,864 | 120,112 | 21,082 | |||
Amendment to Certificate of Incorporation | 9,156,644 | 151,038 | 21,376 |
PART II1A. Risk Factors
Item 5. Market for Registrant’s Common Equity,Risks Related Stockholder Matters and Issuer Purchases of Equity Securities
Prior to March 3, 2003, the Company’s common stock was traded over the counter (OTC) and quoted on the OTC Bulletin Board under the symbol “ANLX”. On March 4, 2003, the common stock was listed on the American Stock Exchange and began trading under the symbol “NLX”.
The range of high and low bid quotations for the Common Stock, as reported by the American Stock Exchange and the OTC Bulletin Board, for each quarterly period during 2003, 2002, and 2001 is shown below. The prices presented below reflect inter-dealer prices without retail mark-ups, mark-downs or commissions, and may not reflect actual transactions.
Year Ended December 31, 2003 | High | Low | ||||
First Quarter (1/1 to 3/31/03) | $ | 3.89 | $ | 2.10 | ||
Second Quarter (4/1 to 6/30/03) | 3.18 | 2.40 | ||||
Third Quarter (7/1 to 9/30/03) | 4.23 | 2.69 | ||||
Fourth Quarter (10/1 to 12/31/03) | 4.22 | 2.92 | ||||
Year Ended December 31, 2002 | ||||||
First Quarter (1/1 to 3/31/02) | 2.45 | 1.60 | ||||
Second Quarter (4/1 to 6/30/02) | 2.85 | 1.73 | ||||
Third Quarter (7/1 to 9/30/02) | 2.88 | 2.09 | ||||
Fourth Quarter (10/1 to 12/31/02) | 2.65 | 2.30 | ||||
Year Ended December 31, 2001 | ||||||
First Quarter (1/1 to 3/31/01) | 1.44 | 0.81 | ||||
Second Quarter (4/1 to 6/30/01) | 1.40 | 1.00 | ||||
Third Quarter (7/1 to 9/30/01) | 2.50 | 1.06 | ||||
Fourth Quarter (10/1 to 12/31/01) | 4.55 | 1.40 |
As of March 25, 2004, there were approximately 2,054 shareholders of record of the Company’s Common Stock. No cash dividends were paid to common shareholders during 2003 or during the past three fiscal years, and no dividends are expected to be declared during 2004 for common shareholders. The ability of the Company to pay dividends on its Common Stock requires the consent of Bank of America, N.A. under the Company’s credit agreement with Bank of America, and the consent of the holders of at least a majority of the outstanding shares of Series A Preferred Stock pursuant to the Certificate of Designations.
Pequot Transaction
Pursuant to the Pequot Purchase Agreement dated July 18, 2003, the Company agreed to:
In addition, on July 18, 2003, the Company entered into a Securities Repurchase Agreement (together with the First Amendment thereto dated September 30, 2003 and the Second Amendment thereto dated November 4, 2003, the “Stout Repurchase Agreement”) with Company’s former Chairman Jon M. Stout, certain members of Mr. Stout’s immediate family including former Company director Shawna Stout, and certain entities controlled by Mr. Stout and his family (collectively, the “Stout Parties”), pursuant to which the Company agreed to purchase an aggregate of 2,625,451 shares of Common Stock and warrants and options exercisable to purchase an aggregate of 1,209,088 shares of Common Stock from the Stout Parties for aggregate consideration of $9,166,844.
The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement were consummated simultaneously at closing (the “Closing”) which occurred on December 9, 2003. The Closing occurred immediately following the approval by the Company’s stockholders of the Pequot Transaction. Because the consummation of the transactions under each of the Pequot Purchase Agreement and the Stout Repurchase Agreement were conditioned upon each other, they constituted a single transaction to be voted upon by the stockholders. The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement are collectively referred to herein as the “Pequot Transaction.” The Series A Preferred Stock, the Convertible Notes and the related warrants sold and issued to Pequot in December 2003 are collectively referred to as the “Pequot Instruments”.
The proceeds from the sale of the Convertible Notes were used to repurchase the securities from the Stout Parties and pay expenses incurred by the Company in connection with the Pequot Transaction. Subsequent to year end, the Company used a portion of the proceeds from the sale of the Series A Preferred Stock to pay in full the outstanding promissory note issued to the Department of Justice under a Settlement Agreement between the former Analex Corporation and the Department of Justice. Remaining proceeds from the sale of the Series A Preferred Stock will be used to finance all or a portion of the cost of future acquisitions by the Company.
Discussed below is a summary of the key terms of the Pequot Instruments. Accounting treatment of these instruments is discussed in further detail inItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. A substantial portion of the face value of these instruments is allocated to the Company’s equity account on its balance sheet, subject to annual accretion over the next four years.To Our Business
Series A Preferred StockWe 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.
The Series A Preferred Stock bears a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event
of default under the Company’s senior credit facility, in additional shares of Series A Preferred Stock. Due to non-cash accounting accretion related to the Series A Preferred Stock, the annual charges taken on the Company’s statement of operations are expected to be substantially larger than the 6% dividend. Holders of Series A Preferred Stock are entitled to vote together with all other classes and series of voting stock of the Company on all actions to be taken by the stockholders of the Company. In addition, as long as 50% of the Series A Preferred Stock originally issued remains outstanding, the Company may not take numerous actions without obtaining the written consent of the holders of a majority of the Series A Preferred Stock.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series A Preferred Stock are entitled to receive, out of the Company’s assets available for shareholder distributions and prior to distributions to junior securities (including the Common Stock), an amount equal to the Series A Purchase Price plus any accrued but unpaid dividends thereon.
The Series A Preferred Stock is convertible into Common Stock at any time at the election of its holders, initially at a ratio of one share of Common Stock for every share of Series A Preferred Stock. The Series A Preferred Stock will automatically convert into Common Stock if, any time following 18 months after the Closing, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the conversion price then in effect ($2.23 as of December 31, 2003) for the Series A Preferred Stock. In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into Common Stock. The Series A Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.
Holders of the Series A Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of the Closing at the Series A Purchase Price, as adjusted for stock splits, stock dividends and similar events, plus accrued but unpaid dividends.
Convertible Notes
The Convertible Notes mature on December 9, 2007. The Convertible Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s senior credit facility, such interest will be accrued and added to the outstanding principal. Due to non-cash accretion related to the Convertible Notes, the annual charges taken on the Company’s statement of operations are expected to be substantially larger than the 7% interest charge.
Prior to the date which is 18 months after the Closing, the Convertible Notes may not be prepaid without the consent of the holders of a majority of the outstanding principal amount of the Convertible Notes. Any time following 18 months after the Closing, the Company, at its sole option, may prepay the Convertible Notes. Such prepayment will be made, at the option of the Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum or by conversion of the principal into shares of Series A Preferred Stock and the payment of interest in cash or in shares of Series A Preferred Stock. Holders of the Convertible Notes may convert the outstanding principal and accrued interest on the Notes into Series A Preferred Stock at any time. The conversion price for the Convertible Notes is 135% of the Series A Purchase Price, subject to adjustment for stock splits, stock dividends and similar events. The Company may cause the automatic conversion of the Convertible Notes into Common Stock if, any time following 18 months after the Closing, the average closing price for the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the Series A Purchase Price.
The Company’s obligations under the Convertible Notes are secured by a lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. Such obligations are subordinated to the rights of the Company’s present and future senior secured lenders.
Warrants
The Warrants are exercisable at any time before the tenth anniversary of the Closing. The Preferred Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Series A Preferred Stock. The Note Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Convertible Notes. The initial exercise price of the Warrants is $3.28 representing a 47% premium to the Series A Purchase Price.
Item 6. Selected Consolidated Financial Data
The following selected consolidated financial data as of December 31, 2003, 2002 and 2001, for the six months ended December 31, 2000 and 1999 and for the fiscal years ended June 30, 2000 and 1999 have been takenRevenue derived from the consolidated financial statements of the Company. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and the related notes thereto included elsewhere in this Report.
Year Ended 12/31/03 | Year Ended 12/31/02 | Year Ended 12/31/01 | Six Months Ended 12/31/00 | Unaudited Six Months Ended 12/31/99 | Fiscal Year 6/30/00 | Fiscal Year 6/30/99 | |||||||||||||||||||
(In thousands of dollars, except per share amounts) | |||||||||||||||||||||||||
Total Revenues(1) | $ | 66,126 | $ | 59,317 | $ | 21,936 | $ | 8,943 | $ | 10,267 | $ | 19,901 | $ | 20,333 | |||||||||||
Operating Income (Loss) | 3,587 | 3,524 | 432 | 190 | (481 | ) | (421 | ) | 63 | ||||||||||||||||
Interest Expense, net of Interest income | 520 | 1,018 | 217 | 112 | 167 | 324 | 78 | ||||||||||||||||||
Income (Loss) Before income taxes | 3,067 | 2,506 | 216 | 85 | (631 | ) | (724 | ) | 48 | ||||||||||||||||
Net Income (Loss) | 2,746 | 2,357 | 196 | 85 | (631 | ) | (745 | ) | 34 | ||||||||||||||||
Dividends and Accretion of Convertible Preferred Stock | 293 | — | — | — | — | — | — | ||||||||||||||||||
Net Income Available to Common Shareholders | 2,453 | 2,357 | 196 | 85 | (631 | ) | (745 | ) | 34 | ||||||||||||||||
Income (Loss) per share(1) | |||||||||||||||||||||||||
Basic | 0.16 | 0.16 | 0.03 | .01 | (.24 | ) | (.23 | ) | .02 | ||||||||||||||||
Diluted | 0.14 | 0.14 | 0.02 | .01 | (.24 | ) | (.23 | ) | .01 | ||||||||||||||||
At Period End: | |||||||||||||||||||||||||
Total Assets | 43,632 | 30,784 | 25,625 | 5,784 | 6,127 | 5,951 | 6,690 | ||||||||||||||||||
Long-term Liabilities | 5,476 | 4,430 | 5,064 | 412 | 1,040 | 702 | 2,160 | ||||||||||||||||||
Working Capital (Deficit) | 17,103 | 676 | (702 | ) | 266 | (1,454 | ) | (13 | ) | (67 | ) | ||||||||||||||
Shareholders’ Equity (Deficit) | 29,729 | 13,902 | 11,175 | 2,002 | (80 | ) | 1,535 | 456 |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the “Selected Consolidated Financial Data”, and the consolidated financial statements and related notes included elsewhere in this Form 10-K.
Overview
Analex specializes in developing intelligence, system engineering and bio-defense services in support of our nation’s security. All of our sales are generated using written contractual arrangements. The contracts require us to deliver technical services to the intelligence community, analyze and support defense systems, design, develop and test aerospace systems according to the specifications provided by our customers. In the case of ABS, the contracts require us to develop medial defenses and treatments for infectious agents such as anthrax and smallpox used in biological warfare and terrorism.
Sales to U.S. federal government agencies and their prime contractors represented approximately 98%99%, 100% and 99% of our total revenues duringrevenue for the twelve monthsfiscal years ended December 31, 2005, 2004 and 2003, and 2002.respectively. The Department of Defense, our principal U.S. government customer, accounted for approximately 44%69%, 55% and 52%42% of our revenues inrevenue for the twelve monthsfiscal years ended December 31, 2005, 2004 and 2003, respectively. NASA generated 30%, 44% and 2002, respectively. With the acquisition of the former Analex Corporation in November 2001, NASA became our largest customer, generating 53% and 45%57% of our revenuesrevenue for the twelve monthsfiscal years ended December 31, 20032005, 2004 and 2002,2003, respectively. Approximately 17% of our revenues20%, 28% and 72% of our operating income for fiscal year 2003 came from one prime contract with an agency within the Department of Defense. Approximately 30% of our revenuesrevenue for the fiscal yearyears ended December 31, 2005, 2004 and 2003, respectively, came from one prime contract with NASA, which has a potential nine-yearwill 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 contract with one Department of Defense customer generated 11%, 16% and four-month contract term if all options are exercised.17% of our revenue for the fiscal years ended December 31, 2005, 2004 and 2003, respectively, and 44%, 62% and 72% of our operating income for the fiscal years ended December 31, 2005, 2004 and 2003, respectively. We expect that federal government contracts will continue to be the source of substantially all of our revenuesrevenue for the foreseeable future.
In fiscal year 2003, a majority of our revenues If we were generated as a prime contractor tosuspended or debarred from contracting with the federal government. We intend to focus on retaining and increasing the percentage of our business as prime contractor because it provides us with stronger client relationships.The following table shows our revenues as prime contractor and as subcontractor as a percentage of our total revenues for the following periods:
Fiscal Year | |||||||||
2003 | 2002 | 2001 | |||||||
Prime contract revenues | 57 | % | 44 | % | 43 | % | |||
Subcontract revenues | 43 | % | 56 | % | 57 | % | |||
Total revenues | 100 | % | 100 | % | 100 | % | |||
We have two reportable segments: (1) Analex, which is engaged in professional services related to information technology and systems engineering for the U.S. government primarily NASA andgenerally, 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
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the amount of business it does with us, our business, operating results, financial condition and (2) Advanced Biosystems (ABS),business prospects could be materially adversely affected.
Changes in the spending priorities of the federal government can materially adversely affect our business.
Our business depends upon continued federal government expenditures on defense, intelligence, aerospace and other programs that we support. Our contracts with the U.S. government are subject to the availability of funds through annual appropriations. These contracts may be terminated by the government for its convenience at any time, and generally do not require the purchase of a fixed quantity of services or products. Reductions in the U.S. government defense, intelligence or aerospace spending could adversely affect our operating results. Any reductions in the U.S. government spending on specific defense, intelligence, or aerospace-related programs or contracts can have a material adverse effect on our business and revenue in the future. A significant change in the spending priorities of the federal government could cause it and its many agencies to reduce their purchases under contracts, to exercise their right to terminate contracts at any time without penalty, or not to exercise options to renew contracts. Any such actions could cause our actual results to differ materially in an adverse manner from those anticipated. Among the factors that could adversely affect our business are:
The failure by Congress to approve budgets in a timely manner could cause the federal agencies we support to delay or reduce spending and that could cause us to lose revenue.
On an annual basis, Congress must approve budgets that govern spending by each of the federal agencies we support. In the past, when Congress was unable to agree on budget priorities, and was therefore unable to pass the annual budget on a timely basis, Congress has enacted a continuing resolution. A continuing resolution allows government agencies to operate at spending levels approved in the previous budget cycle. When government agencies must operate on the basis of a continuing resolution it may delay funding we expect to receive from clients for work we are already performing and will likely result in any new initiatives being delayed, and in some cases being cancelled.
The adoption of new procurement laws or regulations could reduce the amount of services that are outsourced by the federal government and could cause us to lose future revenue.
New legislation, procurement regulations, or union pressure could cause federal agencies to adopt restrictive procurement practices regarding the use of third party service providers. For example, the American Federation of Government Employees, the largest federal employee union, strongly endorses legislation that may restrict the procedure by which services are outsourced to government contractors. If such legislation were to be enacted, it would likely reduce the amount of services that could be outsourced by the federal government, which could materially reduce our future revenue.
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The Office of Management and Budget process for ensuring that government agencies would properly support capital planning initiatives, including information technology investments, could reduce or delay federal information technology spending and cause us to lose revenue.
The Office of Management and Budget, or OMB, supervises spending by federal agencies, including enforcement of the Government Performance Results Act. This Act requires, among other things, that federal agencies make an adequate business justification to support capital planning initiatives, including all information technology investments. The factors considered by OMB include, among others, whether the proposed information technology investment is engagedexpected to achieve an appropriate return on investment, whether related processes are contemporaneously reviewed, whether inter-operability with existing systems and the capacity for these systems to share data across government has been considered, and whether existing off-the-shelf products are being utilized to the extent possible. If our clients do not adequately justify proposed information technology investments to the OMB, the OMB may refuse funding for their new or continuing information technology investments, and we may lose revenue as a result.
The loss of a key executive could impair our relationships with government clients and disrupt the management of our business.
We believe that our success depends on the continued contributions of the members of our senior management. We rely on our senior management to generate business and execute programs successfully. In addition, the relationships and reputation that many members of our senior management team have established and maintain with government personnel contribute to our ability to maintain good client relations and to identify new business opportunities. Although we have stock and bonus incentives for senior management, we do not have any employment agreements providing for a specific term of employment with any member of our senior management (with the exception of Mr. Sterling E. Phillips, our Chief Executive Officer). The loss of any member of our senior management could impair our ability to identify new business opportunities, secure new contracts, maintain good client relations, and successfully manage our business.
We face intense competition from many competitors that have greater resources than we do, which could result in biomedical researchprice reductions, reduced profitability, and loss of market share.
We operate in highly competitive markets and generally encounter intense competition. If we are unable to successfully compete for medical defenses against toxic agents capablenew business or win recompetitions of being used as bioterrorist weapons,existing business, our revenue growth and operating margins may decline. Many of our competitors are larger and have greater financial, technical, marketing, and public relations resources, larger client bases, and greater brand or name recognition than we do. Larger competitors include federal systems integrators such as anthraxSRA International, CACI International Inc., ManTech Corporation, Computer Sciences Corporation and smallpox. The Analex segment consistsScience Applications International Corporation, divisions of two business groups: the Homeland Security Group and the Systems Engineering Group. The Homeland Security Group provides information technology services, systems integration, hardware and software engineering and independent quality assurance in support of the U.S. intelligence community and Department of Defense. The Systems Engineering Group provides engineering, information technology and program management support to NASA, the Department of Defense, and major aerospacelarge defense contractors such as General Dynamics Corporation, Lockheed Martin Corporation, and Northrop Grumman. The following table showsGrumman Corporation, and consulting firms such as Booz Allen Hamilton. Our larger competitors may be able to compete more effectively for very large-scale government contracts. Our larger competitors also may be able to provide clients with different or greater capabilities or benefits than we can provide in areas such as technical qualifications, past performance on large-scale contracts, geographic presence, the ability to provide a broader range of services without creating conflicts of interest or intra-organizational conflicts of interest, price, and the availability of key professional personnel. Our competitors also have established or may establish relationships among themselves or with third parties, including through joint ventures, teaming arrangements or mergers and acquisitions, to increase their ability to address client needs. Accordingly, it is possible that new competitors or alliances among competitors may continue to emerge.
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We may not receive the full amount authorized under contracts and we may not accurately estimate our revenues from each of these segments as a percentagebacklog.
Although some of our total revenuesfederal government contracts require performance over a number of years, Congress appropriates funds for these contracts for only one year at a time. As a result, our contracts typically are only partially funded at any point during their term, and all or some of the past three years:work intended to be performed under the contracts will remain unfunded pending subsequent Congressional appropriations and the obligation of additional funds to the contract by the procuring agency. Nonetheless, in calculating the amount of our backlog, we include amounts from future years of government contracts under which the government has the right, but not the obligation, to exercise an option for us to perform services. Our backlog of orders, based on remaining contract value, believed to be firm as of December 31, 2005 was approximately $291.7 million. However, because we may not receive the full amount we expect under a contract, our estimate of our backlog may be inaccurate and we may post results that differ materially in an adverse manner from those anticipated.
Percent of Revenues by SegmentWe derive significant revenue from contracts awarded through a competitive bidding process, which can impose substantial costs upon us, and we will fail to maintain our current and projected revenue if we fail to compete effectively.
2003 | 2002 | 2001 | |||||||
Analex Segment | |||||||||
Homeland Security Group | 41 | % | 42 | % | 57 | % | |||
Systems Engineering Group | 53 | % | 47 | % | 21 | % | |||
ABS Segment | 6 | % | 11 | % | 22 | % | |||
Total | 100 | % | 100 | % | 100 | % | |||
We derive significant revenue from federal government contracts that are awarded through a competitive bidding process. We expect that most of the government business we seek in the foreseeable future will be awarded through competitive bidding. Competitive bidding imposes substantial costs and presents a number of risks. Such risks include, but are not limited to
OurTo the extent we engage in competitive bidding and are unable to win particular contracts, we not only incur substantial costs in the bidding process that would negatively affect our operating results, but we may be precluded from operating in the market for services that are provided under those contracts for a number of years. Even if we win a particular contract through competitive bidding, our profit margins may be depressed as a result of the costs incurred through the bidding process.
We may lose money on some contracts if we underestimate the resources we need to perform under the contract.
We provide services to the federal government under three types of contracts: cost-plus-fees, time-and-materials,cost-plus-fee, time-and-material, and fixed price contracts.fixed-price. For the fiscal year ended December 31, 2005, 42% of our contracts were cost-plus-fee, 34% were time-and-material, and 24% were fixed-price. Each of these types of contracts, to differing degrees, involves the risk that we could underestimate our cost of fulfilling the contract. In the event that the
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assumptions we use to formulate our pricing for the work prove to be inaccurate, we may lose money on the contract, which would adversely affect our operating results.
Unfavorable government audit results could force us to adjust previously reported operating results and could subject us to a variety of penalties and sanctions.
The following table showsfederal government audits and reviews our revenues from eachperformance on contracts, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards. Like most government contractors, our contracts are audited and reviewed on a continual basis. An audit of these typesour work, including an audit of work performed by companies we may acquire or subcontractors we have engaged or may engage, could result in a substantial adjustment to our previously reported operating results. For example, any costs which were originally reimbursed could subsequently be disallowed. In this case, cash we have already collected may need to be refunded and operating margins may be reduced. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with U.S. federal government agencies. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us, whether or not true.
Failure to maintain strong relationships with other contractors could result in a decline in our revenue.
Approximately 27%, 32% and 43% of our revenue for the years ended December 31, 2005, 2004 and 2003, respectively, were generated as a subcontractor to various prime contractors to the federal government. Although we intend to focus on retaining and increasing the percentage of our total revenuesbusiness as prime contractor because it provides us with stronger client relationships, we may not succeed in doing so. If not, we will continue to depend on relationships with these and other contractors for a significant portion of our revenue in the past three years:foreseeable future. Our business, prospects, financial condition or operating results could be adversely affected if these and other contractors eliminate or reduce their subcontracts with us, either because they choose to establish relationships with our competitors or because they choose to directly offer services that compete with our business, or if the government terminates or reduces these other contractors’ programs or does not award them new contracts.
Fiscal Year | |||||||||
2003 | 2002 | 2001 | |||||||
Cost plus fees | 51 | % | 59 | % | 25 | % | |||
Time and materials | 33 | % | 34 | % | 75 | % | |||
Fixed price | 16 | % | 7 | % | 0 | % | |||
Total | 100 | % | 100 | % | 100 | % | |||
We must continue to recruit and retain qualified skilled employees.
Our objectiveAn integral part of our future success is to grow sales organically and through acquisitions. In order to assist in accomplishing this objective, we havedependent upon our continued to increase our sales, general and administrative expenditures so as to increase our efforts in new business development andability to provide employees who have advanced information technology and technical services skills and who have excellent customer relationships within the necessary infrastructuredefense, aerospace and intelligence communities. As described below, many of these employees are required by our federal government clients to support rapid growthhave security clearances of various levels issued by the appropriate agency. These employees are in great demand and are likely to remain a limited resource in the
14
foreseeable future. If we are unable to recruit and retain a sufficient number of these highly skilled employees, especially those requiring security clearances, our ability to maintain and grow our business could be adversely affected. In addition, some of our contracts contain provisions requiring us to commit to staff a program with certain personnel the customer considers key to our successful performance under the contract. In the event we are unable to provide these key personnel or acceptable substitutions, the client may terminate the contract, and we may not be able to recover its costs in the event the contract is terminated.
Our business is dependent upon obtaining and maintaining required security clearances.
Many of our federal government contracts require our employees to maintain various levels of security clearances, and we are required to maintain certain facility security clearances complying with federal agencies’ requirements. Obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold security clearances. If our employees are unable to obtain or retain security clearances or if our employees who hold security clearances leave us, the client whose work requires cleared employees could terminate the contract or decide not to renew it upon its expiration. In addition, we expect that many of the contracts on which we will bid will require us to demonstrate our ability to obtain facility security clearances and perform work with employees who hold specified types of security clearances. To the extent we are not able to obtain facility security clearances or engage employees with the required security clearances for a particular contract, we may not be able to bid on or win new contracts, or effectively re-bid on expiring contracts.
Employee or subcontractor misconduct, including security breaches, could result in the loss of clients and our suspension or disbarment from organic growthcontracting with the federal government.
We may not be able to prevent our employees or subcontractors from engaging in misconduct, fraud or other improper activities that could adversely affect our business and reputation. Misconduct could include the failure to comply with federal government procurement regulations, regulations regarding the protection of classified information and legislation regarding the pricing of labor and other costs in government contracts. Many of the systems we develop involve managing and protecting information involved in national security and other sensitive government functions. A security breach in one of these systems could prevent us from acquisitions.having access to such critically sensitive systems. The precautions we take to prevent and detect this activity may not be effective, and we could face unknown risks or losses. As a result of employee or subcontractor misconduct, we could face fines and penalties, loss of security clearance and suspension or debarment from contracting with the federal government, which could materially adversely affect our business, operating results and financial condition.
If our subcontractors fail to perform their contractual obligations, our performance as a prime contractor and our ability to obtain future business could be materially and adversely impacted and our actual results could differ materially in an adverse manner from those anticipated.
Our ABS segment, focusing on biodefense research, is dependentperformance of government contracts regularly involves the issuance of subcontracts to other companies upon continued fundingwhich we rely to perform all or a portion of its research efforts from various governmental agencies. New sources of funding for ABS have been identified, however, these new contracts are at a substantially decreased level of effort and shorter duration than our previous contracts. At this time,the work we are uncertainobligated to deliver to our clients. There is a risk that we may have disputes from time to time with our subcontractors, including disputes regarding the quality and timeliness of the work performed. A failure by one or more of our subcontractors to satisfactorily deliver on a timely basis the agreed-upon supplies and/or perform the agreed-upon services may materially and adversely impact our ability to continueperform our obligations as a prime contractor. A subcontractor’s performance deficiency could result in the government terminating our contract for default. A default termination could expose us to obtain funding sourcesliability for ABS. Management is exploring optionsexcess costs of re-procurement by the government and have a material adverse effect on our ability to compete for divestiture of ABS.future contracts and task orders. Such problems with subcontractors could materially adversely affect our business, operating results and financial condition.
In addition,15
Federal government contracts contain provisions giving government customers a variety of rights that are unfavorable to us, including the ability to terminate a contract at any time for convenience.
Federal government contracts contain provisions and are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts. These rights and remedies allow government clients, among other things, under certain conditions, to:
If a government customer terminates one of our keycontracts for convenience, we may recover only our incurred or committed costs, settlement expenses, and profit on work completed prior to the termination. If a federal government customer were to unexpectedly terminate, cancel, or decline to exercise an option to renew with respect to one or more of our significant contracts or suspend or debar us from doing business with government agencies, our revenue and operating results would be materially adversely affected.
We must comply with a variety of laws and regulations, and our failure to comply could cause our actual results to differ materially in an adverse manner from those anticipated.
We must observe laws and regulations relating to the formation, administration and performance of federal government contracts which affect how we do business with our clients and may impose added costs on our business. For example, the Federal Acquisition Regulation and the industrial security regulations of the Department of Defense and related laws include provisions that:
Our failure to comply with these or other laws and regulations could result in contract termination, loss of security clearances, suspension or debarment from contracting with the federal government, civil fines and damages and criminal prosecution and penalties, any of which could materially adversely affect our business, operating results and financial condition.
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We may have difficulty identifying and executing acquisitions on favorable terms; and if we undertake acquisitions, they could be expensive, increase our costs or liabilities, and disrupt our business.
One of our strategies following the Pequot Transaction in December 2003 is to pursue growth through acquisitions. We planhave completed a limited number of acquisitions in our history. We intend to selectively acquire companiesbusinesses that complement or expand our current capabilities. These businesses are especially in demand in the current market, and enhance our existingother prospective purchasers who have substantially greater resources than we do may offer to acquire such businesses andupon such economic terms that are currently reviewing potential targets.hard for us to match. We anticipatemay not be able to acquire candidates at prices that we will needconsider appropriate or to obtain additional financing through salefinance acquisitions on terms that are satisfactory to us. We may desire to use our common stock as consideration in acquisitions, and therefore any decline in the market price of equity and debt securitiesour common stock or any unwillingness of owners of businesses we wish to fundacquire to accept our acquisitions.
The Company’s backlog of orders, based on remaining contract value, believed to be firmcommon stock as of December 31, 2003 was approximately $171 million, of which approximately $170.4 million was attributable to the Analex segment and $0.6 million was attributable to ABS. The portionpart of the total backlog expected to be realized within 2004 is $56 million. Funded backlog as of December 31, 2003 was approximately $19.3 million, of which approximately $0.6 million was attributable to the ABS segment. We expect to consume all of the funded backlog during 2004. Included in the backlog approximation are amounts from future years of government contracts under which the government has the right to exercise an option for the Company to perform services.
All of our U.S. Government contracts are subject to audit and various cost controls, and include standard provisions for termination for the convenience of the U.S. Government. Multi-year U.S. Government contracts and related orders are subject to cancellation if funds for contract performance for any subsequent year become unavailable.
Critical Accounting Policies
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions. The Company’s significant accounting policies are described in Note 2 to the consolidated financial statements. The Company believes that the following critical accounting policies require significant management judgments, estimates and assumptions in the preparation of the consolidated financial statements.
Revenues
The Company’s contracts with the government are typically cost plus fee, time and materials, or fixed-price contracts. Revenues result from work performed on these contracts by the Company’s employees and from pass-through of costs for material and work performed by subcontractors. Revenues on cost-type contracts are recorded as contract-allowable costs are incurred and fees earned. Revenues for time and materials contracts are recorded on the basis of contract-allowable labor hours worked multiplied by the contract defined billing rates, plus the cost of materials used in performance on the contract. Profits on time and material contracts result from the difference between the cost of services performed and the contract defined billing rates for these services. Revenues on certain fixed-price service contracts are recorded each period based on a monthly amount for services provided. Revenues on other fixed-price contracts are recorded as costs are incurred, using the percentage-of-completion method of accounting. Profits on fixed-price contracts result from the difference between the incurred costs and the revenue earned. In the normal course of business, the Company may be party to claims and disputes resulting from modifications and change orders and other contract matters. Claims for additional contract compensation are recognized when realization is probable and estimable.
Long-Lived Assets
In assessing the recoverability of long-lived assets, including goodwill and other intangibles, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or the Company’s related assumptions change in the future, the Company may be required to record impairment charges not previously recorded for these assets.
Contingencies
From time to time, the Company is subject to proceedings, lawsuits and other claims related to labor and other matters. The Company is required to assess the likelihood of any adverse judgments or outcomes to these contingencies as well as potential ranges of probable losses and establish reserves accordingly. The amount of reserves required, if any, may change in future periods due to new developments in each matter or changes in approach to a matter such as a change in settlement strategy.
Results of Operations
Comparison of Year Ended December 31, 2003 to
the Year Ended December 31, 2002
Years Ended December 31, | ||||||||||||||
2003 | 2002 | |||||||||||||
Revenues | $ | 66,126,300 | 100 | % | $ | 59,317,000 | 100 | % | ||||||
Operating costs and expenses: | ||||||||||||||
Costs of revenues | 55,770,400 | 84.3 | 50,436,700 | 85.0 | ||||||||||
Selling, general and administrative | 6,318,000 | 9.6 | 5,048,700 | 8.5 | ||||||||||
Amortization of other intangible assets | 450,800 | .7 | 307,600 | .5 | ||||||||||
Total operating costs and expenses | 62,539,200 | 94.6 | 55,793,000 | 94.1 | ||||||||||
Operating income | 3,587,100 | 5.4 | 3,524,000 | 5.9 | ||||||||||
Interest expense | (519,800 | ) | .8 | (1,018,300 | ) | 1.7 | ||||||||
Income before income taxes | 3,067,300 | 4.6 | 2,505,700 | 4.2 | ||||||||||
Provision for income taxes | 320,900 | .5 | 149,100 | .3 | ||||||||||
Net income | 2,746,400 | 4.2 | 2,356,600 | 4.0 | ||||||||||
Dividends on convertible preferred stock | (56,700 | ) | .1 | — | — | |||||||||
Accretion of convertible preferred stock | (236,300 | ) | .4 | — | — | |||||||||
Net income available to common shareholders | $ | 2,453,400 | 3.7 | % | $ | 2,356,600 | 4.0 | % | ||||||
Revenues by Segment
2003 | 2002 | |||||
Analex Segment | ||||||
Homeland Security Group | $ | 27,006,600 | $ | 24,900,400 | ||
Systems Engineering Group | $ | 35,320,100 | $ | 27,613,600 | ||
ABS Segment | $ | 3,799,600 | $ | 6,803,000 | ||
Total | $ | 66,126,300 | $ | 59,317,000 | ||
Percentage Revenue Growth Year Over Year by Segment
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Revenues for the year ended December 31, 2003 were approximately $66.1 million, an 11.5% increase from the $59.3 million in revenues for the year ended December 31, 2002. Revenues for the Homeland Security Group grew by $2.1 million, or 8%, while revenues for the Systems Engineering Group grew by $7.7 million, or 28%. This growth was offset by a decline in revenues in ABS of $3.0 million, or 44%. The net revenues growth of approximately $6.8 million is primarily due to a full year of revenues generated within the Systems Engineering Group by the NASA ELVIS contract that began July 1, 2002, which amounted to an $11.2 million increase in revenues from 2002 to 2003. This increase was offset by a decline of $4.0 million in the Systems Engineering Group due to reduced efforts on the MRDOC contract. Revenues for the Homeland Security Group increased by $2.1 million, or 8%, due to growth in services provided to the intelligence community and related agencies. In addition, revenues at ABS declined by $3.0 million due to a reduction in research activity as contracts were
completed. New sources of funding for ABS have been identified, however, these new contracts are at a substantially decreased level of effort and shorter duration than our previous contracts. At this time, we are uncertain ofpurchase price could adversely affect our ability to continuecomplete acquisitions or require us to obtain funding sources for ABS. Ifuse more of our cash or incur additional financing to do so.
After an appropriate acquisition candidate has been identified, we may not be able to successfully negotiate the terms of the acquisition, finance the acquisition or, if the acquisition occurs, successfully integrate the acquired business into our existing business. Negotiations of potential acquisitions and the integration of acquired business operations could disrupt our business by diverting management attention away from day-to-day operations. Acquisitions of businesses or other material operations may require additional debt or equity financing, resulting in additional leverage or dilution of equity ownership. We may also not realize cost efficiencies or synergies that we anticipated when selecting our acquisition candidates. Acquisition candidates may have liabilities or adverse operating issues that we fail to discover through our due diligence investigation prior to the acquisition. Any costs, liabilities, or disruptions associated with any future acquisitions we may pursue could adversely affect our operating results. To the extent we are unable to obtain funding, the resultpursue our acquisition strategy, we will be a continued decrease in revenues and operating profit. Increases or decreases in revenue are predominantly attributablerequired to changes in the volume of services provided. As a government contractor, costs billedrely exclusively on internal growth to the government are prescribed by the Federal Acquisition Regulation and include recovery of allowable costs such as labor, fringe benefits, overhead and general and administrative expenses plus a reasonable fee.
Costs of revenue for the year ended December 31, 2003 were approximately $55.8 million, an increase of approximately 11% from the prior year. The increase is primarily due to the costs of revenue within the Systems Engineering Group associated with the ELVIS contract, which were approximately $19.2 million for 2003 compared to $8.8 million for 2002. This was offset by a decline in the costs of revenue of ABS of $2.5 million due to reduced research staff and a reduction of $3.7 million due to declining efforts on the MRDOC contract. Costs of revenue as a percentage of revenues declined from 2002 to 2003. For the year ended December 31, 2003, costs of revenues were approximately 84% and approximately 85% for the year ended December 31, 2002.
Selling, general and administrative expenses totaled approximately $6.3 million, or 9.6% of revenues, for the year ended December 31, 2003, compared with approximately $5.0 million, or 8.5% of revenues, for the year ended December 31, 2002. The $1.3 million, or 25%, increase is due to various factors including the addition of senior business development staff members and increased general and administrative expenses such as corporate insurance, legal fees, shareholder communications expenses, recruiting expenses, and board of director fees.expand our business.
Operating Income by Segment
2003 | 2002 | |||||||
Analex Segment | ||||||||
Homeland Security Group | $ | 3,115,400 | $ | 2,795,800 | ||||
Systems Engineering Group | 1,065,600 | 670,600 | ||||||
ABS Segment | (143,100 | ) | 365,200 | |||||
Amortization | (450,800 | ) | (307,600 | ) | ||||
Total Operating Income | $ | 3,587,100 | $ | 3,524,000 | ||||
Percentage of Operating Income by Segment
2003 | 2002 | |||||
Analex Segment | ||||||
Homeland Security Group | 87 | % | 79 | % | ||
Systems Engineering Group | 30 | % | 19 | % | ||
ABS Segment | (4 | )% | 10 | % | ||
Amortization | (13 | )% | (9 | )% | ||
Total | 100 | % | 100 | % | ||
Percentage Growth of Operating Income Year Over Year by Segment
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The Company had operating income of approximately $3.6 million for the year ended December 31, 2003, comparedWe may need to operating income of approximately $3.5 million for the year ended December 31, 2002. This $0.06 million increase is primarily attributableraise additional capital to operating income within the Systems Engineering Group generated by the ELVIS contract, which approximated a $0.9 million increase over the prior year offset by a decrease of $0.4 million in operating income generated by the MRDOC contract. The Homeland Security Group experienced increased operating income of $0.3 million,fund future acquisitions or 11%, duebe unable to growth in services provided to the intelligence community and related agencies. In addition, ABS experienced a decrease in operating income of $0.5 million for 2003 compared to 2002 due to declining revenues and a one-time charge to write down intangible assets related to patent development. Also contributing to decreased operating income was increased selling, general and administrative expenses as noted above.
The Company had interest expense of $0.5 million for the year ended December 31, 2003, compared to interest expense of $1.0 million for the year ended December 31, 2002. The decrease is primarily due to the removal of guarantee fees associated with the Bank of America Credit Agreement. In addition, during 2003, the Company began accounting for the accretion of non-cash interest charges on its Convertible Notes issued under the Pequot Transaction. This accretion charge amounted to approximately $120,500. On a full year basis, the accretion component of interest expense is expected to be $1.9 million, assuming that the Convertible Notes are not converted to common shares.
The Company had amortization expense of $0.5 million for the year ended December 31, 2003, compared to amortization expense of $0.3 million for the year ended December 31, 2002. The increase in amortization expense is due to the non-compete agreement entered into with Jon Stout, which was entered into under the Pequot Transaction, and amortization expense related to intangible assets established with the award of the ELVIS contract.
Income tax expense for the year ended December 31, 2003 was $0.3 million compared with $0.1 million in the prior year. The Company’s effective tax rate did not change significantly from 2002 to 2003. In both years, the Company’s provision for income taxes was limited to state taxes and alternative minimum tax as the Company has been able to utilize its net operating loss carryforwards to offset taxable income. The Company consumed all net operating loss carryforwards during 2003 and will experience an increase in income tax expense in 2004.
Net income amounted to $2.7 million, or 4% of revenues, an increase of $390,000, or 17%, over the $2.4 million net income last year.
Dividends accrued with respect to 2003 amounted to $56,700, with anraise such additional non-cash accretion charge of approximately $236,300. On a full year basis, the Company expects that cash dividends on the preferred stock will amount to $0.9 million and the non-cash accretion charge will amount to $3.8 million, assuming that the preferred stock is not converted to common shares. Net income available to common shareholders for 2003 amounted to $2.5 million after the dividends on and accretion of Series A Preferred Stock.
Results of Operations
Comparison of Year Ended December 31, 2002 to
the Year Ended December 31, 2001
2002 | 2001 | |||||||||||||
Revenues | $ | 59,317,000 | 100 | % | $ | 21,936,000 | 100 | % | ||||||
Operating costs and expenses: | ||||||||||||||
Costs of revenues | 50,436,700 | 85.0 | 18,157,800 | 82.8 | ||||||||||
Selling, general and administrative | 5,048,700 | 8.5 | 2,967,600 | 13.5 | ||||||||||
Amortization of other intangible assets | 307,600 | .5 | 378,400 | 1.7 | ||||||||||
Total operating costs and expenses | 55,793,000 | 94.1 | 21,503,800 | 98.0 | ||||||||||
Operating income | 3,524,000 | 5.9 | 432,200 | 2.0 | ||||||||||
Interest expense | (1,018,300 | ) | 1.7 | (216,600 | ) | 1.0 | ||||||||
Income before income taxes | 2,505,700 | 4.2 | 215,600 | .9 | ||||||||||
Provision for income taxes | 149,100 | .3 | 19,600 | .1 | ||||||||||
Net income | 2,356,600 | 4.0 | 196,000 | .9 | ||||||||||
Dividends on convertible preferred stock | — | — | — | — | ||||||||||
Accretion of convertible preferred stock | — | — | — | — | ||||||||||
Net income available to common shareholders | $ | 2,356,600 | 4.0 | % | $ | 196,000 | .9 | % | ||||||
Revenues by Segment
2002 | 2001 | |||||
Analex Segment | ||||||
Homeland Security Group | $ | 24,900,400 | $ | 12,516,400 | ||
Systems Engineering Group | $ | 27,613,600 | $ | 4,658,300 | ||
ABS Segment | $ | 6,803,000 | $ | 4,761,300 | ||
Total | $ | 59,317,000 | $ | 21,936,000 | ||
Percentage Revenue Growth Year Over Year by Segment
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Revenues for the year ended December 31, 2002 were approximately $59.3 million, a 170% increase from the $21.9 million in revenues for the year ended December 31, 2001. Revenues for the Homeland Security Group grew by $12.4 million, or 99%, while revenues for the Systems Engineering Group grew by $22.9 million, or 488%, and revenues for ABS grew by $2.1 million, a 43% increase. This increase is primarily due to revenues of approximately $27.0 million attributable to the business acquired from the former Analex Corporation in November 2001, coupled with revenues of approximately $9.0 million generated by the NASA ELVIS contract that began July 1, 2002. In addition, approximately $2.0 million of additional revenues were generated by ABS due to an increase in research under National Institutes of Health grants that were awarded in mid-2001 and early 2002. Increases or decreases in revenue are predominantly attributable to changes in the volume of services provided. As a government contractor, costs billed to the government are prescribed by the Federal Acquisition Regulation and include recovery of allowable costs such as labor, fringe benefits, overhead and general and administrative expenses plus a reasonable fee.
Costs of revenue for the year ended December 31, 2002 were approximately $50.4 million, an increase of approximately 180% from the prior year. The increase is primarily due to the costs of revenue from the business acquired from the former Analex Corporation, which were approximately $23.0 million, coupled with costs associated with the ELVIS contract, which were approximately $8.0 million. In addition, approximately $1.0 million of additional costs were attributable to the increased research efforts at ABS. Costs of revenue as a percentage of revenues were approximately 85% for the year ended December 31, 2002 and 83% for the year ended December 31, 2001.
Selling, general and administrative expenses totaled approximately $5.0 million, or 8.5% of revenues, for the year ended December 31, 2002, compared with approximately $3.0 million, or 13.5% of revenues, for the year ended December 31, 2001. The $2.0 million, or 70% increase is primarily due to the addition of the former Analex Corporation’s costs associated with additional corporate and management staff required by the increased size of the Company. In addition, 2002 included the bid and proposal costs associated with winning the ELVIS contract, which were approximately $0.2 million. However, the increase in the Company’s revenues reduced selling, general and administrative expenses as a percentage of revenues, allowing the Company to increase spending on such items as new business development while improving operating profit margins.
Operating Income by Segment
2002 | 2001 | |||||||
Analex Segment | ||||||||
Homeland Security Group | $ | 2,795,800 | $ | 279,800 | ||||
Systems Engineering Group | 670,600 | 344,600 | ||||||
ABS Segment | 365,200 | 186,200 | ||||||
Amortization | (307,600 | ) | (378,400 | ) | ||||
Total Operating Income | $ | 3,524,000 | $ | 432,200 | ||||
Percentage of Operating Income by Segment
2002 | 2001 | |||||
Analex Segment | �� | |||||
Homeland Security Group | 79 | % | 65 | % | ||
Systems Engineering Group | 20 | % | 80 | % | ||
ABS Segment | 10 | % | 43 | % | ||
Amortization | (9 | )% | (88 | )% | ||
Total | 100 | % | 100 | % | ||
Percentage Growth of Operating Income Year Over Year by Segment
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The Company had operating income of approximately $3.5 million for the year ended December 31, 2002, compared to operating income of approximately $0.4 million for the year ended December 31, 2001. This $3.1 million increase is primarily attributable to the profitability of the business acquired from the former Analex Corporation, which contributed approximately $2.0 million along with operating income generated by the ELVIS contract, which approximated $0.3 million. In addition, ABS operating income increased by approximately $0.2 million from 2001 to 2002, due to factors mentioned above.
The Company had interest expense of $1.0 million for the year ended December 31, 2002, compared to interest expense of $0.2 million for the year ended December 31, 2001. The increase is primarily due to $0.8 million of interest on debt related to the acquisition of Analex Corporation, partially offset by a reduction in interest rates.
The Company had amortization expense of $0.3 million for the year ended December 31, 2002, compared to amortization expense of $0.4 million for the year ended December 31, 2001. The decrease in amortization expense is due to the adoption of SFAS 142, which ceased amortization of the goodwill resulting from a 1999 acquisition, which was offset by a full year of amortization of certain intangible assets related to the acquisition of Analex Corporation.
Income tax expense for the year ended December 31, 2002 was $0.1 million compared with $0.02 million in the prior year. The Company’s effective tax rate did not change significantly from 2001 to 2002. In both years, the Company’s provision for income taxes was limited to state taxes and alternative minimum tax as the Company has been able to utilize its net operating loss carryforwards to offset taxable income.
Net income amounted to $2.4 million, or 4% of revenues, a $2.2 million increase, an eleven-fold increase, over the $.2 million net income in 2001.
Accounting Treatment of The Pequot Transactioncapita.
In July 2003, we entered into a stock purchase agreement with Pequot with respect to the sale of our Series A Preferred Stock, Convertible Notes, Preferred Warrants and Note Warrants to the Pequot funds (the “Pequot Purchase Agreement”). On December 9, 2003, pursuant to the Pequot Purchase Agreement, the Company (i) issued and sold to Pequot an aggregate of 6,726,457 shares of the Company’s Series A Preferred Stock, par value $0.02 per share, (the “Series A Preferred Stock”) for a purchase price of $2.23 per share (the “Series A Purchase Price”), representing an aggregate consideration of approximately $15,000,000; (ii) issued and sold to the Pequot $10,000,000 in aggregate principal amount of the Company’s Secured Subordinated Convertible Promissory Notes (the “Convertible Notes”), the initial conversion price of which is $3.01 (representing 135% of the Series A Purchase Price); and (iii) issued to Pequot Preferred Warrants and Note Warrants, the initial exercise price of which is $3.28 (representing a 47% premium to the Series A Purchase Price). The Series A Preferred Stock, the Convertible Notes and the related warrants are collectively referred to hereinafter as the “Pequot Instruments.”
Series A Preferred Stock
The Company determined the initial carrying value of the Series A Preferred Stock by a two-step allocation process: first to the Preferred Warrants; and second, to an embedded conversion option. First the Company allocated the proceeds from the sale of the Series A Preferred Stock between the Series A Preferred Stock and the Preferred Warrants based on their relative fair values, which resulted in recording a discount on the Series A Preferred Stock. The value of the Preferred Warrants was determined using the Black-Scholes option pricing model. The Preferred Warrants were valued using the exercise price of $3.28 pursuant to the Pequot Purchase Agreement, the stock price as of the date of the date of the Closing of $4.04, a risk free rate of 2.80%, a volatility of 94.80%, and an expected life of four years. The risk free rate was equal to the four-year U.S. Treasury rate, as the period to the earliest redemption date of the Series A Preferred Stock is four years from December 9, 2003 (the “Closing date”). The volatility was based on an average of three measurements: the actual volatility in the Company’s stock price over the four years prior to the Closing date; the actual volatility in the Company’s stock price from the date of the acquisition of the former Analex Corporation, November 3, 2001 to the Closing date; and the actual volatility in the Company’s stock price from the listing date on the American Stock Exchange, March 4, 2003, to the Closing date.
Second, in accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, after allocating the Series A Preferred Stock proceeds as described above, the Company calculated the embedded conversion price and used it to measure the intrinsic value of the embedded conversion option.
This value was determined by calculating the number of shares of common stock into which the Series A Preferred Stock is convertible. The value allocated to the Series A Preferred Stock (after value was allocated to the Preferred Warrants) was then divided by the number of shares of common stock into which the Series A Preferred Stock is convertible. The result, $1.66, was then compared to the current fair value of $4.04, the Company’s stock price as of the Closing date. Since the conversion price was less than the fair value as of the Closing date, a beneficial conversion feature exists. The difference between the conversion price and the fair value as of the Closing date was multiplied by the total number of shares of common stock into which the Series A Preferred Stock is convertible. The result was a beneficial conversion of approximately $11.1 million. The amount of the beneficial conversion was recorded as additional paid in capital, resulting in a further discount on the Series A Preferred Stock. The table below details the accounting treatment of the Series A Preferred Stock.
Allocation of Series A Preferred Stock Proceeds
Proceeds of Series A Preferred Stock | $ | 15,000,000 | |
Allocated relative fair value of preferred stock | $ | 11,142,400 | |
Allocated relative fair value of preferred warrants | $ | 3,857,600 | |
Balance Sheet presentation of Series A Preferred Stock at December 31, 2003 | |||
Allocated relative fair value of preferred stock | $ | 11,142,400 | |
Less: discount on preferred stock | $ | 10,519,800 | |
Less: issuance costs of preferred stock | $ | 622,600 | |
Net carrying value of preferred stock prior to accretion | $ | — | |
Accretion of preferred stock | $ | 236,300 | |
Net carrying value of preferred stock at December 31, 2003 | $ | 236,300 | |
The discount on the Series A Preferred Stock created as a result of the allocation of fair value to the Preferred Warrants and the beneficial conversion charge will be accreted to the Series A Preferred Stock over a four-year period to the earliest redemption date. Issuance costs of $622,600 are recorded as an additional discount and will be accreted to the Series A Preferred Stock over the four-year period to the earliest redemption date.
The Series A Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Therefore, the Company will accrue the dividends payable each quarter, which is $225,000. Both the accretion of and dividends on the Series A Preferred Stock will reduce net income attributable to common shareholders. As a result, in the absence of acquisitions that might add substantial incremental earnings, the net income to common shareholders for 2004 is likely to be a loss.
The annual cash dividend payable on the Series A Preferred Stock amounts to $900,000 and the annual non-cash accretion amounts to $3,750,000. The total expected annual charge related to the Series A Preferred Stock, thus, amounts to $4,650,000. For 2003, since the Series A Preferred Stock was only issued on December 9, 2003, the total charge amounted to $236,300.
If the holders of the Series A Preferred Stock were to convert their shares into common shares, there would be a one-time, non-cash charge to write-off the unamortized discount related to the Series A Preferred Stock. The unamortized discount is comprised of the amount allocated to the fair value of the Preferred Warrants, the discount on the preferred stock due to beneficial conversion and issuance costs, less any accretion and amortization taken. At December 31, 2003, that amount was $14,763,700.
Convertible Notes
The Company determined the initial carrying value of the Convertible Notes by a two-step allocation process: first to the Note Warrants; and, second, to an embedded conversion option.
First, the Company allocated the proceeds from the sale of the Convertible Notes between the Convertible Notes and the Note Warrants based on their relative fair values, which resulted in the recording of a discount on the Convertible Notes. The value of the Note Warrants was determined using the Black-Scholes option pricing model. The Note Warrants were valued using the exercise price of $3.28 as stated in the agreement, the stock price as of the date of the date of the Closing of $4.04, a risk free rate of 2.80%, a volatility of 94.80%, and an expected life of four years. The risk free rate was equal to the four-year U.S. Treasury rate, as the Convertible Notes mature in four years. The volatility was based on an average of three measurements: the actual volatility in the Company’s stock price over the four years prior to the Closing date; the actual volatility in the Company’s stock price from the date of the acquisition of the former Analex Corporation, November 3, 2001 to the Closing date; and the actual volatility in the Company’s stock price from the listing date on the American Stock Exchange, March 4, 2003, to the Closing date.
Second, after allocating the Convertible Notes proceeds, the Company calculated the embedded conversion price and used it to measure the intrinsic value of the embedded conversion option. This was determined by calculating the number of shares of common stock into which the Convertible Notes were convertible. The value allocated to the Convertible Notes (after value was allocated to the Warrants) was then divided by the number of shares of common stock into which the Convertible Debt is convertible. The result, $1.66, was then compared to the current fair value of $4.04, the Company’s stock price as of the Closing date. Since the conversion price was less than the current fair value, a beneficial conversion feature exists. The difference between the conversion price and the current fair value was multiplied by the total number of shares of common stock into which the Convertible Notes are convertible. The result was a beneficial conversion of approximately $5.3 million. The amount of the beneficial conversion was recorded as additional paid in capital, resulting in a further discount on the Convertible Notes. The table below details the accounting treatment of the Convertible Notes.
Allocation of Convertible Notes Proceeds | |||
Proceeds of the convertible notes | $ | 10,000,000 | |
Allocated relative fair value of convertible notes | $ | 8,094,700 | |
Allocated relative fair value of note warrants | $ | 1,905,300 | |
Balance Sheet presentation of Convertible Debt at December 31, 2003 | |||
Allocated relative fair value of convertible notes | $ | 8,094,700 | |
Less: discount on convertible notes | $ | 5,327,200 | |
Net carrying value of convertible notes prior to amortization and accretion | $ | 2,767,500 | |
Amortization of discount | $ | 113,900 | |
Net carrying value of convertible notes at December 31, 2003 | $ | 2,881,400 | |
The discount on the Convertible Notes created as a result of the allocation of fair value to the Note Warrants will be amortized to interest expense over the four-year period to the maturity of the Convertible Notes using the effective yield method. Issuance costs of $415,000 are recorded as deferred financings costs and will be amortized to interest expense over the four-year period to the maturity of the Convertible Notes.
The Convertible Notes accrue interest at 7% per annum, which is payable quarterly in cash.
The annual interest payable on the Convertible Notes amounts to $700,000 and the annual non-cash interest and accretion charges amount to $1,911,900. The total expected annual charge related to the Convertible Notes, thus, amounts to $2,611,900. For 2003, since the Convertible Notes were only issued on December 9, 2003, the total charge amounted to $113,900.
If the holders of the Convertible Notes were to convert the notes into common shares, there would be a one-time, non-cash charge to write-off the unamortized discount related to the Convertible Notes. The unamortized discount is comprised of the amount allocated to the fair value of the Note Warrants, the discount on the convertible notes due to beneficial conversion and issuance costs, less any accretion and amortization taken. At December 31, 2003, that amount was $7,527,100.
Stout Repurchase Agreement
The Stout Repurchase Agreement provided for the Stout Non-Competition Agreement between the Company and Jon Stout. The $600,000 consideration to be paid under the Stout Non-Competition Agreement was recognized as a liability as of the Closing date and will be paid quarterly over the three-year life of the agreement.
Also, included in the Stout Repurchase Agreement was the repurchase of certain warrants and stock options. The Company estimated the fair value of the warrants as of the Closing date using a fair value option pricing model and determined that the amount the Stout Parties are receiving to purchase warrants is less than the fair value as of the Closing date. Therefore, the Company did not incur any additional compensation expense related to the purchase of the warrants. However, as the Company also purchased certain stock options held by the Stout Parties, the Company incurred compensation expense as a result of the purchase of stock options from the Stout Parties of $95,800, which is equal to the amount paid to purchase the stock options.
Impact of Pequot Transaction on Shareholder’s Equity
The following table shows the changes in Shareholder’s Equity due to the Pequot Transaction.
Change to Additional Paid In Capital: | ||||
Issuance of preferred stock | 10,519,800 | |||
Issuance of convertible debt | 5,327,200 | |||
Stout Repurchase Agreement | (9,018,500 | ) | ||
Net change in Additional Paid In Capital | 6,828,500 | |||
Warrants: | ||||
Preferred Stock Warrants | 3,857,600 | |||
Convertible Debt Warrants | 1,905,300 | |||
Net change in Warrants | 5,762,900 | |||
Net change in Shareholder’s Equity due to Pequot Transaction | $ | 12,591,400 | ||
Capital Resources and Liquidity
The working capital at December 31, 2003 increased by approximately $16.4 million from December 31, 2002, primarily due to cash provided by the Pequot Transaction along with the Company’s continued profitability. Proceeds of the Pequot Transaction were $25 million, of which $9.4 million was used to fund the activities pursuant to the Stout Repurchase Agreement. The working capital at December 31, 2002 increased by approximately $1.4 million from December 31, 2001, primarily due to increased profitability generated by the Company’s purchase of the former Analex Corporation and the award of the ELVIS contract.
In the twelve months ended December 31, 2003, the Company recorded net income of $2.7 million and EBITDA (as defined below) of $4.1 million, after add-backs for interest of $0.5 million, taxes of $0.3 million, depreciation of $0.1 million and amortization of $0.5 million. In the twelve months ended December 31, 2002, the Company recorded net income of $2.4 million and EBITDA of $3.9 million, after add-backs for interest of $1.0 million, taxes of $0.1 million, depreciation of $0.1 million and amortization of $0.3 million.
While weWe expect that the proceeds from the Pequot Transaction, the borrowing availability under our credit facility, together with cash provided by operations, will be sufficient to fund our working capital needs for normal operations for at least the next twelve months,months. However, we anticipate that we will need to obtain additional financing either through sale of equity orand debt securities or from our credit facility to fund our acquisitions.
In We may seek additional funds by incurring additional indebtedness, issuing additional equity securities, or by other means. There is no assurance that additional financing could be obtained when we need it. If additional financing is raised through sale of our equity securities, there could be a significant dilutive effect on the absenceownership interests and voting rights of acquisitions, given the substantial charges associatedour existing stockholders and warrant and option holders. Currently, we have no agreements, arrangements or understandings with the Convertible Notes and the Series A Preferred Stock, it is possible that the Company mightrespect to acquisition of any entity or business. We may also need to renegotiate its covenants under its bank lineobtain additional financing over the next twelve months if our current plans or projections prove to be inaccurate or our expected cash flows prove to be insufficient to fund our operations because of credit during 2004 in order the remain in compliance with the terms of its credit facility. The Company’s expectation, however, is that acquisitions will be consummated and therefore, we do not consider it a material risk.
lower-than-expected revenues, unanticipated expenses or other unforeseen difficulties. Our ability to obtain additional financing will depend on a number of factors, including market conditions, our operating performance and investor interests.interest. These factors may make the timing, amount, terms and conditions of any financing unattractive. If additional financing is raised through sale of our common stock, it may result in significant dilution to our existing stockholders.
InOur substantial convertible preferred stock and debt could adversely affect our financial and operating flexibility.
On December 9, 2003, we sold to Pequot $10 million in aggregate principal amount of Series A Convertible Notes.Notes (“Series A Convertible Note”). The Series A Convertible Notes bear interest at an annual rate of 7%. They are secured by a lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. The Convertible Notes will mature on December 9, 2007. On December 9, 2003, we also issued for $15 million, 6,726,457 shares of Series A Convertible Preferred Stock (“Series A Preferred Stock”) and 1,345,291 Common Stock Warrants exercisable at $3.28 per share. The indebtedness incurred with respect toSeries A Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. In
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May 2004, we issued in aggregate principal amount of $12 million of convertible secured senior subordinated promissory notes (“Series B-1 Notes”) and 857,142 Common Stock Warrants exercisable at $4.32 per share. In September 2004, the Series B-1 Notes were converted into 3,428,571 shares of Series B Convertible NotesPreferred Stock (“Series B-1 Preferred Stock”). In April 2005, the Company issued for $25 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 exercisable at $4.29 per share. All Series B Convertible Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Our quarterly preferred stock dividend expense is material in relation to our ability to service the debt from our operating cash flow and our ability to repay the debt in full at maturity. Thereapproximately $800,000. No assurance can be no assurancegiven that sufficient funds will be available to meet our operating needs, or to repaypay the Convertible Notesdividends on the Series A Preferred Stock, the Series B Preferred Stock, or to redeem the Series A Convertible Note, the Series A Preferred Stock and the Series B Preferred Stock in accordance with their respective terms. In connection with the acquisition of ComGlobal, we amended our credit agreement with Bank of America. Our revolving credit facility with Bank of America was increased to $40 million. We drew down $22 million from the credit facility on April 1, 2005 in connection with our acquisition of ComGlobal. As of December 31, 2005, the Company had an outstanding balance under its credit facility with Bank of America of approximately $27.6 million. The balance outstanding on our revolving credit facility is serviced by our operating cash flows. This may affect our ability to repaymeet the Convertible Notes at maturity may also be adversely affected by the right of the holdersinterest and dividend obligations of the Series A Preferred Stock to contemporaneously require the Company to redeem their shares ofand Series A Preferred Stock.B instruments.
EBITDA consists of earnings before interest expense, interestOur debt instruments contain numerous financial and other income, income taxes, depreciation and amortization. EBITDA does not represent funds available for the Company’s discretionary use and is not intended to represent cash flow from operations. EBITDA should also not be construed as a substitute for operating income or a better measure of liquidity than cash flow from operating activities, which are determined in accordance with accounting principles generally accepted in the U.S. EBITDA excludes componentsoperational covenants that are significant in understanding and assessing the Company’s results of operations and cash flows. EBITDA is considered to be relevant and useful information, which is often reported and widely used by analysts, investors and other interested parties. Accordingly, the Company is disclosing this information to permit a more comprehensive analysis of the Company’s operating performance, as an additional meaningful measure of performance and liquidity, and to provide additional information with respect to the Company’s ability to meet future debt service, capital expenditure and working capital requirements.
Net cash provided by operating activities was $2.7 million during the twelve months ended December 31, 2003, compared to $1.3 million for the prior year. The increased net cash provided by operating activities resulted from a decreased accounts receivable balance due to a reduction in days outstanding, offset by a decrease in accounts payables due to the timing of certain trade payments. Net cash provided by operating activities was $1.3 million during the twelve months ended December 31, 2002, compared to a net use of cash from operating activities of $0.4 million for the prior year. The increased net cash provided by operating activities resulted primarily from increased net income in 2002 compared to 2001.further limit our operational flexibility.
Net cash used in investing activities during the twelve months ended December 31, 2003 was $1.0 million. Net cash used in investing activities in this period was primarily related to the Jon Stout Non-Competition Agreement totaling $0.6 million as an intangible asset related to the Pequot Transaction. In addition, fixed asset purchases of $0.4 million were made. Net cash used in investing activities during the twelve months ended December 31, 2002 was $0.2 million. Net cash used in investing activities in this period was for fixed asset purchases and legal fees associated with the filing of patent applications for ABS.
Net cash provided by financing activities in 2003 amounted to $12.3 million compared to net cash used by financing activities in 2002 of $0.8 million. This increase is primarily attributable to the Pequot Transaction. For 2003, the Company generated a net increase in cash and equivalents of $12.9 million compared to a net increase of $0.2 million in 2002. Net cash used by financing activities in 2002 amounted to $0.8 million compared to net cash provided by financing activities in 2001 of $6.5 million. In 2002 the Company paid down net bank debt of $1.0 million compared to net bank borrowings of $2.3 million and net proceeds from the issuance of common stock of $3.9 million in 2001 associated with the acquisition of the former Analex Corporation. For 2002, the Company generated a net increase in cash and equivalents of $0.2 million compared to a net decrease of $0.2 million in 2001.
Interest expense of $519,800 consists of cash and non-cash expense. Cash interest expense was $405,900 and non-cash interest expense which is generated by amortization of the Convertible Debt discount was $113,900.
Effective November 2001, the Company acquired Analex, a professional services and program management firm whose principal customers are NASA and the U.S. intelligence community, for approximately $13,898,000. The purchase price was satisfied with cash payments of $6,510,000, 3,520,339 shares of Common Stock valued at $4,664,000, the issuance of promissory notes of $1,773,000, non-compete arrangements for which consideration was $892,000, and the satisfaction of other certain liabilities of Analex.
The fair value of the assets acquired and liabilities assumed approximated their book value of $6,092,400 and $5,730,000, respectively. The Company incurred financial, legal and accounting costs associated with the Analex purchase of approximately $570,000. During 2002, certain contingencies were finalized including the settlement of the Analex closing balance sheet requirements and the award of the ELVIS contract.
On November 2, 2001, to finance the acquisition of Analex, the Company entered into a Credit AgreementOur credit facility with Bank of America which provides the Company with a $4,000,000 Revolving Credit Facility through November 2, 2006 and a five-year $3,500,000 Term Loan. The Revolving Credit Facility has an annual renewal occurring April 30 of each year. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. In August 2002, the credit limit on the Revolving Credit Facility was increased to $8,000,000. At December 31, 2003, there was no outstanding balance on the Revolving Credit Facility while the outstanding balance on the Term Loan was $2.0 million. Interest on each of the facilities is at the LIBOR Rate plus an applicable margin. The Credit Facility and Term Loan are secured by the accounts receivable and other assets of the Company.
Upon the Closing of the Pequot Transaction, Bank of America and the Company entered into a modification of the Credit Agreement amendingcontains financial covenant requirements. The Company must maintain a Total Funded Debtcovenants setting forth certain maximum ratios for total funded debt to EBITDA ratio of no greater than 4.0 to 1.0 from Closing until September 30, 2004, and no greater than
3.5 to 1.0 October 1, 2004 and thereafter. In addition, the Company must maintain a Fixed Charge Coverage Ratio of no less than 1.05 to 1.0 from Closing until December 31, 2003, of no less than 1.1 to 1.0 from January 1, 2004 until September 30, 2004, of no less than 1.2 to 1.0 October 1, 2004 and thereafter. As of December 31, 2003, the Company was in compliance with each of these covenants.minimum ratios for fixed charge coverage. The credit agreementfacility 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 pursuant to the certificate of designation)Stock) or other distributions, create liens on assets, enter into sale andcertain leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. The credit facility is generally secured by all the assets of our business.
Our ability to comply with the financial covenants in our credit agreement will be affected by our financial performance our ability to complete an acquisition as well as events beyond our control, including prevailing economic, financial and industry conditions. The breach of any of the covenants in our credit agreements could result in a default, which would permit Bank of America to declare all amounts borrowed thereunder, together with accrued and unpaid interest, to be due and payable. If we are unable to repay our indebtedness, Bank of America could proceedexercise its security rights against our accounts receivable and other assets which are the collateral securing the indebtedness. In
We cannot predict the absenceresults of acquisitions, givenlegal proceedings which may arise from time to time in the substantial charges associatedordinary 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
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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. This matter is scheduled for trial on March 20 and 21, 2006, and 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. 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.
Risks Related to Our Common Stock
It is likely that we will continue to report net losses to common shareholders due to certain non-cash accretions arising from our financing instruments.
It is likely that we will continue to report net losses to common shareholders due to non-cash accretions related to the outstanding Series A Convertible NotesNote, Series A Preferred Stock and Series B Preferred Stock. An aggregate of 3,428,571 shares of Series B Preferred Stock were issued and sold in connection with our acquisition of Beta Analytics, Inc (“BAI”) in 2004. An aggregate of 7,142,856 shares of Series B Preferred Stock were issued in connection with our acquisition of ComGlobal in April 2005. Pursuant to the U.S. Generally Accepted Accounting Principles, accounting for the Series A Convertible Note, the Series A Preferred Stock and Series B Preferred Stock and related Warrants (collectively, the “Financing Instruments”) will include cash and non-cash charges each year for as long as the Financing Instruments remain outstanding and are not converted into our common stock. We incur quarterly non-cash interest and accretion charges of approximately $2.0 million on our outstanding Financing Instruments and cash charges of approximately $1.0 million. In addition, a significant portion of these charges are not tax deductible.
Investors, whose interests may not be aligned with yours, will have the ability to exercise significant influence over the Company, which could result in actions of which you or other stockholders may not approve.
Using the method of calculation in accordance with the SEC rules on beneficial ownership, General Electric Pension Trust (“GEPT”) and New York Life Capital Partners II, LP (“NYL”) together with Pequot Private Equity Fund III, L.P and Pequot Offshore Private Equity Partners III, L.P (collectively, “Pequot,” and together with GEPT and NYL, the “Investors”) currently beneficially hold approximately 29%, 23%, and 52% of our outstanding voting securities, respectively. Pursuant to the provisions of an Amended and Restated Stockholders’ Agreement dated May 28, 2004, the Investors together with certain other principal stockholders, have agreed to vote their securities for a nine-person board comprised of the CEO, two (2) directors designated by a Pequot Majority in Interest (as defined in the Amended and Restated Stockholders’ Agreement), one (1) non-employee director designated by our CEO and reasonably acceptable to the Investors, and five (5) independent directors nominated by our Nominating Committee. In the event that we fail to redeem the Series A Preferred Stock or the
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Series B Preferred Stock and such failure continues for a period of nine (9) consecutive months, Pequot or the Investors, if required after September 15, 2008, as the case may be, will have the right to designate additional members to the Board as is necessary for the members of the Board designated by Pequot or the Investors, as the case may be, to constitute a majority of the Board. In addition, for as long as 50% of the Series A Preferred Stock originally issued remains outstanding or 25% of the Series B Preferred Stock originally issued remains outstanding, we may not take numerous actions without obtaining the written consent of the holders of a majority of the Series A Preferred Stock or the Series B Preferred Stock.
Holders of our Preferred Stock have such a significant ownership interests that it could deter any third party from making an offer to buy our company.
The significant ownership interest and significant influence of the Investors as a whole could effectively deter a third party from making an offer to acquire our company, which might involve a premium over the current stock price or other benefits for stockholders, or otherwise prevent changes in the control or management of our company. Both the Series A Preferred Stock and the Series B Preferred Stock bear a cumulative annual dividend of 6%. If our available cash for operations does not meet certain specified levels or if the cash dividend payment on the Series A Preferred Stock or the Series B Preferred Stock will result in an event of default under our credit facility, dividends will be paid in additional shares of Series A Preferred Stock or Series B Preferred Stock, as the case may be, causing our Investors’ ownership interest to be even higher. There are also no restrictions, in the form of a standstill agreement or otherwise, on the ability of the Investors or its affiliates to purchase additional securities of our Company and thereby further consolidate their ownership interest.
A substantial number of shares are eligible for sale in the near future, which could cause our Common Stock price to decline significantly.
Future sales of our Common Stock in the public market could lower our stock price and impair our ability to raise funds in any new stock offerings. As of December 31, 2005, we had approximately 16.3 million outstanding shares of Common Stock that were subject to dilution by:
Sales of a substantial amount of Common Stock in the public market, or the perception that these sales may occur, could adversely affect the market price of our Common Stock prevailing from time to time in the public market and could impair our ability to raise funds in additional stock offerings.
The price of our Common Stock could be volatile.
Our Common Stock is listed on the American Stock Exchange and has experienced, and may experience in the future, significant price and volume fluctuations which could adversely affect the market price of our Common Stock without regard to our operating performance. In addition, the trading price of our Common Stock could be subject to significant fluctuations in response to actual or anticipated variations in our quarterly
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operating results announcements by us or our competitors, factors affecting the defense, intelligence and/or aerospace industries generally, changes in national or regional economic conditions, changes in securities analysts’ estimates for our competitors’ or industry’s future performance or general market conditions. The market price of our Common Stock could also be affected by general market price declines or market volatility in the future or future declines or volatility in the prices of stocks for companies in our industry.
As a result of the preferential rights of Series A and Series B Preferred Stock, holders of Common Stock may receive no payment at all upon a liquidation of our Company.
Upon any liquidation, dissolution or winding up of our Company, holders of Series A Preferred Stock and Series B Preferred Stock are entitled to receive, out of our assets available for stockholder distributions and prior to distributions to junior securities (including our Common Stock), an amount equal to, in the case of Series A Preferred Stock, the Series A Preferred Stock purchase price plus any accrued but unpaid dividends, and in the case of Series B Preferred Stock, the Series B Preferred Stock purchase price plus any accrued but unpaid dividends. No distribution upon liquidation may be made to the holders of Common Stock until the holders of the Series A Preferred Stock and Series B Preferred Stock have been paid their liquidation preferences. As a result, it is possible that, upon liquidation, all amounts available for the Company might needholders of our equity would be paid to renegotiatethe holders of the Series A Preferred Stock and Series B Preferred Stock, and that the holders of Common Stock would not receive any payment.
Item 2. Properties
As of December 31, 2005, we own real property with approximately 4,300 square feet. This property, the former corporate headquarters of BAI, is located in Upper Marlboro, Maryland. This property is currently under contract for sale, although there is no assurance that the sale will close. We also leased a total of approximately 153,000 square feet of office space, including approximately 28,500 square feet at our new corporate headquarters located at 2677 Prosperity Ave., Suite 400, Fairfax, VA 22031. In addition to our headquarters and operations in Virginia, we lease facilities in Maryland, Florida, Colorado, Ohio, Nevada and California. These leases expire at various dates through 2012. (See Note 12 of the Notes to Consolidated Financial Statements.)
Item 3. Legal Proceedings
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 our 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.
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On April 29, 2005 we were 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 we terminated on February 14, 2005. Under the complaint, HKSBS is seeking damages of $830,000 together with legal fees and expenses. We believe the complaint is without merit, however, we cannot predict the outcome of the proceeding at this time. 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 is scheduled for trial on March 20 and 21, 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 4. Submission of Matters to a Vote of Security Holders
We held our Annual Meeting of Stockholders on May 19, 2005. Results of the meeting can be found in Item 4 of our Form 10-Q for the fiscal quarter ended June 30, 2005, filed with the Securities and Exchange Commission on August 2, 2005, and the same is being incorporated by reference herein.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Common Stock is listed on the American Stock Exchange and trades under the symbol “NLX”.
The range of the high and low sales prices for the Common Stock, as reported on the American Stock Exchange, for each quarterly period during 2005 and 2004 are shown below. The prices presented below reflect inter-dealer prices without retail mark-ups, mark-downs or commissions, and may not reflect actual transactions.
Year Ended December 31, 2005 | High | Low | ||
First Quarter (1/1 to 3/31/05) | 4.49 | 3.25 | ||
Second Quarter (4/1 to 6/30/05) | 3.80 | 3.01 | ||
Third Quarter (7/1 to 9/30/05) | 3.93 | 2.96 | ||
Fourth Quarter (10/1 to 12/31/05) | 3.20 | 2.86 | ||
Year Ended December 31, 2004 | High | Low | ||
First Quarter (1/1 to 3/31/04) | 4.70 | 3.19 | ||
Second Quarter (4/1 to 6/30/04) | 5.35 | 2.90 | ||
Third Quarter (7/1 to 9/30/04) | 3.50 | 2.60 | ||
Fourth Quarter (10/1 to 12/31/04) | 5.00 | 3.08 |
As of March 7, 2006, there were approximately 2,400 shareholders of record of our common stock. No cash dividends were paid to common shareholders during 2005 or during the past three fiscal years, and no dividends are expected to be declared during 2006 for common shareholders. Our ability to pay dividends on our common stock requires the consent of the holders of the Series A Preferred Stock and Series B Preferred Stock and Bank of America, N.A., as required under our credit agreement with them.
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Item 6. Selected Consolidated Financial Data
The following selected consolidated financial data as of December 31, 2005, 2004, 2003, 2002 and 2001 have been taken from our consolidated financial statements. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and the related notes thereto included elsewhere in this Report.
Year Ended 12/31/05 | Year Ended 12/31/04 | Year Ended 12/31/03 | Year Ended 12/31/02 | Year Ended 12/31/01 | ||||||||||||||||
(In thousands of dollars, except per share amounts) | ||||||||||||||||||||
Total revenue | $ | 141,162 | $ | 94,417 | $ | 62,327 | $ | 52,514 | $ | 17,184 | ||||||||||
Operating income | 9,002 | 6,306 | 3,562 | 3,159 | 318 | |||||||||||||||
Interest expense, net of interest income | (3,846 | ) | (8,922 | ) | (520 | ) | (1,018 | ) | (217 | ) | ||||||||||
Income (loss) from continuing operations | 1,907 | (3,809 | ) | 2,731 | 2,132 | 82 | ||||||||||||||
Income from discontinued operations, net of income taxes | — | 8 | 16 | 225 | 114 | |||||||||||||||
Loss on disposal of discontinued operations, net of income tax | (113 | ) | (545 | ) | — | — | — | |||||||||||||
Dividends on Series A Convertible Preferred Stock | (900 | ) | (903 | ) | (57 | ) | — | — | ||||||||||||
Dividends on Series B-1 Convertible Preferred Stock | (720 | ) | (211 | ) | — | — | — | |||||||||||||
Dividends on Series B-2 Convertible Preferred Stock | (1,125 | ) | — | — | — | — | ||||||||||||||
Accretion of convertible preferred stock | (5,706 | ) | (3,750 | ) | (236 | ) | — | — | ||||||||||||
Net income available to common shareholders | $ | (6,657 | ) | $ | (9,210 | ) | $ | 2,454 | $ | 2,357 | $ | 196 | ||||||||
Net income (loss) available to common shareholders per share: | ||||||||||||||||||||
Continuing operations: | ||||||||||||||||||||
Basic | $ | (0.41 | ) | $ | (0.60 | ) | $ | 0.16 | $ | 0.15 | $ | 0.01 | ||||||||
Diluted | $ | (0.41 | ) | $ | (0.60 | ) | $ | 0.14 | $ | 0.13 | $ | 0.01 | ||||||||
Discontinued operations: | ||||||||||||||||||||
Basic | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.00 | $ | 0.01 | $ | 0.02 | ||||||||
Diluted | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.00 | $ | 0.01 | $ | 0.01 | ||||||||
Net income (loss) available to common shareholders: | ||||||||||||||||||||
Basic | $ | (0.42 | ) | $ | (0.64 | ) | $ | 0.16 | $ | 0.16 | $ | 0.03 | ||||||||
Diluted | $ | (0.42 | ) | $ | (0.64 | ) | $ | 0.14 | $ | 0.14 | $ | 0.02 | ||||||||
At period end: | ||||||||||||||||||||
Total assets | 131,092 | 74,922 | 43,632 | 30,784 | 25,625 | |||||||||||||||
Long-term liabilities | 38,938 | 12,767 | 5,476 | 4,430 | 5,064 | |||||||||||||||
Working capital | 22,439 | 10,219 | 17,185 | 676 | (43 | ) | ||||||||||||||
Shareholders’ equity | 38,961 | 32,966 | 29,493 | 13,902 | 11,175 |
See Item 7 “Management’s Discussion and Analysis” for an explanation of events that materially affect comparability.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the “Selected Consolidated Financial Data”, and the consolidated financial statements and related notes included elsewhere in this Form 10-K.
FORWARD-LOOKING STATEMENTS
Certain matters contained in the following discussion and analysis concerning our operations, cash flows, financial position, economic performance, and financial condition, including in particular, the likelihood of our success in growing our business through acquisitions or otherwise, the realization of sales from backlog, and the sufficiency of capital to meet our working capital needs, include forward-looking statements within the meaning
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of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that 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 in an adverse manner from those anticipated in these forward-looking statements for many reasons, and as a result of many factors, including those identified in the Risk Factors section of this Form 10-K
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-K. We assume no obligation to update any such forward-looking statements.
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, financial condition and future prospects. We will discuss and provide our analysis of the following:
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. 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. 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.
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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.
Our principal customer is the U.S. government. Revenue generated from contracts to federal government agencies and their prime contractors represented approximately 99%, 100% and 99% of our total revenue for the years ended December 31, 2005, 2004 and 2003, respectively. Our principal U.S. government customer is the DoD, which, directly or through its covenantsprime contractors, accounted for approximately 69%, 55%, and 42%, of our revenue for the years ended December 31, 2005, 2004, and 2003, respectively. NASA is also a significant customer, generating 30%, 44%, and 57% of our revenue for the years ended December 31, 2005, 2004 and 2003, respectively. For fiscal years ended December 31, 2005, 2004 and 2003, approximately 11%, 16% and 17%, respectively, of our revenue and 44%, 62% and 72%, respectively, of our operating income came from one prime contract with an agency within the Department of Defense. For fiscal years ended December 31, 2005, 2004 and 2003 approximately 20%, 28% and 30%, 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.
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 69.9% of our revenue for the year ended December 31, 2005. 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 and the National Security Agency. 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 30.1% of our revenue for the year ended December 31, 2005. 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 its bankour 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.
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 a wholly-owned subsidiary of Analex and is reported as a part of our Homeland Security Group.
On May 28, 2004, we acquired Beta Analytics, Inc. (“BAI”). BAI’s services cover a range of life-cycle protection and physical security services specifically in the areas of information protection, physical security, intelligence threat assessment and analysis, technology protection, security management and security education and training. BAI is a wholly-owned subsidiary of Analex and is reported as a part of our Homeland Security Group.
During the second quarter of 2004, we concluded that our then wholly-owned subsidiary, Advanced Biosystems, Inc. (“ABS”), did not fit with our long-term strategic plan and decided to divest ABS. ABS was engaged in biomedical research for broad-spectrum defenses against toxic agents capable of being used as bioterrorist weapons, such as anthrax and smallpox. We disposed of ABS on November 16, 2004. Therefore, the
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results of operations of ABS are reported as discontinued operations, net of applicable income taxes, for all periods presented. Historically, we reported ABS as a separate business segment.
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 years ended December 31,:
2005 | 2004 | 2003 | |||||||
Prime contract revenue | 73 | % | 68 | % | 57 | % | |||
Subcontract revenue | 27 | % | 32 | % | 43 | % | |||
Total revenue | 100 | % | 100 | % | 100 | % | |||
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.
SELECTED KEY METRICS EVALUATED BY MANAGEMENT
We manage and assess the performance of our business by evaluating a variety of metrics. Selected key metrics are discussed below.
Revenue Growth
Our revenue growth during 2005 was driven primarily by strategic acquisitions. Our total revenue growth rate was 49.5% for 2005, compared to 51.5% for 2004. Organic growth decelerated in 2005 as certain customers experienced funding reductions to help offset the cost of the continuing war in Iraq. We have recently begun to make incremental investments in a centralized business development team and new processes that we believe will improve future organic revenue growth.
Contract Backlog
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 December 31,:
2005 | 2004 | 2003 | |||||||
Funded backlog | $ | 50.8 | $ | 57.0 | $ | 19.3 | |||
Unfunded contract value | 240.9 | 135.0 | 151.7 | ||||||
Total estimated backlog | $ | 291.7 | $ | 192.0 | $ | 171.0 | |||
Our total backlog of over $291.7 million as of December 31, 2005 represented a 52% increase over the backlog as of December 31, 2004. We currently expect to recognize revenue during fiscal 2006 from approximately 41% of our total backlog as of December 31, 2005.
Contract mix
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
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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 years ended December 31,:
2005 | 2004 | 2003 | |||||||
Cost-plus-fee | 42 | % | 42 | % | 51 | % | |||
Time and material | 34 | % | 39 | % | 33 | % | |||
Fixed-price | 24 | % | 19 | % | 16 | % | |||
Total | 100 | % | 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.
Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)
We believe EBITDA is useful 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 for the years ended December 31, 2005, 2004 and 2003 was $13.1 million, $8.0 million and $4.1 million, respectively. EBITDA, as a percentage of revenue, the years ended December 31, 2005, 2004 and 2003 was 9.3%, 8.5% and 6.6%, respectively.
EBITDA, or earnings before interest, taxes, depreciation and amortization, 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.
Days Sales Outstanding
Days sales outstanding, or DSO, is a measure of how efficiently we manage the billing and collection of our accounts receivable, our most significant working capital requirement. For the fiscal quarter ended December 31, 2005 our DSO was 75 days. This represents an increase over the approximately 60 days we have historically experienced. Timing issues related to certain contract actions arising during the fourth quarter are primarily responsible for this increase. We believe these contract actions have been addressed and expect our DSO to trend more towards historical levels.
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RESULTS OF OPERATIONS AND RELATED INFORMATION
The following table sets forth some items from our consolidated statements of operations, and these items expressed as a percentage of revenue, for the periods indicated.
Year Ended December 31, | |||||||||||||||||
2005 | % of Revenue | 2004 | % of Revenue | % Change | |||||||||||||
(in thousands) | |||||||||||||||||
Revenue | $ | 141,162 | 100.0 | % | $ | 94,417 | 100.0 | % | 49.5 | % | |||||||
Operating cost and expenses | |||||||||||||||||
Cost of revenue | 112,374 | 79.6 | 75,605 | 80.1 | 48.6 | ||||||||||||
Selling, general and administrative | 15,681 | 11.1 | 10,777 | 11.4 | 45.5 | ||||||||||||
Depreciation and amortization | 732 | 0.5 | 308 | 0.3 | 137.7 | ||||||||||||
Amortization of intangible assets | 3,373 | 2.4 | 1,421 | 1.5 | 137.4 | ||||||||||||
Total operating cost and expenses | 132,160 | 93.6 | 88,111 | 93.3 | 50.0 | ||||||||||||
Operating income | 9,002 | 6.4 | 6,306 | 6.7 | 42.8 | ||||||||||||
Interest expense, net | (3,846 | ) | (2.7 | ) | (8,922 | ) | (9.4 | ) | (56.9 | ) | |||||||
Income (loss) from continuing operations before income taxes | 5,156 | 3.7 | (2,616 | ) | (2.7 | ) | 297.1 | ||||||||||
Provision for income taxes | 3,249 | 2.3 | 1,193 | 1.3 | 172.3 | ||||||||||||
Income (loss) from continuing operations | 1,907 | 1.4 | (3,809 | ) | (4.0 | ) | 150.1 | ||||||||||
Income from discontinued operations, net of tax | — | — | 8 | — | (100.0 | ) | |||||||||||
Loss on disposal of discontinued operations, net of income taxes | (113 | ) | (0.1 | ) | (545 | ) | (0.6 | ) | (79.3 | ) | |||||||
Net income (loss) | 1,794 | 1.3 | (4,346 | ) | (4.6 | ) | (141.3 | ) | |||||||||
Dividends on convertible preferred stock | (2,745 | ) | (2.0 | ) | (1,114 | ) | (1.2 | ) | 146.4 | ||||||||
Accretion of convertible preferred stock | (5,706 | ) | (4.0 | ) | (3,750 | ) | (4.0 | ) | 52.2 | ||||||||
Net loss available to common shareholders | $ | (6,657 | ) | (4.7 | )% | $ | (9,210 | ) | (9.8 | ) | (27.7 | )% | |||||
Year Ended December 31, | |||||||||||||||||
2004 | % of Revenue | 2003 | % of Revenue | % Change | |||||||||||||
(in thousands) | |||||||||||||||||
Revenue | $ | 94,417 | 100.0 | % | $ | 62,327 | 100.0 | % | 51.5 | % | |||||||
Operating cost and expenses | |||||||||||||||||
Cost of revenue | 75,605 | 80.1 | 52,437 | 84.1 | 44.2 | ||||||||||||
Selling, general and administrative | 10,777 | 11.4 | 5,787 | 9.3 | 86.2 | ||||||||||||
Depreciation and amortization | 308 | 0.3 | 90 | 0.2 | 242.2 | ||||||||||||
Amortization of intangible assets | 1,421 | 1.5 | 451 | 0.7 | 215.1 | ||||||||||||
Total operating cost and expenses | 88,111 | 93.3 | 58,765 | 94.3 | 49.9 | ||||||||||||
Operating income | 6,306 | 6.7 | 3,562 | 5.7 | 77.0 | ||||||||||||
Interest expense, net | (8,922 | ) | (9.4 | ) | (520 | ) | (0.8 | ) | 1,615.8 | ||||||||
(Loss) income from continuing operations before income taxes | (2,616 | ) | (2.7 | ) | 3,042 | 4.9 | (186.0 | ) | |||||||||
Provision for income taxes | 1,193 | 1.3 | 311 | 0.5 | 283.6 | ||||||||||||
(Loss) income from continuing operations | (3,809 | ) | (4.0 | ) | 2,731 | 4.4 | (239.5 | ) | |||||||||
Income from discontinued operations, net of tax | 8 | — | 15 | — | (50.0 | ) | |||||||||||
Loss on disposal of discontinued operations, net of income taxes | (545 | ) | (0.6 | ) | — | — | NM | ||||||||||
Net (loss) income | (4,346 | ) | (4.6 | ) | 2,746 | 4.4 | (258.2 | ) | |||||||||
Dividends on convertible preferred stock | (1,114 | ) | (1.2 | ) | (57 | ) | (0.1 | ) | 1,854.4 | ||||||||
Accretion of convertible preferred stock | (3,750 | ) | (4.0 | ) | (236 | ) | (0.4 | ) | 1,489.0 | ||||||||
Net loss (income) available to common shareholders | $ | (9,210 | ) | (9.8 | ) | $ | 2,453 | 3.9 | % | (475.3 | )% | ||||||
NM — not meaningful
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Revenue
Our revenue for the year ended December 31, 2005 was $141.2 million, an increase of $46.7 million, or 49.5%, from the prior year.
Our Homeland Security Group provided $98.7 million, or 69.9%, of our revenue for the year ended December 31, 2005. This represented an 87.7% increase from the prior year. Contributing to this increase were the effects of our acquisition of BAI in May 2004, our acquisition of ComGlobal in April 2005 and increased independent verification and validation services provided in support of launches of expendable launch vehicles by the United States Air Force and the NRO. In addition, we provided increased information and technology asset protection solutions to various agencies within the United States Government including the Missile Defense Agency (“MDA”) and Counterintelligence Field Activity (“CIFA”).
Our Systems Engineering Group provided $42.5 million, or 30.1%, of our revenue for the year ended December 31, 2005. Systems Engineering Group revenue increased approximately 1.3% for the year ended December 31, 2005 compared to the prior year. This increase is attributable to an increase in NASA directed purchasing and a 7.2% increase in revenue from our ELVIS contract. These increases were offset by the expected continued step-down of our Microgravity Research Development and Operations subcontract (“MRDOC”).
Our revenue for the year ended December 31, 2004 was $94.4 million, an increase of $32.1 million, or 51.5%, from the same period in the prior year.
The Homeland Security Group provided $52.5 million, or 55.6%, of our revenue for the year ended December 31, 2004. This represented a 93.9% increase from the prior year. Contributing to this increase was the effect of our acquisition of BAI in May 2004 and also increased independent verification and validation services provided in support of launches of expendable launch vehicles by the United States Air Force and the NRO.
The Systems Engineering Group provided $41.9 million, or 44.4%, of our revenue for the year ended December 31, 2004. This represented a 19.1% increase from the prior year. This increase was attributable to growth in our services rendered in connection with our ELVIS and Glenn Engineering & Support Services (“GESS”) contracts (both with NASA), which amounted to an aggregate increase of approximately $7.7 million. This increase was offset by a decline of $1.1 million due to the expected continued step-down of our MRDOC contract. The GESS contract is scheduled to end in April 2006, and we plan to participate in a recompetition for the award of a follow-on contract in 2006.
Cost of Revenue
Cost of revenue for the year ended December 31, 2005 was $112.3 million, an increase of $36.8 million, or 48.6%, from the prior year. This increase resulted from our acquisitions of BAI and ComGlobal. Cost of revenue, as a percentage of revenue for the year ended December 31, 2005 was 79.6%, compared to 80.1% for the prior year. The decrease in cost of revenue, as a percentage of revenue, for year ended December 31, 2005 was attributable to a more profitable contract mix from our acquired companies offset by an increase in personnel fringe benefit costs in 2005 compared to the prior year.
Cost of revenue for the year ended December 31, 2004 was $75.6 million, an increase of $23.2 million, or 44.2%, from the prior year. Cost of revenue, as a percentage of revenue for the year ended December 31, 2004 was 80.1%, compared to 84.1% for the prior year. The decrease in cost of revenue, as a percentage of revenue, for year ended December 31, 2004 was attributable to the improved profitability of our contract base, which decreases cost of revenue in relation to revenue.
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Selling, General and Administrative Expenses (“SG&A”)
SG&A for the year ended December 31, 2005 was $15.7 million, an increase of $4.9 million, or 45.5%, from the prior year. The increase resulted primarily from our acquisitions of BAI and ComGlobal. In addition, we incurred approximately $1.3 million of what we believe were one-time expenses in 2005. These expenses related to transition costs to fill senior executive positions, due diligence costs for an acquisition we did not close, and recording a reserve against a NASA receivable (refer to Item 3. Legal Proceedings in this Form 10-K for a full description). SG&A as a percentage of revenue was 11.1% for the year ended December 31, 2005 compared to 11.4% for 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. For 2005, the $1.3 million of one time expenses increased SG&A as a percentage of revenue approximately 0.9 percentage points.
SG&A for the year ended December 31, 2004 was $10.8 million, an increase of $5.0 million, or 86.2%, from the prior year. SG&A as a percentage of revenue was 11.4% for the year ended December 31, 2004 compared to 9.3% for the prior year. The increase in our SG&A expense as a percentage of revenue for the year ended December 31, 2004 was attributable to acquisition-related integration costs, investments to support growth and enhance our central infrastructure and new expenditures to comply with public-company reporting requirements, including the Sarbanes-Oxley Act of 2002.
Depreciation and Amortization of Intangible Assets
Depreciation expense for the year ended December 31, 2005 was $0.7 million, an increase of $0.4 million or 137.7% from the prior year. We acquired $1.1 million of fixed assets with the ComGlobal acquisition in April 2005 and $0.7 million of fixed assets with the BAI acquisition in May 2004. The increased depreciation expense resulted from depreciation of these acquired fixed assets.
Intangible amortization expense for the year ended December 31, 2005 was $3.4 million, an increase of $2.0 million, or 137.4%, from the prior year. This increase was attributable to the additional amortization expense associated with the $7.4 million of identifiable intangible assets resulting from the April 2005 acquisition of ComGlobal and the $6.1 million of identifiable intangible assets resulting from the May 2004 acquisition of BAI.
Depreciation expense for the year ended December 31, 2004 was $0.3 million, an increase of $0.2 million or 242.2% from the prior year. This increase resulted from the depreciation expense associated with the $0.7 million of fixed assets we acquired as part of the BAI acquisition in May 2004.
Intangible amortization expense for the year ended December 31, 2004 was $1.4 million, an increase of $1.0 million, or 215.1%, from the prior year. This increase was attributable to the additional amortization expense associated with the $6.1 million of identifiable intangible assets resulting from the May 2004 acquisition of BAI.
Operating Income
Operating income for the year ended December 31, 2005 was $9.0 million, an increase of $2.7 million, or 42.8%, from the prior year. Operating margin for the year ended December 31, 2005 was 6.4% compared to 6.7% for the prior year. The decrease in our operating margin resulted primarily from the increased amortization expense associated with acquisition related identifiable intangible assets.
Operating income for the year ended December 31, 2004 was $6.3 million, an increase of $2.7 million, or 77.0%, from the prior year. Operating margin for the year ended December 31, 2004 was 6.7% compared to 5.7% for the prior year. The increase in our operating margin was attributable to improved contract profitability, offset by increased SG&A expenses as described above and increased amortization expense associated with our BAI acquisition.
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Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)
EBITDA, as defined below, for the year ended December 31, 2005 was $13.1 million after adding depreciation and amortization of $0.7 million and intangible amortization of $3.4 million to operating income of $9.0 million. This was an increase of $5.1 million, or 63.1% from the prior year. EBITDA, as a percent of revenue, was 9.3% compared to 8.5% for the prior year. The increase in EBITDA margin for the year ended December 31, 2005 was attributable to higher contract profitability and improved SG&A leverage despite the $1.3 million of one-time expenses described above.
EBITDA for the year ended December 31, 2004 was $8.0 million after adding depreciation and amortization of $0.3 million and intangible amortization of $1.4 million to operating income of $6.3 million. This was an increase of $3.9 million, or 95.1% from the prior year. For the year ended December 31, 2004 EBITDA, as a percent of revenue, was 8.5% compared to 6.6% for the prior year. The increase in EBITDA margin for year ended December 31, 2004 was attributable to improved contract profitability offset by the higher SG&A expenses described above.
EBITDA, or earnings before interest, taxes, depreciation and amortization, 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 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.
Net Interest Expense
Net interest expense for the year ended December 31, 2005 was $3.8 million, a decrease of $5.1 million, or 56.9%, from the prior year. For year ended December 31, 2004, we recorded $5.8 million of interest expense incurred on our Series B Senior Subordinated Notes. We did not record any interest expense on our Series B Senior Subordinated Notes during the year ended December 31, 2005 because in September 2004, we converted these notes into our Series B-1 Convertible Preferred Stock. The elimination of the interest on our Series B Note was partially offset by increased interest expense associated with the $22 million borrowed on our Credit Facility in connection with our acquisition of ComGlobal.
Net interest expense for the year ended December 31, 2004 was $8.9 million, an increase of $8.4 million from the same period in the prior year. For the year ended December 31, 2004, we recorded $5.8 million of interest expense incurred on our Series B Senior Subordinated Notes, which originated in May 2004 and were converted into Series B-1 Convertible Preferred Stock in September 2004. We also recorded a full year of interest on our Series A Convertible Notes, which originated in December 2003.
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Provision for Income Taxes
The provision for income taxes for the year ended December 31, 2005 was $3.2 million, an increase of $2.1 million, or 172.3%, from the prior year. The provision for income taxes for the year ended December 31, 2004 was $1.2 million, an increase of $0.9 million, or 283.6%, from 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, is impacted significantly by the non-tax deductible interest and accretion expense associated with our convertible notes and preferred stock issued since 2003.
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 and convertible note, to make quarterly dividend payments on our convertible preferred stock and to make selective strategic acquisitions.
Cash Flow
For the year ended December 31, 2005, net cash provided by operating activities was $3.4 million, compared to $2.1 million for the same period in the prior year. For the year ended December 31, 2004, net cash provided by operating activities was $2.1 million, compared to $2.7 million for the same period in the prior year.
Cash flow from operating activities begins with net income from continuing operations, which is adjusted by adding back non-cash charges (such as depreciation, amortization and bad debt expense) and then adjusted for the changes in working capital accounts. Accounts receivable represents one of our largest components of working capital. 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. For the year ended December 31, 2005, compared to 2004, our operating income grew, increasing the amount of operating cash flow. This operating income growth was offset by increases in our working capital resulting from an increase in our fourth-quarter DSO. This increase resulted from the fact it took an extended period of time to resolve certain contract actions with three customers during the fourth quarter. The collection of approximately $5.0 million of accounts receivable was delayed as a result. We believe these contract actions have been addressed and expect our DSO to trend more towards historical levels. For the year ended December 31, 2004, compared to 2003, our operating income grew, improving our operating cash flow. This operating income growth was offset by increased use of cash by our discontinued operation.
Cash used in investing activities for the years ended December 31, 2005, 2004 and 2003 was $46.7 million, $27.6 million and $1.0 million, respectively. Cash provided by financing activities for the years ended December 31, 2005, 2004 and 2003 was $45.9 million, $12.4 million and $12.2 million, respectively. Our cash flows from investing and financing activities were primarily attributable to our BAI acquisition in May 2004 and our ComGlobal acquisition in April 2005.
In May 2004, we issued our Series B-1 Notes, receiving $12 million in proceeds. We used these proceeds, in conjunction with financing proceeds of $10 million we received in December 2003, to fund the cash portion of the purchase of BAI. The total purchase price of BAI, including transaction related costs, was $37.9 million.
In April 2005, we received proceeds of $25 million when we issued our Series B-2 Convertible Preferred Stock. In addition, we borrowed $22 million from our Senior Revolving Credit Facility. We used these proceeds to purchase ComGlobal. The purchase price of ComGlobal, including transaction related costs, was $47.9 million. See Note 9 to the Notes to Consolidated Financial Statements for the details and a summary of changes in our financing instruments issued in connection with our 2004 and 2005 acquisition activity.
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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 revolving line of credit during 2004(“the Credit Facility”) used for senior acquisition financing and working capital requirements. On April 1, 2005, in orderconnection with the acquisition of ComGlobal, the Credit Facility was amended and restated to remainincrease the amount of the facility from $20 million to $40 million, 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 December 31, 2005 we were in compliance with these covenants. The Credit Facility has a maturity date of May 31, 2008. Interest on the termsCredit Facility is at the LIBOR Rate plus an applicable margin as specified the agreement. As of its credit facility.December 31, 2005, the outstanding balance of the Credit Facility was $27.6 million. The Company’s expectation, however,interest rate at December 31, 2005 was 7.39%. Borrowing availability under our Credit Facility continues to be sufficient to fund normal operations. Available borrowing capacity on our Credit Facility at December 31, 2005 was approximately $4.2 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. The Credit Facility is that acquisitions will be consummated and therefore, we do not consider it a material risk.generally secured by all assets of our business.
Private Stock Offering
In October 2001,March 2005, our Board of Directors, including its compensation committee, comprised solely of independent directors, approved the Company issued 3,961,060sale of up to 300,000 shares of unregistered Common Stock for aggregate considerationto certain employees of approximately $3,868,000 through a private placement pursuantComGlobal as an inducement material to Regulation Dtheir employment with us. In April 2005, all of the approved shares of our unregistered Common Stock were sold to 22 employees of ComGlobal. We received $840,000 from the sale of such shares. The sale was made in an exempt offering under Rule 506 of the Securities Act of 1933, consistingas amended. We recognized $105,000 of (i)stock compensation expense related to this transaction.
Guarantees and Commitments
Pursuant to the Company’sNovember 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 December 31, 2005, 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 as of December 31, 2005 was in excess of the maximum guaranteed share price of $1.14$2.20 per share, to purchasers who purchased less than $500,000 worth thereof or (ii) units consisting ofwe did not accrue any amounts under the Company’s Common Stock and warrants to purchase 0.2061 shares of the Company’s Common Stock at an exercise price of $0.02 per share for each share purchased at a price of $1.14 per unit for purchasers who purchased $500,000 or more of the Company’s equity. Two of such purchasers are former directors or affiliates of a former director. All of these proceeds were directed to financing the acquisition of Analex.guarantee.
On November 2, 2001, the Companywe issued promissory notes to certain Analex sellers totaling approximately $773,000$0.8 million with a five-year term, bearing interest at 6%. As of December 31, 2003,September 30, 2005 the outstanding balance onof the promissory notes was $490,900. The Companyapproximately $0.3 million. We also entered into non-competition agreements with these sellers for total payments of $540,000 over a three-year period. In addition, the Company entered into non-competition agreements with former employees totaling $352,000,$0.4 million, on a discounted basis, payable over various periods. Asperiods with a current balance of $52,000 at December 31, 2003,2005.
In August 2005, we entered into a lease agreement for approximately 28,500 square feet to be used as our new corporate headquarters. The lease commenced on January 1, 2006 and has a term of seven years with one optional renewal period of five years. Future minimum lease payments over the outstanding balanceseven-year lease term will be approximately $5.6 million.
33
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R)Share-Based Payment, which replaces SFAS No. 123Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees. SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost is measured based on the non-competition agreements was $534,700.grant-date fair value of the equity or liability instruments issued. SFAS No. 123(R) requires liability awards to be re-measured each reporting period and compensation costs to be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123(R) is effective as of the beginning of the first fiscal year that begins after June 15, 2005. We will adopt the provisions of SFAS No. 123(R) during the first quarter of 2006.
WithSFAS No. 123(R) permits companies to adopt its purchaserequirements using either the modified prospective method or the modified retrospective method. Under the modified prospective method, compensation cost is recognized beginning with the effective date for all share-based payments granted after the effective date and for all awards granted to employees prior to the effective date of Analex,SFAS No. 123(R) that remain unvested on the effective date. The modified retrospective method includes the requirements of the modified prospective method, but also permits entities to restate either all prior periods presented or prior interim periods of the year of adoption for the impact of adopting this standard. It is anticipated we will apply the modified prospective method upon adoption. We expect that the initial adoption of SFAS 123(R) will not have a material impact on our Consolidated Statements of Operations. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We believe this reclassification will not have a material impact on our Consolidated Statements of Cash Flows.
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 assumed a note payable to the Department of Justice (“DOJ”). The agreement provides for quarterlyvariability in interest payments of $80,000 consisting of principal and interest at 7% through February 2006, with a final payment due in May 2006. As of December 31, 2003, the outstanding balance on the DOJ note payable was $538,100. This liability arose as a settlement between the former Analex Corporation and the Department of Justice in 1994 due to false claims made bychanges in interest rates. The Company does not currently use interest rate swaps or other means to reduce the former Analex Corporation to the U.S. government during the years 1982 through 1986.interest rate exposure on these variable rate obligations. The terms of the Pequot Transaction required using proceeds of the transaction to repay the DOJ note in full. An audit was requested by the government prior to acceptance of the note repayment. The government completed their audit subsequent to year end and the repayment was accepted.Company does not hold any derivatives.
On May 29, 2002, Analex announced that it had been awarded a $164 million Expendable Launch Vehicle Integrated Support (“ELVIS”) prime contract by NASA. In conjunction with this award the Company issued promissory notes to certain Analex sellers totaling $1,000,000 with a three-year term, bearing interest at prime plus 1%. At December 31, 2003, the outstanding balance on these notes was $583,300.
Contractual Obligations
Preferred Stock
Holders of a majority of the outstanding shares of Series A Preferred Stock may require the Company to redeem their Series A Preferred Stock together with accrued but unpaid dividends in four equal quarterly installments any time on or after September 15, 2008, which is also the Series B Redemption Date. Holders of two-thirds of the Series B Preferred Stock may also require the Company to redeem their Series B Preferred Stock together with accrued but unpaid dividends in four equal quarterly installments any time on or after September 15, 2008, the Series B Redemption Date. However, since the Company has up to sixty (60) days from the Series B Redemption Date to make the first quarterly installment, the Company’s obligation to pay for the
redemption price of both the Series A and Series B Preferred Stock is not triggered until November 15, 2008, at the earliest. The table below summarizes this possible future contractual obligation.
Financing Instrument | Redemption Payment Period | Quarterly Redemption Price | Total Redemption Price | |||||
Series A Preferred Stock | November 15, 2008—August 2009 | $ | 3,750,000 | $ | 15,000,000 | |||
Series B Preferred Stock | November 15, 2008—August 2009 | $ | 9,250,000 | $ | 37,000,000 |
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Debt, leases and other non-cancelable obligations
The Company has contractual obligations to pay long-term debt, leases and other non-cancelable obligations. The following table aggregates the amounts of these obligations as of December 31, 2003:2005:
Year | Long-term debt(1) | Operating Leases | Non-Compete Agreements | Total | Long-term debt (1) | Operating Leases | Non-Compete Agreements | Total | ||||||||||||||||
2004 | $ | 1,725,400 | $ | 1,068,900 | $ | 461,900 | $ | 3,256,200 | ||||||||||||||||
2005 | 1,113,400 | 804,600 | 442,700 | 2,360,700 | ||||||||||||||||||||
2006 | 815,100 | 77,500 | 166,400 | 1,059,000 | $ | 387,500 | $ | 2,919,600 | $ | 156,500 | $ | 3,463,600 | ||||||||||||
2007 | 10,000,000 | — | 13,700 | 10,013,700 | 10,000,000 | 1,521,900 | — | 11,521,900 | ||||||||||||||||
2008 | — | 1,393,300 | — | 1,393,300 | ||||||||||||||||||||
2009 | — | 1,192,900 | — | 1,192,900 | ||||||||||||||||||||
2010 | — | 985,600 | — | 985,600 | ||||||||||||||||||||
2011 | — | 1,006,600 | — | 1,006,600 | ||||||||||||||||||||
2012 | — | 1,028,300 | — | 1,028,300 | ||||||||||||||||||||
Total contractual obligations | $ | 13,653,900 | $ | 1,951,000 | $ | 1,084,700 | $ | 16,689,600 | $ | 10,387,500 | $ | 10,048,200 | $ | 156,500 | $ | 20,592,200 | ||||||||
(1) | Does not include line of credit. |
Payments for long-term debt do not include interest payments. Lease commitments could require higher payments than shown in the table due to escalation provisions that are tied to various measures of inflation. The lease commitments reflect only existing commitments and do not include future requirements necessary to replace existing leases. In addition to the contractual obligations included above, the Company also has routine purchase order commitments for materials and supplies that are entered into in the normal course of business and are not in excess of current requirements.
Pursuant to the November 2, 2001 acquisition of 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 (“Guaranteed Shares”), if such shares are sold within such period and if certain other conditions are satisfied. As of December 31, 2003,2005, the maximum that the Company would be required to pay under the terms of the guarantee was $1,628,571.$1,628,600. This amount is calculated by multiplying the number of shares subject to the guarantee by their associated guaranteed purchase price, assuming the Company’s common stockCommon Stock has no fair market value. As of December 31, 2003,2005, there were 214,286 shares with an associated purchase price guarantee of $1.60 per share, 214,286 shares with an associated guaranteed purchase price of $1.80 per share, and 214,286 shares with an associated guaranteed purchase price of $2.00 per share, and 214,285214,286 shares with an associated guaranteed purchase price of $2.20 per share. As the fair market value of the Company’s common stockCommon Stock was in excess of the guaranteed share prices as of December 31, 2003,2005, no amounts were accrued under the guarantee.
Recently Issued Accounting Standards
Item 7A. | Quantitative and Qualitative Disclosure about Market Risk |
In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact, either positive or negative, on future results of operations or financial condition.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21,Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue No. 00-21 did not have a material impact on the financial position or results of operations.
In November 2002, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that upon issuance of certain guarantees, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45’s provisions for initial recognition and measurement are required to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure provisions of FIN 45 are effective for financial statements of interim or annual periods that end after December 15, 2002. As the Company has not entered into or modified any guarantees subsequent to December 31, 2002, the implementation of FIN 45 did not impact the Company’s financial position or results of operations. The Company has updated its disclosures to comply with the requirements in FIN 45.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have a significant impact on the Company’s financial position or results of operations.
Forward-looking Statements
Certain matters contained in this discussion and analysis concerning our operations, cash flows, financial position, economic performance, and financial condition, including in particular, the likelihood of our success in growing our business through acquisitions or otherwise, the realization of sales from backlog, and the sufficiency of capital to meet our working capital needs, include forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that 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:
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-K. We assume no obligation to update any such forward-looking statements.
Item 7A. 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 improvementsexpenditures exposes the Company to variability in interest payments due to changes in interest rates. The Company uses andoes not currently use interest rate swapswaps or other means to reduce the interest rate exposure on these variable rate obligations. The Company does not hold any derivatives for trading or speculative purposes.derivatives.
The Company’s $3.5 million term loan facility from Bank of America carries interest comprised of two components: floating-rate LIBOR plus a credit performance margin. The Company has entered into an interest-rate swap agreement with Bank of America whereby its obligation to pay floating-rate LIBOR was swapped into a fixed rate obligation at 4.25% beginning in January 2002. The Company continues to have the obligation to pay the credit performance margin in addition to its swapped 4.25% payment obligation. The total effective interest rate on the swapped portion of the Term Loan amounted to 7.25% at December 31, 2003.35
Interest rate hedges that are designated as cash flow hedges hedge the future cash outflows on debt. Interest rate swaps that convert variable payments to fixed payments, interest rate caps, floors, collars and forwards are cash flow hedges. The unrealized gains/losses in the fair value of these hedges are reported on the balance sheet and included in other long-term liabilities with a corresponding adjustment to either accumulated other comprehensive income/(loss) or in earnings depending on the hedging relationship. If the hedging transaction is a cash flow hedge, then the offsetting gains/losses are reported in accumulated other comprehensive income/(loss). Over time, the unrealized gains/losses held in accumulated other comprehensive income/(loss) will be recognized in earnings consistent with when the hedged items are recognized in earnings.
Under the interest rate swap, the Company pays the bank at a fixed rate and receives variable interest at a rate approximating the variable rate of the Company’s debt, thereby creating the equivalent of a fixed rate obligation. The following table summarizes the original financial terms of the Company’s interest rate swap:
Notional Value | Variable Rate Received | Fixed Rate Paid | Effective Date | Expiration Date | ||||
$2,950,000 | LIBOR | 4.25% | 1/1/02 | 12/1/04 |
The notional value of the interest rate swap declines as the amount of the Term Loan is paid down. At December 31, 2003, the notional value of the swap was $1,750,000. Increases in prevailing interest rates could increase the Company’s interest payment obligations relating to variable rate debt. For example, a 100 basis points increase in interest rates would increase annual interest expense by $3,000, based on debt levels at December 31, 2003.
Item 8. Financial Statements and Supplementary Data
Item 8. | Financial Statements and Supplementary Data |
The information required by this item is set forth under Item 15(a), which information is incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
Item 9A. Controls and Procedures
Item 9A. | 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 December 31, 2003,2005, in timely alerting them to material information relating to the Company required to be included in the Company’s periodic SEC filings.
Our management, including our 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.
Item 9B. | Other Information |
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The names of our current seven directors and certain other information about them are set forth below:
Directors | Age | Director Since | Office Held with Company | |||
Sterling E. Phillips, Jr. | 57 | 2001 | Chairman of the Board, and Chief Executive Officer | |||
Peter C. Belford, Sr. | 57 | 2001 | Director | |||
C. Thomas Faulders, III | 54 | 2004 | Director | |||
Lincoln D. Faurer | 76 | 2003 | Director | |||
Martin M. Hale, Jr. | 32 | 2003 | Director | |||
Gerald A. Poch | 57 | 2003 | Director | |||
Daniel R. Young | 70 | 2003 | Director |
Sterling E. Phillips, Jr., was appointed the Company’s President and Chief Executive Officer and a director in January 2001. In December 2003, Mr. Phillips was elected Chairman of the Board. He ceased to be the President of the Company in February 2004. Prior to joining the Company, Mr. Phillips held senior management positions with Federal Data Corporation in the Science and Engineering and Corporate Marketing Groups from 1996 to 2001. From 1993 to 1996, he was the Chief Operating Officer of TRI-COR Industries, Inc. an information technology company, and from 1992 to 1993 served as President of Business Development for Computer Sciences Corporation. Prior to these positions, he held senior national and international marketing positions with International Business Machines Corporation for twenty-four years.
Peter C. Belford, Sr., who was appointed to the Board in November 2001, has more than 30 years experience in building and operating companies in the Federal Government sector. Mr. Belford was President of Analex Corporation from 2000 until it was acquired by the Company in November 2001. From 1997 through 2000, he held the position of Senior Vice President for Federal Data Corporation, a government information technology services provider, and from 1985 to 1997 served as President and Chief Operating Officer of NYMA, Inc., a federal contractor. Prior to these positions, Mr. Belford served thirteen years as Vice President with Computer Sciences Corporation, an information technology services provider.
C. Thomas Faulders, IIIwas appointed to the Board in February 2004. Mr. Faulders has been the Chairman and Chief Executive Officer of LCC International Inc. since June 1999. He has directed the financial turnaround and subsequent growth of the company. He is responsible for the strategic direction, day-to-day operations, sales and financial matters of the company. Prior to joining LCC, Mr. Faulders served as Executive Vice President and Chief Financial Officer of BDM International, as well as President of its Integrated Supply Chain division. From March 1992 through March of 1995, Mr. Faulders was the Chief Financial Officer of COMSAT Corporation. Prior to COMSAT, he served in a variety of areas for MCI – including Senior Vice President of Business Marketing, Vice President of Large Account Sales and Treasurer. Prior to his six years with MCI, Mr. Faulders served in key positions with Satellite Business Systems.
Lincoln D. Faurer was appointed to the Board in April 2003. Mr. Faurer has more than 15 years of experience in building and operating companies in the government contracting industry and was Director of the National Security Agency from 1981 to 1985. Since 1992, Mr. Faurer has been the President of LDF Inc., which provides consulting services on command, control, communications, computing and intelligence (C4I) matters. In addition to being a retired Air Force officer, Mr. Faurer has held senior positions with various intelligence organizations including Defense Intelligence Agency, NATO Military Committee, HQS U.S. European Command and HQS U.S. Southern Command. Mr. Faurer serves as a director of ALPHATECH, Inc. and TSI TelSys Corp. and also serves on the advisory board of ManTech Aegis Research Corporation, a subsidiary of ManTech International Corp.
Martin M. Hale, Jr.was appointed to the Board in December 2003. Mr. Hale is a General Partner of Pequot Ventures, the venture capital/private equity arm of Pequot Capital Management, Inc. Mr. Hale joined Pequot in February 1997 and focuses on investments in defense, wireless hardware, software and services for the Pequot venture and private equity funds. Prior to joining Pequot, Mr. Hale was an associate at Geocapital Partners, L.L.C., an early stage venture capital firm. Prior to Geocapital, he served as a senior financial analyst in the information technology mergers and acquisitions group at Broadview International L.L.C. Mr. Hale is a director of several private companies.
Gerald A. Poch was appointed to the Board in December 2003. Mr. Poch has served as Managing Director of Pequot Capital Management, Inc., Pequot’s investment manager/advisor, since January 2000. He is also a General Partner of Pequot Ventures. From August 1998 through January 2000, he was a principal of Pequot Capital Management and one of the leaders of Pequot’s venture capital team. From August 1996 to June 1998 he was the Chairman, President and Chief Executive Officer of GE Capital Information Technology Solutions, Inc., a technology solutions provider. Prior to that, he was a founder, and served as Co-Chairman and Co-President, of AmeriData Technologies, Inc., a value-added reseller and systems integrator of hardware and software systems. Mr. Poch is also a director of Andrew Corporation and BriteSmile, Inc., both public companies. In addition, Mr. Poch is a director of a number of private companies.
Daniel R. Young was appointed to the Board in April 2003. In 1976, Mr. Young joined Federal Data Corporation as Executive Vice President. He was appointed President in 1985 and became Chief Executive Officer in 1995. From 1995 until Federal Data was acquired by Northrop-Grumman in 2000, he was Vice Chairman and Chief Executive Officer. Mr. Young is a graduate of the University of Texas where he earned a B.S. degree in engineering and a J.D. from the University of Texas School of Law. He also served as an officer in the U.S. Navy. Mr. Young serves as a director of GTSI Corporation and Halifax Corporation, and also serves on the advisory boards of several public and private companies.
The Board has affirmatively determined that Messrs. Faurer, Faulders and Young are “independent” under the standards and rules of the American Stock Exchange and the Securities and Exchange Commission. Beginning in 2004, at least one executive session per year will be conducted by our independent directors, without the presence of management.
As of February 2004, Messrs. Faurer, Faulders and Young are members of our Audit Committee and Messrs. Faurer, Faulders and Poch are members of our Compensation Committee.
The Audit Committee is comprised entirely of independent non-employee directors. The Board has affirmatively determined that all members of the Audit Committee are “financially sophisticated” under the definition contained in the American Stock Exchange rules, and that Mr. Faulders has all the necessary attributes to be an “audit committee financial expert” under the SEC rules. The Audit Committee has a written charter which is annually reviewed and updated if necessary. Based on its current charter, the Audit Committee’s responsibilities include, among other things:
The Compensation Committee evaluates management’s recommendations and makes its own recommendations to the Board concerning the compensation of the Company’s executive officers. It is also responsible for the formulation of the Company’s executive compensation policy and the research, analysis and subsequent recommendation regarding the establishment and administration of the Company’s stock option and stock purchase plans.
Compensation of Directors
As of January 1, 2003, directors receive a quarterly cash fee of $3,000 for their services. In addition, directors receive $1,000 per Board meeting attended, and $500 for each committee meeting attended (unless such meeting is combined with a full Board meeting). Under the Company’s 2002 Stock Option Plan, each non-employee director is entitled to be granted an option to purchase 5,000 shares of Common Stock on the date of such director’s initial appointment to the Board and, while such director serves on the Board, he or she is entitled to be granted an option to purchase 5,000 shares of Common Stock on the date of the first Board meeting held in each new fiscal year. Directors who are employees do not receive any additional compensation for their service as directors. Directors are reimbursed for out-of-pocket expenses associated with their attendance at Board meetings.
Executive Officers
The following table contains information as to the executive officers of the Company, who are not also directors of the Company:
Name | Age | Officer Since | Office Held With Company | |||
Michael Stolarik | 53 | 2004 | President and Chief Operating Officer | |||
Ronald B. Alexander | 56 | 2001 | Senior Vice President, Chief Financial Officer and Corporate Secretary | |||
Stephen C. Dolbey | 57 | 2003 | Vice President | |||
Charles Floyd | 63 | 2003 | Vice President | |||
Heinz Wimmer | 59 | 2003 | Vice President | |||
Julie Holt | 40 | 2003 | President, Advanced Biosystems, Inc. (subsidiary) |
Michael Stolarik was appointed President and Chief Operating Officer of the Company in February 2004. Most recently, Mr. Stolarik was Managing Partner of the INSIGHT Consulting Group, LLC, which focused on introducing commercial businesses to federal government contracting. Prior to INSIGHT, he was Executive Vice President, Technical Resources Sector, of Titan Corporation. Mr. Stolarik joined Titan from GRC International, Inc. where he was President and CEO of this AT&T subsidiary. During this period, he was also a member of the AT&T Government Markets Senior Leadership Team. From 1995 through 1997, he was President and CEO of Space Applications Corporation. Prior to these positions, Mr. Stolarik spent 20 years at BDM International, Inc., where he rose to the position of Corporate Vice President.
Ronald B. Alexander was appointed Senior Vice President and Chief Financial Officer of the Company in November 2001 and Corporate Secretary in June 2002.From March 2000 until joining the Company, Mr. Alexander was the managing director of Alexander & Co., a financial and management consulting firm. From 1990 forward, Mr. Alexander has served as the Chief Financial Officer of public companies doing business in market segments involving computer manufacturing, IT technology and systems’ engineering, software development, internet infrastructure development, telecommunications equipment and services, and professional services. These firms include Commodore International, Ltd., a global computer manufacturing company, GRC International, a professional services government contractor and telecommunications equipment and systems developer, AppNet Systems, Inc., a provider of e-commerce solutions and TTC Inc., a telecommunications equipment and systems manufacturer.
Stephen C. Dolbey was appointed Vice President of the Company in January 2003. Mr. Dolbey is responsible for western operations, focusing on advanced software development and test using modern CASE tools and innovative testing concepts in the area of embedded real time systems. From March 1988 until November 2001, Mr. Dolbey was Vice President and Chief Information Officer of the former Analex Corporation acquired in November 2001. From 1964 to 1988, Mr. Dolbey held various management and engineering positions with Westinghouse Defense Systems.
Charles Floydwas appointed Vice President of the Company in January 2003. Mr. Floyd joined Analex in 2002 as Program Manager of the Company’s ELVIS contract with NASA. He has over 36 years of experience in vehicle systems and sub-systems, systems integration and test, and flight software development and testing. Twenty years were with NASA, and the 16 most recent have been in senior and program management positions in contracts supporting NASA. From 1994 to 1999, Mr. Floyd was with Raytheon, from 1991 to 1994 with Northrop-Grumman, and from 1985 to 1991 with Lockheed Martin.
Heinz Wimmer was appointed Vice President of the Company in January 2003. Mr. Wimmer is responsible for mid-west operations focusing on independent verification and validation activity with the National Reconnaissance Office for their Atlas expendable launch vehicle missions. From February 2000 until November 2001, Mr. Wimmer was Vice President of the former Analex Corporation acquired in 2001. Prior to joining Analex, Mr. Wimmer concluded a 34 year career with NASA at the Glenn Research Center including 25 years experience with expendable launch vehicles.
Julie Holt was appointed Vice President of the Company in January 2003 and also serves as President of the Company’s Advanced Biosystems, Inc. (ABS) subsidiary. Prior to joining the Company, from 1998 to 2002, Ms. Holt was Program Manager at Battelle Memorial Institute, where she coordinated consequence management programs with federal, state, and local emergency management agencies and hazardous material first responders. In addition, Ms. Holt is a former Foreign Service Officer with the U.S. Department of State.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Exchange Act requires the Company’s officers, directors and persons who own more than 10% of a registered class of he Company’s equity securities to file repots of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and greater than 10% stockholders are required by the regulations to furnish the Company with copies of the Section 16(a) forms which they file.
To the Company’s knowledge, based solely on a review of the copies of such reports furnished to the Company, and written representations that no other reports were required during the year ended December 31, 2003, all Section 16(a) filing requirements applicable to the Company’s officers, directors and greater than ten percent beneficial owners were complied with in a timely manner, except that Mr. Charles Floyd, Mr. Gerald Young, Ms. Lese Ann Kodger, former directors, Messrs. Gilluly and Stout, and former executive officer, George Tonn have failed to timely file their Form 4s.
Code of Conduct and Ethics
The Board has adopted a Code of Conduct and Ethics that is applicable to all officers (including chief executive officer, chief operating officer, chief financial officer, principal accounting officer, controller and any person performing similar functions), directors and employees of the Company. The Code is attached as Exhibit 14 with this Annual Report on Form 10-K.
In support of its Code of Conduct and Ethics and to facilitate reporting of any actual or suspected misconduct, the Company maintains a toll-free Ethics Hotline at 1-866-274-3865, which is available 24 hours a day, 7 days a week. The Hotline’s function is to receive information relating to possible non-compliance with the Code of Conduct and Ethics, as well as concerns or complaints regarding the Company’s accounting, or internal controls, or auditing matters. Both the Code of Conduct and Ethics and the Hotline information will be posted on the Company’s web site atwww.analex.com. Any amendment to, or waiver from, a provision of this Code of Conduct and Ethics will be promptly disclosed on the Company’s web site atwww.analex.com. The Company will also provide copies of its Code of Conduct and Ethics without charge to any stockholder who makes written request to our Chief Financial Officer at our headquarters address.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth information concerning all compensation paid by the Company during the year ended December 31, 2003 to its Chief Executive Officer, and each of the five other most highly paid executive officers (the “Named Executive Officers”):
Summary Compensation Table
Item 10. | Directors and Executive Officers of the Registrant |
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Stock Option Grants
The Company grants options to its executive officers under its 2002 Stock Option Plan and, in some cases, pursuant to stock option agreements outside any of its equity incentive plans. The following table provides details regarding all stock options granted to the Named Executive Officers during the year ended December 31, 2003:
Option Grants in Last Fiscal Year
Individual Grants | Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term(2) | ||||||||||||||
Name | Number of Securities Underlying Options Granted | % of Total Options Granted to Employees in 2003 | Exercise or Base Price ($/sh) | Expiration Date | |||||||||||
5% | 10% | ||||||||||||||
Sterling E. Phillips, Jr. | 200,000 | 25 | % | 2.42 | 1/29/13 | $ | 304,000 | $ | 772,000 | ||||||
Ronald B. Alexander | 100,000 100,000 | 13 13 | % % | 2.42 2.54 | 1/29/13 6/5/13 | $ $ | 152,000 140,000 | $ $ | 386,000 374,000 | ||||||
Stephen C. Dolbey | 50,000 | 6 | % | 2.42 | 1/29/13 | $ | 76,000 | $ | 193,000 | ||||||
Heinz L. Wimmer | 50,000 | 6 | % | 2.42 | 1/29/13 | $ | 76,000 | $ | 193,000 | ||||||
George W. Tonn(3) | — | — | — | — | — | — | |||||||||
Charles W. Floyd | 50,000 | 6 | % | 2.42 | 1/29/13 | $ | 76,000 | $ | 193,000 |
Options ExercisedThe information required by Items 10, 11, 12, 13 and Year End Option Values
The following table sets forth certain information regarding options exercised during the year ended December 31, 2003 and the value14 of unexercised options held asPart III of December 31, 2003 by the Named Executive Officers:
Aggregated Options Exercises in Last Fiscal Year and Fiscal Year-End Option Values
Name | Shares Acquired on Exercise (#) | Value Realized ($) | Number of Securities Underlying Unexercised Options at FY-End (#) | Value of Unexercised In-the-Money Options at FY-End ($)(1) | ||||||||||
Exercisable | Unexercisable | Exercisable | Unexercisable | |||||||||||
Sterling E. Phillips, Jr. | — | — | 1,417,779 | 371,025 | $ | 2,759,207 | $ | 508,653 | ||||||
Ronald B. Alexander | — | — | 241,668 | 133,332 | $ | 496,252 | $ | 155,998 | ||||||
Stephen C. Dolbey | — | — | 33,335 | 41,665 | $ | 44,669 | $ | 53,081 | ||||||
Heinz L. Wimmer | — | — | 66,668 | 58,332 | $ | 93,002 | $ | 77,248 | ||||||
George W. Tonn(2) | — | — | — | — | — | — | ||||||||
Charles W. Floyd | — | — | 16,668 | 33,332 | $ | 20,502 | $ | 48,331 |
EMPLOYMENT AGREEMENTS, TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENTS
On January 16, 2001, Mr. Phillips entered into an employment agreement with the Company pursuant to which he was appointed to the positions of President and Chief Executive Officer. The employment agreement provides for an initial term of one year, continuing on a month to month basis thereafter until terminated by either the Company or Mr. Phillips by giving thirty (30) days written notice. Pursuant to the employment agreement, Mr. Phillips purchased 66,667 shares of the Company’s restricted Common Stock, for $0.75 per share. In addition, under the agreement, Mr. Phillips was awarded a five-year, non-qualified stock option to purchase 875,725 shares of the Company’s Common Stock at the exercise price equal to 100% of the fair market value of the common stock on the grant date, exercisable in one-third increments over a two-year period. The employment agreement provides for an initial annual base salary of $175,000, subject to subsequent determination by the Compensation Committee of the Board. Mr. Phillips’ annual salary for the year ended December 31, 2003 was $220,000. Under the agreement, Mr. Phillips is eligible for an annual bonus upon the successful completion of annual milestones as agreed upon by Mr. Phillips and the Board of Directors at the recommendation of the Compensation Committee. The amount of the bonus is determined by the Board with the recommendation of the Compensation Committee. If the Company terminates Mr. Phillips’ employment without “Cause” (as defined in the agreement), Mr. Phillips is entitled to receive, on a bi-weekly basis within 12 months after the date of termination, the sum of (i) his base salary through the date of termination to the extent not already paid, (ii) any compensation he has previously deferred, (iii) any accrued vacation pay, to the extent not already paid, and (iv) the base salary that wouldForm 10-K have been payable for the twelve month period immediately following such termination. If Mr. Phillips’ employment is terminated for “Cause” (as definedomitted in the agreement) or he voluntarily leaves employment with the Company, he is not entitledreliance on General Instruction G(3) to any remuneration past the date of termination. The employment agreement provides for reimbursement of Mr. Phillips’ reasonable expenses incurred in connection with his dutiesForm 10-K and medical and other customary benefits.
Mr. Jon M. Stout, former Chairman of the Board, had an employment agreement with the Company pursuant to which he was paid $140,000 during the year ended December 31, 2003. Pursuant to an Employment Termination Agreement dated December 9, 2003, Mr. Stout received a lump sum payment of $280,000 from the Company in consideration of the termination of his employment agreement. In addition, the Company entered into a Non-Competition Agreement with Mr. Stout in December 2003. As long as Mr. Stout is in compliance with the Non-Competition Agreement, the Company will pay him $50,000 every three months, during the term of the agreement, for an aggregate consideration of $600,000.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The responsibility of the Compensation Committee is to administer the Company’s executive compensation programs, to monitor corporate performance and its relationship to compensation of executive officers and to make appropriate recommendations concerning matters of executive compensation. This report sets forth the major components of executive compensation and the basisare incorporated herein by which 2003 compensation determinations were made with respect to the executive officers of the Company.
Compensation Policy and Guidelines
The main objective of the Company is to maintain and increase the profitability of its operations and to maximize value for stockholders, employees and clients. The goals of the Company’s compensation policy are to align executive compensation with the Company’s long-term business objectives and performance, to enable the Company to attract and retain high-quality executive officers and employees who will contribute to the long-term success of the Company and to reward such executive officers and employees for their successful efforts in attaining objectives beneficial to the growth and profitability of the Company.
In order to achieve the Company’s goals, the Compensation Committee has developed the following principles that serve as guidance for compensation decisions for all employees: (i) to attract and retain the most
highly qualified management and employee team, (ii) to pay competitively with prevailing industry standards, (iii) to emphasize sustained performance by aligning monetary rewards with stockholder interests, (iv) to emphasize performance-related contributions as the basis of pay decisions, and (v) to provide incentive bonus awards for management based upon attaining revenue and profitability goals. To implement these policies, the Compensation Committee has designed a compensation program consisting of base salary, an annual incentive bonus plan, stock options and other employment benefits.
Compensation Program Elements
The Company’s compensation levels and benefits are reviewed on an annual basis to determine whether they are competitive and reasonable in light of the overall performance of the Company and the Company’s ability to attract and retain talented executives. The Company’s focus is on growth and profitability.
Base Salary. Salary levels are primarily determined by the Compensation Committee in consideration of the performance of the individual executive, the financial performance of the Company and the prevailing industry standards for similar executives of similar companies. The Company’s philosophy regarding base salaries is conservative, using published industry reports and surveys on executive compensation. Approximately 47% of the Company’s business is in information technology, 47% in engineering and 6% in bio-medical fields. The Company therefore compares itself for this purpose with other small public technology service providers and/or government contracting firms that are primarily in the business of providing information technology or engineering services to the government. The Compensation Committee has not evaluated corporate performance of these firms other than to develop a general sense that they are successful growing firms. Periodic increases in base salary relate to individual contribution evaluated against pre-established objectives.
Stock Options. The Company believes the compensation program should provide employees with an opportunity to increase their ownership and potentially gain financially from Company stock price increases. By this approach, the interests of stockholders, executives and employees are closely aligned. Through the Company’s 2002 Stock Option Plan, executives and employees are eligible to receive stock options, giving them the right to purchase shares of Common Stock of the Company at a specified price in the future. The Compensation Committee believes the use of stock options as the basis for long-term incentive compensation meets the Compensation Committee’s defined compensation strategy and the team-based operations approach that the Company has adopted.
In considering the award of stock options, management and the Compensation Committee consider several factors: individual performance versus assigned objectives; profit contribution; criticality of the individual to the future success of the Company, and overall contributionreference to the Company’s success. Management recommends option grantsdefinitive proxy statement to the Compensation Committee and the Compensation Committee revises and approves the final grants. As part of the process, the Compensation Committee also reviews the current stock and option holdings of the nominees, their total compensation and the history of option grants to each individual under consideration.
Bonus and Incentive Programs. The Company’s executive officers and operating managers participate in an incentive compensation program which awards cash bonuses of specific amounts based on attaining or exceeding specific revenue and profitability targets established at the beginning of fiscal year 2003. These targets may include revenue, new business, divisional EBITDA, or corporate EBITDA. Underachievement of the target by a specified percentage will generate no bonus, and overachievement of the target by a specified percentage will generate a defined multiple of the bonus up to a maximum amount specified.
For instance, the Company did not pay any cash bonuses to executive officers in 2001. In 2002 however, due to the improved financial performance of the Company and the individual performance of the executive officers receiving bonuses, the Company paid an aggregate of $603,100 in cash bonuses to its executive officers. In 2003, the Company paid an aggregate of $542,400 in cash bonuses to its executive officers.
Executive officers are entitled to additional cash bonuses based upon performance at the discretion of the Compensation Committee and in some cases, the Chief Executive Officer. The cash bonuses paid to the Named Executive Officers in 2003 are set forth in the “Executive Compensation—Summary Compensation Table”.
Severance Compensation. To retain highly qualified executive officers, the Company from time to time enters into severance agreements with certain of its officers. The determination of whether the Company would benefit from a severance agreement with a particular officer is subjective, based upon such officer’s experience and value to the Company.
Other Benefits. The Company’s philosophy is to provide adequate health and welfare oriented benefits to executives and employees, but to maintain a highly conservative posture relative to executive benefits.
2003 Compensation for the President and Chief Executive Officer
During 2003, Mr. Phillips was paid an annual base salary of $220,000 and received a bonus of $185,412 based upon the Company’s performance against annual budgetary targets established by the Board. Mr. Phillips was eligible for the bonus because the Company has achieved an EBITDA target established by the Compensation Committee at the beginning of fiscal year 2003. Underachievement of the target by a specified percentage will generate no bonus, and overachievement of the target by a specified percentage will generate a defined multiple of the bonus up to a maximum amount specified.
In addition, consistent with the Compensation Committee’s goal of increasing employee ownership of Common Stock, described above, Mr. Phillips was awarded options to purchase 200,000 shares of Common Stock in 2003. The options vest over a two year period, with one-third vesting on the date of grant and one-third vesting on each of the first and second anniversaries of the date of grant. The options expire five years from the grant date, and have an exercise price equal to the fair market value of the Common Stock on the grant date. It is the Compensation Committee’s view that the award of these stock options continues to be an effective way of tying Mr. Phillips’ financial interests to those of the Company’s stockholders, since the value of these stock options is directly linked to increases in stockholder value.
Summary
The Compensation Committee believes the total compensation program for executives of the Company, including the Chief Executive Officer, is appropriate and competitive with the total compensation programs provided by similar companies in the industry with which the Company competes. The Compensation Committee believes its compensation practices are directly tied to stockholder returns and linked to the achievement of annual and longer-term financial and operating results of the Company on behalf of the Company’s stockholders.
The material in this report is not “soliciting material,” is not deemed filed with the SEC and is not incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
Submitted by the Compensation Committee
Peter C. Belford
Lincoln D. Faurer
Compensation Committee Interlocks and Insider Participation
From January 2003 through March 2003, the members of the Compensation Committee were Peter C. Belford and Shawna L. Stout. Lincoln D. Faurer joined the Compensation Committee in April 2003. In
December 2003, Gerald Poch replaced Shawna Stout, and in February 2004, Thomas Faulders replaced Peter Belford. None of the members of the Compensation Committee during the year ended December 31, 2003 was, during such year or prior thereto, an officer or employee of the Company or any of its subsidiaries, except that Mr. Belford was an officer of the former Analex Corporation, until it was acquired by the Company in November 2001. During the year ended December 31, 2003, no executive officer of the Company served as a director or member of the compensation committee (or other board committee performing similar functions, or in the absence of such committee, the entire board of directors) of another entity, one of whose executive officers served as a director or member of the Compensation Committee of the Company.
During the year ended December 31, 2003, Mr. Belford was paid $150,008 pursuant to a promissory note issued to him in connection with the November 2001 acquisition of the former Analex Corporation. In July 2002, pursuant to the terms of the merger agreement for the Analex acquisition, the Company issued a promissory note in the principal amount of $200,000 to Mr. Belford with respect to the award of the NASA Expendable Launch Vehicle Integrated Support (ELVIS) contract to the Company. This note has a three-year term, is payable in twelve quarterly payments, and bears an interest rate equal to the prime rate plus one percent, adjustable on an annual basis on the anniversary date of the note. In 2003, the Company paid Mr. Belford $75,521Regulation 14A promulgated under this note.
Ms. Stout’s father, Jon M. Stout, has an employment agreement with the Company pursuant to which he was paid $140,000 during the year ended December 31, 2003. Pursuant to an Employment Termination Agreement dated December 9, 2003, Mr. Stout received a lump sum payment of $280,000 from the Company in consideration of the termination of his employment agreement. In addition, the Company entered into a Non-Competition Agreement with Mr. Stout in December 2003. As long as Mr. Stout is in compliance with the Non-Competition Agreement, the Company will pay him $50,000 every three months, during the term of the agreement, for an aggregate consideration of $600,000.
Common Stock Performance Graph
The following graph compares the cumulative, five-year stockholder returns on the Company’s Common Stock with the cumulative returns of the (i) American Stock Exchange Market Index, (ii) the Media General Other Business Services Index, comprised of the common stock of approximately 200 companies, excluding the Company, in diversified business service industries, and (iii) the Media General Information Technology Services Index, comprised of approximately 43 companies, excluding the Company, providing computer and information technology consulting, development and implementation services. The graph assumes the value of the investment in the Company’s Common Stock and each index was $100 on July 1, 1998.
Fiscal Year Ending(1)
Company | 1999 | 2000 | 6 months ended 12/31/00 | 2001 | 2002 | 2003 | ||||||
Analex Corporation | 100.00 | 58.34 | 77.09 | 116.67 | 156.68 | 243.36 | ||||||
Medial General Information Technology Services Index | 100.00 | 72.41 | 69.91 | 74.69 | 40.61 | 57.53 | ||||||
AMEX Market Index | 100.00 | 114.99 | 106.59 | 101.68 | 97.62 | 132.87 |
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information as of March 15, 2004 regarding the beneficial ownership of the Company’s Common Stock of (i) each person known to the Company to be the beneficial owner, within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of more than 5% of the outstanding shares of Common Stock, (ii) each director of the Company, (iii) each executive officer of the Company named in the Summary Compensation Table (see “Executive Compensation”) and (iv) all current executive officers and directors of the Company as a group. Unless otherwise indicated, the address of each named beneficial owner is c/o Analex Corporation, 5904 Richmond Highway, Suite 300, Alexandria, Virginia 22303. Except to the extent indicated in the footnotes, each of the beneficial owners named below has sole voting and investment power with respect to the shares listed. The percentages shown below are calculated in accordance with Securities and Exchange Commission rules and are based on 13,036,175 shares of Common Stock outstanding as of March 15, 2004.amended.
Name and Address | Number of Shares | Percent of Class | ||||
Pequot Capital Management, Inc. 500 Nyala Farm Road Westport, CT 06880 | 12,057,796 | (1)(2) | 48.1 | % | ||
J. Richard Knop Windsor Group One Discovery Square, Suite 700 12919 Sunset Hills Road Reston, VA 20190 | 1,074,982 | (1)(3) | 8.0 | % | ||
Peter C. Belford, Sr. | 1,038,733 | (1) | 8.0 | % | ||
C. W. Gilluly, Ed.D. 415 First Street, S.E. Washington, D.C. 20003 | 818,751 | (1)(4) | 6.3 | % | ||
Lese Ann Kodger P.O. Box 45515 Westlake, OH 44145 | 806,093 | (1) | 6.2 | % | ||
Gerald R. McNichols, Sc.D. | 742,984 | (1)(5) | 5.7 | % | ||
DRG Irrevocable Trust | 700,000 | (6) | 5.4 | % | ||
DSG Irrevocable Trust | 700,000 | (7) | 5.4 | % | ||
RSSJ Associates, LLC | 716,014 | (8) | 5.5 | % | ||
Martin M. Hale, Jr. | 12,061,128 | (1)(9) | 48.1 | % |
36
Name and Address Number of Shares Percent of Class Gerald A. Poch Thomas Faulders Lincoln D. Faurer Daniel R. Young Sterling E. Phillips, Jr. Ronald B. Alexander Michael Stolarik George W. Tonn(17) Heinz L. Wimmer Charles W. Floyd Stephen C. Dolbey Stockholders’ Agreement Voting Group All current directors and executive officers as a group (13 persons) 12,061,128 (1)(10) 48.1 % 1,666 (11) * 4,999 (12) * 24,999 (13) * 1,828,905 (1)(14) 12.4 % 281,112 (15) 2.1 % 100,000 (16) * 218,393 1.7 % 114,741 (18) * 33,715 (19) * 71,574 (20) * 19,009,983 (1)(2) 70.8 % 15,564,904 (21) 56.8 %
* Less than 1%PART IV
Set forth below is certain information as of December 31, 2003 with respect to compensation plans (including individual compensation arrangements) under which equity securities of the Company are authorized for issuance.
Plan category | Number of securities to be issued upon exercise of outstanding options and rights | Weighted average exercise price | Number of securities remaining available for issuance under the plan(s) | |||||
Equity compensation plans approved by stockholders | ||||||||
2002 Stock Option Plan | 1,607,579 | $ | 2.36 | 392,421 | ||||
2000 Stock Option Plan | 519,000 | $ | 1.18 | 81,000 | ||||
1994 Stock Option Plan | 178,300 | $ | 1.06 | 466,700 | ||||
Equity compensation plans not approved by stockholders | 875,725 | (1) | $ | 1.38 | 0 |
Item 13. Certain Relationships and Related Transactions
In connection with the Stout Repurchase Agreement between the Company, former Chairman of the Board, Mr. Jon M. Stout and certain members of Mr. Stout’s immediate family, including former Company director, Ms. Shawna Stout, and certain entities controlled by Mr. Stout and his family (the “Stout Parties”), the Company purchased from the Stout Parties in December 2003, an aggregate of 2,625,451 shares of Common Stock and warrants and options exercisable to purchase an aggregate of 1,209,088 shares of Common Stock for an aggregate consideration of $9,166,844.21.
Pursuant to an Employment Termination Agreement dated December 9, 2003, Mr. Jon M. Stout also received a lump sum payment of $280,000 from the Company in consideration of the termination of his employment agreement. In addition, the Company entered into a Non-Competition Agreement with Mr. Stout, which provides that for as long as Mr. Stout is in compliance with the Non-Competition Agreement, the Company will pay him $50,000 every three months, during the term of the agreement, for an aggregate consideration of $600,000.
During the year ended December 31, 2003, Lese Ann Kodger, a beneficial holder of more than 5% of the Company’s Common Stock, Alex Patterson, Ms. Kodger’s brother, and Peter C. Belford, a director of the Company, were paid $13,500, $16,500 and $150,008 respectively, pursuant to promissory notes issued in connection with the November 2001 acquisition of the former Analex Corporation. In July 2002, pursuant to the terms of the merger agreement for the Analex acquisition, the Company issued promissory notes in the principal amounts of $200,000 and $700,000 to Mr. Belford and Mr. Patterson, respectively, with respect to the award of the NASA Expendable Launch Vehicle Integrated Support (ELVIS) contract to the Company. Each of these notes has a three-year term, is payable in twelve quarterly payments, and bears an interest rate equal to the prime rate plus one percent, adjustable on an annual basis on the anniversary date of the note. In 2003, the Company paid Mr. Belford and Mr. Patterson $75,521 and $264,323.
Item 14. Principal Accountant Fees and Services
Our Audit Committee is responsible for appointment of the Company’s independent auditors. The following table sets forth the aggregate fees billed to Analex for the fiscal year ended December 31, 2003 and 2002, by the Company’s principal accountants, Ernst & Young LLP.
2003 | 2002 | |||||
Audit Fees(1) | $ | 225,928 | $ | 105,100 | ||
Audit-Related Fees(2) | — | 53,500 | ||||
Tax Compliance | 41,000 | 6,000 | ||||
Total Fees | $ | 266,928 | $ | 164,600 | ||
The audit and non-audit services performed by Ernst & Young LLP in 2003 were pre-approved by the Audit Committee. The Audit Committee has determined that the provision of certain designated audit-related, tax and all other services do not impair the independence of Ernst & Young. The Audit Committee has given general approval for the Chief Financial Officer or his designee to engage Ernst & Young to provide certain permitted services if the fee for such services is not expected to exceed 5% of the total amount of fees paid by the Company to Ernst & Young during the fiscal year in which the services are rendered, and that such services have been promptly brought to the attention of the Audit Committee prior to the completion of the audit.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Financial Statements
Report of Independent | F-1 | |
Consolidated Balance Sheets as of December 31, | F-2 | |
F-3 | ||
F-4 | ||
F-5 | ||
F-6 |
(a) (2) Financial Statement Schedules
All schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and notes thereto.
(a) (3) Exhibits
Exhibit Index | ||
2.1 | Agreement and Plan of Merger by and among Analex Corporation, certain Sellers, Analex Corporation Employee Stock Ownership Plan and Trust, Hadron, Inc. and Hadron Acquisition Corp., as of October 31, 2001 (previously filed). | |
2.2 | Agreement and Plan of Merger by and among Analex Corporation, Alpha-N Acquisition Corporation, ComGlobal Systems , Incorporated and Stockholders of ComGlobal, dated April 1, 2005 (incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on April 6, 2005). | |
3.1 | Certificate of Incorporation (incorporated by reference to the Company’s Form 10-Q for the fiscal quarter ended June 30, 2002 and filed with the Commission on August 14, 2002). | |
3.1.1 | Certificate of Amendment of Certificate of Incorporation, dated November 19, 2001 (incorporated by reference to the Company’s form 10-Q for the fiscal quarter ended June 30, 2002 and filed with the Commission on August 14, 2002). | |
3.1.2 | Certificate of Amendment of Certificate of Incorporation, dated June 25, 2002 (incorporated by reference to the Company’s Form 10-Q for the fiscal quarter ended June 30, 2002 and filed with the Commission on August 14, 2002). | |
3.1.3 | Certificate of Amendment, dated December 9, 2003, to Certificate of Incorporation (incorporated by reference to the Company’s registration statement on a Form S-3 filed with the Commission on January 8, 2004). | |
3.1.4 | Certificate of Designations, |
37
Exhibit Index | ||
3.1.5 | Amendment to Certificate of Designations, Powers, Preferences and Rights of Series A Convertible Preferred Stock (incorporated by reference to Annex B of the Company’s Definitive Proxy Statement on Schedule 14A filed with the Commission on August 9, 2004). | |
3.1.6 | Certificate of Designations, Powers, Preferences and Rights of Series B Convertible Preferred Stock (incorporated by reference to Annex C of the Company’s Definitive Proxy Statement on Schedule 14A filed with the Commission on August 9, 2004). | |
3.2 | Amended and Restated Bylaws (incorporated by reference to the Company’s registration statement on a Form S-3 filed with the Commission on January 8, 2004). |
3.2.1 | Amendment No. 1 to Amended and Restated Bylaws (incorporated by reference to the Company’s Amendment No. 1 to the Form S-3 registration statement filed with the Commission on March 10, 2004). | |
3.2.2 | Amendment No. 2 to Amended and Restated Bylaws (incorporated by reference to the Company’s Form 8-K filed with the Commission on June 15, 2004). | |
3.2.3 | Amendment No. 3 to Amended and Restated By-Laws (incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on April 12, 2005). | |
4.1 | Form of Secured Subordinated Convertible Promissory Note (incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on July 21, 2003). | |
4.2 | Form of Common Stock Purchase Warrant issued to the Pequot Funds, General Electric Pension Trust and New York Life Capital Partners (incorporated by reference to Annex E of the Company’s | |
10.1.1 | ||
10.1.2 | ||
10.1.3 | ||
10.1.5 | Form of Option Exchange and Stock Appreciation Right Agreement under the 2000 Stock Incentive Plan (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). | |
10.1.6 | Analex Corporation 2002 Stock Incentive Plan (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). | |
10.1.7 | Form of Stock Appreciation Right Agreement under the 2002 Stock Incentive Plan (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). | |
10.1.8 | Form of Option Exchange and Stock Appreciation Right Agreement under the 2002 Stock Incentive Plan (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). | |
10.1.9 | Restricted Stock Award Agreement with C. Wayne Grubbs, dated February 22, 2006 (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). |
38
Exhibit Index | ||
10.1.10 | Restricted Stock Award Agreement with V. Joseph Broadwater dated February 22, 2006 (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). | |
10.1.11 | Restricted Stock Award Agreement with Stephen C. Matthews, dated February 22, 2006 (incorporated by reference to the Form 8-K dated February 22, 2006, filed with the Commission on February 28, 2006). | |
10.2 | Form of Employment Agreement between the Company and Sterling E. Phillips, Jr. dated January 16, 2001 (incorporated by reference to the exhibits filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 filed with the Commission on August 14, 2001). | |
10.2.1 | Promissory Note between Peter C. Belford, Sr. and Hadron, Inc. dated November 5, 2001, pursuant to the Agreement and Plan of Merger between Hadron, Inc. and Analex Corporation (incorporated by reference to the exhibits filed with the Company’s Form 10-K for the year ended December 31, 2001 filed with the Commission on March 26, 2002). | |
10.2.2 | Promissory Note between Lese Ann Kodger and Hadron, Inc. dated November 5, 2001, pursuant to the Agreement and Plan of Merger between Hadron, Inc. and Analex Corporation (incorporated by reference to the exhibits filed with the Company’s Form 10-K for the year ended December 31, 2001 filed with the Commission on March 26, 2002). | |
10.2.3 | Promissory Note between Alex Patterson and Hadron, Inc. dated November 5, 2001, pursuant to the Agreement and Plan of Merger between Hadron, Inc. and Analex Corporation (incorporated by reference to the exhibits filed with the Company’s Form 10-K for the year ended December 31, 2001 filed with the Commission on March 26, 2002, Exhibit No. 10.26). | |
10.2.4 | Employment Termination Agreement by and between Analex Corporation and Jon M. Stout (incorporated by reference to the Company’s Current Report on Form 8-K dated July 18, 2003 and filed July 21, 2003). | |
10.2.5 | Confidentiality and Non-Competition Agreement by and between Analex Corporation and Jon M. Stout (incorporated by reference to the Company’s Current Report on Form 8-K dated July 21, 2003). | |
10.3 | Amended and Restated Credit Agreement by and between |
10.3.1 | Amended and Restated Intercreditor and Subordination Agreement by and among Bank of America, N.A., Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., General Electric Pension Trust, New York Life Capital Partnership, II, L.P., Analex Corporation and the subsidiaries of Analex Corporation, dated May 28, 2004 (incorporated by reference to Annex J of the Company’s Definitive Proxy Statement on Schedule 14A filed with the Commission on August 9, 2004). | |
10.3.2 | Junior Intercreditor and Subordination Agreement by and among, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., General Electric Pension Trust, New York Life Capital Partnership, II, L.P., Analex Corporation and the subsidiaries of Analex Corporation, dated May 28, 2004 (incorporated by reference to Annex K of the Company’s Definitive Proxy Statement on Schedule 14A filed with the Commission on August 9, 2004). | |
10.3.3 | Security Agreement between Hadron, Inc. and Bank of America, N.A. dated November 2, 2001 (incorporated by reference to the exhibits filed with the Company’s Form 10-K for the year ended December 31, 2001 filed with the Commission on March 26, 2002). | |
Pledge Agreement between Hadron, Inc. and Bank of America, N.A. dated November 2, 2001 (incorporated by reference to the exhibits filed with the Company’s Form 10-K for the year ended December 31, 2001 filed with the Commission on March 26, 2002). |
39
Exhibit Index | ||
10.3.7 | Amended and Restated Continuing and Unconditional Guaranty between Bank of America, N.A. and Subsidiaries of the Company dated | |
10.3.8 | ||
10.3.9 | ||
10.3.10 | ||
Expendable Launch Vehicle Integrated Support (ELVIS) contract by and between the Registrant and The National Aeronautics and Space Administration (NASA) (incorporated by reference to the Company’s Form 10-Q for the fiscal quarter ended June 30, 2002 and filed with the Commission on August 14, 2002). | ||
Subordinated Note and Series A Convertible Preferred Stock Purchase Agreement dated July 18, 2003, by and among the Company, Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III, L.P. (incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on July 21, 2003). | ||
Securities Repurchase Agreement, dated as of July 18, 2003, by and among Analex Corporation, Jon M. Stout, Patricia Stout, Shawna Stout, Marcus Stout, Stout Dynastic Trust and S Co, LLC (incorporated by reference to the Company’s Current Report on Form 8-K dated July 18, 2003 and filed July 21, 2003). | ||
10.6.1 | Series B Convertible Preferred Stock Purchase Agreement by and among Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., General Electric Pension Trust, New York Life Capital Partnership, II, L.P., Analex Corporation and the subsidiaries of Analex Corporation, dated May 28, 2004 (incorporated by reference to Annex A of the Company’s Definitive Proxy Statement on Schedule 14A filed with the Commission on August 9, 2004). | |
10.6.2 | Amended and Restated Stockholders’ Voting Agreement, dated |
40
Exhibit Index | ||
10.6.3 | ||
10.7 | Stock Purchase Agreement by and among Analex Corporation, Beta Analytics, Inc. and other parties named in the agreement, dated May 6, 2004 (incorporated by reference to the registrant’s Form 10-Q for the fiscal quarter ended March 31, 2004). | |
10.8 | Written Incentive Stock Option Agreement, dated September 1, 2005, by and between Analex Corporation and C. Wayne Grubbs (incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on | |
| ||
| ||
| ||
23* | Consent of Independent Registered Public Accounting Firm. | |
31.1* | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2* | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
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
On October 30, 2003,November 3, 2005, the Company filed a Form 8-K to include its financial results for the fiscal quarter ended September 30, 2003.2005.
On December 24, 2003, the Company filed a Form 8-K to disclose that (i) as of the closing of the Pequot Transaction on December 9, 2003, Pequot beneficially owned approximately 48.4% of the outstanding Common Stock and the Voting Stockholders (as defined in a Stockholders Agreement among Pequot and other principal stockholders of the Company), as a group, beneficially owned approximately 70.7% of the outstanding Common Stock; and (ii) immediately following the closing of the Pequot Transaction, the Board was constituted in accordance with the Stockholders’ Agreement and consisted of at the time Mr. Phillips, two directors designated by the Pequot Funds (Gerald A. Poch and Martin M. Hale, Jr.), and three non-employee directors designated by Mr. Phillips (Peter Belford, Sr., Lincoln D. Faurer and Daniel R. Young).41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March | ANALEX CORPORATION | |||||||
By: | /s/ STERLING E. PHILLIPS, JR. | By: | /s/ | |||||
Sterling E. Phillips, Jr. Chairman and Chief Executive Officer (Principal Executive Officer) |
Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/ Peter C. Belford, | Director | March | ||
/ C. Thomas Faulders, III | Director | March | ||
/ Lincoln D. Faurer | Director | March | ||
/s/ MARTIN HALE, JR. Martin Hale, Jr. | Director | March | ||
/S/ THOMAS L. HEWITT Thomas L. Hewitt | Director | March 3, 2006 | ||
/s/ DANIEL P. MARCH Daniel P. March | Director | March 2, 2006 | ||
/s/ STERLING E. PHILLIPS, JR. Sterling E. Phillips, Jr. | Chairman | March | ||
/s/ GERALD POCH Gerald Poch | Director | March | ||
/s/ DANIEL R. YOUNG Daniel R. Young | Director | March |
42
REPORT OF INDEPENDENT AUDITORSREGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Analex Corporation
We have audited the accompanying consolidated balance sheets of Analex Corporation and subsidiaries as of December 31, 20032005 and 20022004 and the related consolidated statements of operations, convertible preferred stock and shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003.2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditingthe standards generally accepted inof the United States.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includesstatements, assessing the accounting principles used and significant estimates made by management, as well asand evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Analex Corporation and subsidiaries at December 31, 20032005 and 2002,2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003,2005, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the consolidated financial statements, the Company changed its accounting for goodwill and intangible assets, which was effective in 2001 for acquisitions subsequent to July 1, 2001, and January 1, 2002 for all acquisitions prior to July 1, 2001.
/s/ ERNST & YOUNG LLP
McLean, Virginia
February 13, 200422, 2006
F-1
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 20032005 AND 20022004
2003 | 2002 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 14,177,500 | $ | 301,800 | ||||
Accounts receivable, net | 10,719,400 | 12,556,100 | ||||||
Deferred tax asset | 150,000 | — | ||||||
Prepaid expenses and other | 483,600 | 270,500 | ||||||
Total current assets | 25,530,500 | 13,128,400 | ||||||
Fixed assets, net | 552,900 | 216,700 | ||||||
Goodwill | 15,281,600 | 15,534,600 | ||||||
Contract rights and other intangibles, net | 1,753,000 | 1,770,200 | ||||||
Deferred financing costs | 464,600 | 75,900 | ||||||
Other | 49,500 | 58,400 | ||||||
Total other assets | 18,101,600 | 17,655,800 | ||||||
Total assets | $ | 43,632,100 | $ | 30,784,200 | ||||
LIABILITIES, CONVERTIBLE PREFERRED STOCK | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 776,200 | $ | 3,294,700 | ||||
Note payable—line of credit | — | 2,187,700 | ||||||
Note payable—bank term note | 700,000 | 700,000 | ||||||
Notes payable —other | 1,487,400 | 1,012,100 | ||||||
Other current liabilities | 5,463,500 | 5,258,400 | ||||||
Total current liabilities | 8,427,100 | 12,452,900 | ||||||
Note payable—bank term note | 1,341,700 | 2,041,700 | ||||||
Notes payable—other | 1,209,300 | 2,297,200 | ||||||
Convertible debt | 2,881,400 | — | ||||||
Other | 43,800 | 90,600 | ||||||
Total long-term liabilities | 5,476,200 | 4,429,500 | ||||||
Total liabilities | 13,903,300 | 16,882,400 | ||||||
Commitments and contingencies | ||||||||
Series A convertible preferred stock | 236,300 | — | ||||||
Shareholders’ equity: | ||||||||
Common stock $.02 par; authorized 65,000,000 shares; issued and outstanding—December 31, 2003, 13,036,666 shares and December 31, 2002, 14,427,080 shares | 260,700 | 288,500 | ||||||
Additional paid in capital | 28,519,100 | 21,171,400 | ||||||
Warrants outstanding | 5,762,900 | — | ||||||
Deferred compensation | — | (7,700 | ) | |||||
Accumulated other comprehensive loss | (43,800 | ) | (90,600 | ) | ||||
Accumulated deficit | (5,006,400 | ) | (7,459,800 | ) | ||||
Total shareholders’ equity | 29,492,500 | 13,901,800 | ||||||
Total liabilities, convertible preferred stock and shareholders’ equity | $ | 43,632,100 | $ | 30,784,200 | ||||
2005 | 2004 | |||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 3,459,200 | $ | 1,034,200 | ||||
Accounts receivable, net | 31,067,500 | 18,350,400 | ||||||
Prepaid expenses and other | 4,192,000 | 4,037,800 | ||||||
Inventory | 253,500 | — | ||||||
Property held for sale | 430,600 | — | ||||||
Total current assets | 39,402,800 | 23,422,400 | ||||||
Property and equipment, net | 2,726,000 | 1,434,700 | ||||||
Contract rights and other intangible assets, net | 10,404,800 | 6,363,500 | ||||||
Goodwill | 77,887,000 | 43,175,200 | ||||||
Other assets | 671,700 | 526,300 | ||||||
Total assets | $ | 131,092,300 | $ | 74,922,100 | ||||
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities | ||||||||
Accounts payable | $ | 1,877,300 | $ | 2,452,100 | ||||
Notes payable—other | 387,500 | 904,200 | ||||||
Deferred tax liability, net | 780,300 | 927,400 | ||||||
Other current liabilities | 13,918,600 | 8,919,500 | ||||||
Total current liabilities | 16,963,700 | 13,203,200 | ||||||
Notes payable—line of credit | 27,631,400 | 5,624,100 | ||||||
Notes payable—other | — | 329,600 | ||||||
Series A convertible note | 6,497,700 | 4,689,500 | ||||||
Deferred tax liability, net | 3,677,200 | 2,123,500 | ||||||
Other long term liabilities | 1,131,500 | — | ||||||
Total long-term liabilities | 38,937,800 | 12,766,700 | ||||||
Total liabilities | 55,901,500 | 25,969,900 | ||||||
Commitments and contingencies (Note 12) | — | — | ||||||
Series A convertible preferred stock; 6,726,457 shares issued and outstanding at December 31, 2005 and December 31, 2004 | 7,736,300 | 3,986,300 | ||||||
Series B-1 convertible preferred stock; 3,428,571 shares issued and outstanding at December 31, 2005 and December 31, 2004 | 12,000,000 | 12,000,000 | ||||||
Series B-2 convertible preferred stock; 7,142,856 shares issued and outstanding at December 31, 2005; 0 shares issued and outstanding at December 31, 2004 | 16,493,300 | — | ||||||
Shareholders’ equity | ||||||||
Common stock; $0.02 par; authorized 65,000,000 shares; issued and outstanding December 31, 2005, 16,340,445 shares and December 31, 2004, 15,422,110 shares | 326,800 | 308,400 | ||||||
Additional paid-in capital | 50,279,000 | 40,070,300 | ||||||
Warrants outstanding | 9,228,300 | 6,803,300 | ||||||
Accumulated deficit | (20,872,900 | ) | (14,216,100 | ) | ||||
Total shareholders’ equity | 38,961,200 | 32,965,900 | ||||||
Total liabilities, convertible preferred stock and shareholders’ equity | $ | 131,092,300 | $ | 74,922,100 | ||||
See Notes to Consolidated Financial StatementsThe accompanying notes are an integral part of these consolidated financial statements
F-2
ANALEX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002,2005, 2004 AND 20012003
2003 | 2002 | 2001 | 2005 | 2004 | 2003 | |||||||||||||||||||
Revenues | $ | 66,126,300 | $ | 59,317,000 | $ | 21,936,000 | ||||||||||||||||||
Operating costs and expenses: | ||||||||||||||||||||||||
Costs of revenue | 55,770,400 | 50,436,700 | 18,157,800 | |||||||||||||||||||||
Revenue | $ | 141,161,800 | $ | 94,416,700 | $ | 62,326,700 | ||||||||||||||||||
Operating cost and expenses | ||||||||||||||||||||||||
Cost of revenue | 112,373,600 | 75,605,000 | 52,436,500 | |||||||||||||||||||||
Selling, general and administrative | 6,318,000 | 5,048,700 | 2,967,600 | 15,681,500 | 10,776,800 | 5,787,500 | ||||||||||||||||||
Depreciation and amortization | 731,700 | 308,100 | 90,000 | |||||||||||||||||||||
Amortization of intangible assets | 450,800 | 307,600 | 378,400 | 3,372,700 | 1,420,900 | 450,800 | ||||||||||||||||||
Total operating costs and expenses | 62,539,200 | 55,793,000 | 21,503,800 | 132,159,500 | 88,110,800 | 58,764,800 | ||||||||||||||||||
Operating income | 3,587,100 | 3,524,000 | 432,200 | 9,002,300 | 6,305,900 | 3,561,900 | ||||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||
Interest income | — | — | 8,600 | 9,300 | 80,300 | — | ||||||||||||||||||
Interest expense | (519,800 | ) | (1,018,300 | ) | (225,200 | ) | (3,855,900 | ) | (9,002,200 | ) | (519,800 | ) | ||||||||||||
Total other expense | (519,800 | ) | (1,018,300 | ) | (216,600 | ) | ||||||||||||||||||
Income before income taxes | 3,067,300 | 2,505,700 | 215,600 | |||||||||||||||||||||
Income (loss) from continuing operations before income taxes | 5,155,700 | (2,616,000 | ) | 3,042,100 | ||||||||||||||||||||
Provision for income taxes | 320,900 | 149,100 | 19,600 | 3,248,800 | 1,193,400 | 311,200 | ||||||||||||||||||
Net income | 2,746,400 | 2,356,600 | 196,000 | |||||||||||||||||||||
Dividends on convertible preferred stock | (56,700 | ) | — | — | ||||||||||||||||||||
Income (loss) from continuing operations | 1,906,900 | (3,809,400 | ) | 2,730,900 | ||||||||||||||||||||
Income from discontinued operations, net of income taxes | — | 8,200 | 15,500 | |||||||||||||||||||||
Loss on disposal of discontinued operations, net of income taxes | (113,200 | ) | (545,000 | ) | — | |||||||||||||||||||
Net income (loss) | 1,793,700 | (4,346,200 | ) | 2,746,400 | ||||||||||||||||||||
Dividends on Series A convertible preferred stock | (900,000 | ) | (902,400 | ) | (56,700 | ) | ||||||||||||||||||
Dividends on Series B-1 convertible preferred stock | (720,000 | ) | (211,100 | ) | — | |||||||||||||||||||
Dividends on Series B-2 convertible preferred stock | (1,125,000 | ) | — | — | ||||||||||||||||||||
Accretion of convertible preferred stock | (236,300 | ) | — | — | (5,705,500 | ) | (3,750,000 | ) | (236,300 | ) | ||||||||||||||
Net income available to common shareholders | $ | 2,453,400 | $ | 2,356,600 | $ | 196,000 | ||||||||||||||||||
Net (loss) income available to common shareholders | $ | (6,656,800 | ) | $ | (9,209,700 | ) | $ | 2,453,400 | ||||||||||||||||
Net income per share: | ||||||||||||||||||||||||
Net (loss) income available to common shareholders per share: | ||||||||||||||||||||||||
Continuing operations | ||||||||||||||||||||||||
Basic | $ | (0.41 | ) | $ | (0.60 | ) | $ | 0.16 | ||||||||||||||||
Diluted | $ | (0.41 | ) | $ | (0.60 | ) | $ | 0.14 | ||||||||||||||||
Discontinued operations | ||||||||||||||||||||||||
Basic | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.00 | ||||||||||||||||
Diluted | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.00 | ||||||||||||||||
Net (loss) income available to common shareholders: | ||||||||||||||||||||||||
Basic | $ | 0.16 | $ | 0.16 | $ | 0.03 | $ | (0.42 | ) | $ | (0.64 | ) | $ | 0.16 | ||||||||||
Diluted | $ | 0.14 | $ | 0.14 | $ | 0.02 | $ | (0.42 | ) | $ | (0.64 | ) | $ | 0.14 | ||||||||||
Weighted average number of shares: | ||||||||||||||||||||||||
Basic | 14,878,312 | 14,412,554 | 7,721,779 | 15,931,936 | 14,435,676 | 14,878,312 | ||||||||||||||||||
Diluted | 17,670,001 | 17,081,651 | 9,588,029 | 15,931,936 | 14,435,676 | 17,670,001 | ||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements
See Notes to Consolidated Financial StatementsF-3
ANALEX CORPORATION
CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 20022005, 2004 AND 20012003
Convertible Preferred Stock | Shareholders’ Equity | ||||||||||||||||||||||||||||||||||
Common Stock | Additional Paid in | Warrants Outstanding | Deferred Compensation | Accumulated Other Loss | Accumulated Deficit | Total | |||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||
Balance—December 31, 2000 | — | $ | — | 6,450,913 | $ | 129,000 | $ | 11,885,300 | $ | — | $ | — | $ | — | $ | (10,012,400 | ) | $ | 2,001,900 | ||||||||||||||||
Shares issued pursuant to sale of common stock | — | — | 4,027,727 | 80,600 | 3,837,000 | — | — | — | — | 3,917,600 | |||||||||||||||||||||||||
Shares and warrants issued pursuant to acquisition of Analex | — | — | 3,572,143 | 71,400 | 4,687,200 | — | — | — | — | 4,758,600 | |||||||||||||||||||||||||
Deferred stock compensation | — | — | — | — | 38,800 | — | (38,800 | ) | — | — | — | ||||||||||||||||||||||||
Amortizaton of deferred stock compensation | — | — | — | — | — | — | 16,500 | — | — | 16,500 | |||||||||||||||||||||||||
Shares purchased pursuant to the Employee Stock Purchase Plan | — | — | 39,964 | 800 | 40,400 | — | — | — | — | 41,200 | |||||||||||||||||||||||||
Exercise of options and warrants | — | — | 285,228 | 5,700 | 237,600 | — | — | — | — | 243,300 | |||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | 196,000 | 196,000 | |||||||||||||||||||||||||
Balance—December 31, 2001 | — | — | 14,375,975 | 287,500 | 20,726,300 | — | (22,300 | ) | — | (9,816,400 | ) | 11,175,100 | |||||||||||||||||||||||
Amortizaton of deferred stock compensation | — | — | — | — | — | — | 14,600 | — | — | 14,600 | |||||||||||||||||||||||||
Warrants issued pursuant to bank guarantee | — | — | — | — | 345,400 | — | — | — | — | 345,400 | |||||||||||||||||||||||||
Shares returned and retired in connection with Analex acquisition | — | — | (51,804 | ) | (1,000 | ) | (58,000 | ) | — | — | — | — | (59,000 | ) | |||||||||||||||||||||
Shares purchased pursuant to the Employee Stock Purchase Plan | — | — | 81,739 | 1,600 | 139,100 | — | — | — | — | 140,700 | |||||||||||||||||||||||||
Exercise of options and warrants | — | — | 21,170 | 400 | 18,600 | — | — | — | — | 19,000 | |||||||||||||||||||||||||
Unrealized loss on derivative contract | — | — | — | — | — | — | — | (90,600 | ) | — | (90,600 | ) | |||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | 2,356,600 | 2,356,600 | |||||||||||||||||||||||||
Total comprehensive income | 2,266,000 | ||||||||||||||||||||||||||||||||||
Balance—December 31, 2002 | — | — | 14,427,080 | 288,500 | 21,171,400 | — | (7,700 | ) | (90,600 | ) | (7,459,800 | ) | 13,901,800 | ||||||||||||||||||||||
Amortizaton of deferred stock compensation | — | — | — | — | — | — | 7,700 | — | — | 7,700 | |||||||||||||||||||||||||
Issuance of preferred warrants and beneficial conversion charge on convertible preferred stock | 6,726,457 | — | — | — | 10,519,800 | 3,857,600 | — | — | — | 14,377,400 | |||||||||||||||||||||||||
Accretion of discount on convertible preferred stock | — | 236,300 | — | — | — | — | — | — | (236,300 | ) | (236,300 | ) | |||||||||||||||||||||||
Dividends on convertible preferred stock | — | — | — | — | — | — | — | — | (56,700 | ) | (56,700 | ) | |||||||||||||||||||||||
Repurchase and retirement of common shares owned by J. Stout | — | — | (2,625,451 | ) | (52,500 | ) | (9,018,500 | ) | — | — | — | — | (9,071,000 | ) | |||||||||||||||||||||
Issuance of note warrants and beneficial conversion charge on convertible notes | — | — | — | — | 5,327,200 | 1,905,300 | — | — | — | 7,232,500 | |||||||||||||||||||||||||
Shares purchased pursuant to the Employee Stock Purchase Plan | — | — | 86,892 | 1,700 | 189,000 | — | — | — | — | 190,700 | |||||||||||||||||||||||||
Exercise of options and warrants | — | — | 1,148,145 | 23,000 | 311,800 | — | — | — | — | 334,800 | |||||||||||||||||||||||||
Unrealized gain on derivative contract | — | — | — | — | — | — | — | 46,800 | — | 46,800 | |||||||||||||||||||||||||
Other | — | — | — | — | 18,400 | — | — | — | — | 18,400 | |||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | 2,746,400 | 2,746,400 | |||||||||||||||||||||||||
Total comprehensive income | 2,793,200 | ||||||||||||||||||||||||||||||||||
Balance—December 31, 2003 | 6,726,457 | $ | 236,300 | 13,036,666 | $ | 260,700 | $ | 28,519,100 | $ | 5,762,900 | $ | — | $ | (43,800 | ) | $ | (5,006,400 | ) | $ | 29,492,500 | |||||||||||||||
Cumulative Preferred Stock | Common Stock | ||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Additional Paid in Capital | Warrants Outstanding | Deferred Compensation | Accumulated Other Comprehensive Loss | Accumulated Deficit | Total | ||||||||||||||||||||||||||
Balance—January 1, 2003 | — | $ | — | 14,427,080 | $ | 288,500 | $ | 21,171,400 | $ | — | $ | (7,700 | ) | $ | (90,600 | ) | $ | (7,459,800 | ) | $ | 13,901,800 | ||||||||||||||
Amortization of deferred stock compensation | — | — | — | — | — | — | 7,700 | — | — | 7,700 | |||||||||||||||||||||||||
Issuance of preferred warrants and beneficial conversion charge on convertible preferred stock | 6,726,457 | — | — | — | 10,519,800 | 3,857,600 | — | — | — | 14,377,400 | |||||||||||||||||||||||||
Accretion of discount on cumulative preferred stock | — | 236,300 | — | — | — | — | — | — | (236,300 | ) | (236,300 | ) | |||||||||||||||||||||||
Dividends on convertible preferred stock | — | — | — | — | — | — | — | — | (56,700 | ) | (56,700 | ) | |||||||||||||||||||||||
Repurchase and retirement of common shares | — | — | (2,625,451 | ) | (52,500 | ) | (9,018,500 | ) | — | — | — | — | (9,071,000 | ) | |||||||||||||||||||||
Issuance of note warrants and beneficial conversion charge on convertible notes | — | — | — | — | 5,327,200 | 1,905,300 | — | — | — | 7,232,500 | |||||||||||||||||||||||||
Shares issued pursuant to the Employee Stock Purchase Plan | — | — | 86,892 | 1,700 | 189,000 | — | — | — | — | 190,700 | |||||||||||||||||||||||||
Exercise of options and warrants | — | — | 1,148,145 | 23,000 | 311,800 | — | — | — | — | 334,800 | |||||||||||||||||||||||||
Other | — | — | — | — | 18,400 | — | — | — | — | 18,400 | |||||||||||||||||||||||||
Unrealized gain on derivative contract | — | — | — | — | — | — | — | 46,800 | — | 46,800 | |||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | 2,746,400 | 2,746,400 | |||||||||||||||||||||||||
Total comprehensive income | — | — | — | — | — | — | — | — | — | 2,793,200 | |||||||||||||||||||||||||
Balance—December 31, 2003 | 6,726,457 | 236,300 | 13,036,666 | 260,700 | 28,519,100 | 5,762,900 | — | (43,800 | ) | (5,006,400 | ) | 29,492,500 | |||||||||||||||||||||||
Issuance of note warrants and beneficial conversion charge on convertible notes | — | — | — | — | 3,720,000 | 720,000 | — | — | — | 4,440,000 | |||||||||||||||||||||||||
Issuance of preferred warrants and convertible preferred stock | 3,428,571 | 12,000,000 | — | — | 320,400 | 320,400 | — | — | — | 640,800 | |||||||||||||||||||||||||
Accretion of discount on cumulative preferred stock | — | 3,750,000 | — | — | — | — | — | — | (3,750,000 | ) | (3,750,000 | ) | |||||||||||||||||||||||
Dividends on convertible preferred stock | — | — | — | — | — | — | — | — | (1,113,500 | ) | (1,113,500 | ) | |||||||||||||||||||||||
Issuance costs of fully discounted cumulative preferred stock | — | — | — | — | (79,800 | ) | — | — | — | — | (79,800 | ) | |||||||||||||||||||||||
Shares issued pursuant to the Employee Stock Purchase Plan | — | — | 107,370 | 2,100 | 315,600 | — | — | — | — | 317,700 | |||||||||||||||||||||||||
Exercise of options and warrants | — | — | 445,614 | 8,900 | 348,400 | — | — | — | — | 357,300 | |||||||||||||||||||||||||
Issuance of common stock to sellers of Beta Analytics International | — | — | 1,832,460 | 36,700 | 6,926,600 | — | — | — | — | 6,963,300 | |||||||||||||||||||||||||
Unrealized gain on derivative contract | — | — | — | — | — | — | — | 43,800 | — | 43,800 | |||||||||||||||||||||||||
Net loss | — | — | — | — | — | — | — | — | (4,346,200 | ) | (4,346,200 | ) | |||||||||||||||||||||||
Total comprehensive loss | — | — | — | — | — | — | — | — | — | (4,302,400 | ) | ||||||||||||||||||||||||
Balance—December 31, 2004 | 10,155,028 | 15,986,300 | 15,422,110 | 308,400 | 40,070,300 | 6,803,300 | — | — | (14,216,100 | ) | 32,965,900 | ||||||||||||||||||||||||
Issuance of preferred warrants and convertible preferred stock | 7,142,856 | 14,537,800 | — | — | 7,960,700 | 2,425,000 | — | — | — | 10,385,700 | |||||||||||||||||||||||||
Accretion of discount on cumulative preferred stock | — | 5,705,500 | — | — | — | — | — | — | (5,705,500 | ) | (5,705,500 | ) | |||||||||||||||||||||||
Dividends on convertible preferred stock | — | — | — | — | — | — | — | — | (2,745,000 | ) | (2,745,000 | ) | |||||||||||||||||||||||
Shares issued pursuant to the Employee Stock Purchase Plan | — | — | 144,669 | 2,900 | 433,000 | — | — | — | — | 435,900 | |||||||||||||||||||||||||
Exercise of options and warrants | — | — | 473,666 | 9,500 | 858,500 | — | — | — | — | 868,000 | |||||||||||||||||||||||||
Tax effect of options exercised | — | — | — | — | 17,500 | — | — | — | — | 17,500 | |||||||||||||||||||||||||
Issuance of common stock to employees of ComGlobal Systems, Incorporated | — | 300,000 | 6,000 | 939,000 | — | — | — | — | 945,000 | ||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | 1,793,700 | 1,793,700 | |||||||||||||||||||||||||
Total comprehensive income | — | — | — | — | — | — | — | — | — | 1,793,700 | |||||||||||||||||||||||||
Balance—December 31, 2005 | 17,297,884 | $ | 36,229,600 | 16,340,445 | $ | 326,800 | $ | 50,279,000 | $ | 9,228,300 | $ | — | $ | — | $ | (20,872,900 | ) | $ | 38,961,200 | ||||||||||||||||
See Notes to Consolidated Financial StatementsThe accompanying notes are an integral part of these consolidated financial statements
F-4
ANALEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002,2005, 2004 AND 20012003
2003 | 2002 | 2001 | ||||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 2,746,400 | $ | 2,356,600 | $ | 196,000 | ||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||||||
Depreciation | 118,500 | 111,400 | 146,200 | |||||||||
Amortization of intangible assets | 450,800 | 307,600 | 378,000 | |||||||||
Amortization of debt discount and deferred financing costs | 140,400 | 345,400 | 37,500 | |||||||||
Stock-based compensation expense | 122,000 | 14,600 | 16,500 | |||||||||
Deferred tax benefit | 253,000 | — | — | |||||||||
Write-off of patent related costs | 153,200 | — | — | |||||||||
Changes in operating assets and liabilities: | ||||||||||||
Accounts receivable | 1,836,700 | (4,278,500 | ) | (940,700 | ) | |||||||
Deferred tax asset | (150,000 | ) | — | — | ||||||||
Prepaid expenses and other | (213,100 | ) | (47,200 | ) | (39,100 | ) | ||||||
Other assets | (406,300 | ) | 57,600 | (11,300 | ) | |||||||
Accounts payable | (2,518,500 | ) | 1,923,300 | 108,600 | ||||||||
Other current liabilities | 148,400 | 478,100 | (327,100 | ) | ||||||||
Other long-term liabilities | — | 30,600 | — | |||||||||
Net cash provided by (used in) operating activities | 2,681,500 | 1,299,500 | (435,400 | ) | ||||||||
Cash flows from investing activities: | ||||||||||||
Purchase of Analex, net of cash acquired | — | — | (6,167,900 | ) | ||||||||
Property additions | (441,500 | ) | (67,100 | ) | (86,000 | ) | ||||||
Intangible additions | (600,000 | ) | (172,900 | ) | — | |||||||
Net cash used in investing activities | (1,041,500 | ) | (240,000 | ) | (6,253,900 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from borrowings on bank and other loans | 1,829,000 | 491,200 | 5,500,000 | |||||||||
Proceeds from stock options and warrants exercised | 334,800 | 19,000 | 243,300 | |||||||||
Proceeds from sale of common stock | — | — | 3,917,600 | |||||||||
Proceeds from employee stock purchase plan | 190,700 | 140,700 | 41,200 | |||||||||
Proceeds from issuance of convertible debt | 10,000,000 | — | — | |||||||||
Proceeds from issuance of convertible preferred stock, net of issuance costs | 14,377,300 | — | — | |||||||||
Repurchase of stock, stock options and warrants | (9,166,800 | ) | — | — | ||||||||
Payments on bank and other loans | (5,329,300 | ) | (1,491,700 | ) | (3,164,600 | ) | ||||||
Net cash provided by (used in) financing activities | 12,235,700 | (840,800 | ) | 6,537,500 | ||||||||
Net increase (decrease) in cash and cash equivalents | 13,875,700 | 218,700 | (151,800 | ) | ||||||||
Cash and cash equivalents at beginning of year | 301,800 | 83,100 | 234,900 | |||||||||
Cash and cash equivalents at end of year | $ | 14,177,500 | $ | 301,800 | $ | 83,100 | ||||||
2005 | 2004 | 2003 | ||||||||||
Reconciliation of net income (loss) to cash provided by operating activities | ||||||||||||
Net income (loss) | $ | 1,793,700 | $ | (4,346,200 | ) | $ | 2,746,400 | |||||
Net loss (income) from discontinued operations | 113,200 | 536,800 | (15,500 | ) | ||||||||
Net income (loss) from continuing operations | 1,906,900 | (3,809,400 | ) | 2,730,900 | ||||||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities | ||||||||||||
Depreciation | 731,700 | 308,100 | 90,000 | |||||||||
Amortization of intangible assets | 3,372,700 | 1,420,900 | 450,800 | |||||||||
Amortization of debt discounts | 1,808,200 | 6,888,900 | 140,400 | |||||||||
Amortization of deferred financing costs | 188,900 | 779,700 | — | |||||||||
Stock-based compensation expense | 105,000 | — | 122,000 | |||||||||
Loss on disposal of fixed assets | 5,700 | — | — | |||||||||
Loss on impairment of assets held for sale | 66,000 | — | — | |||||||||
Tax benefit on exercise of stock options | 17,500 | — | — | |||||||||
Changes in operating assets and liabilities, net of effect of acquisition | ||||||||||||
Accounts receivable | (4,441,400 | ) | (3,754,100 | ) | 1,026,400 | |||||||
Prepaid expenses and other | 1,907,900 | (2,608,100 | ) | (213,100 | ) | |||||||
Inventory | 205,500 | — | — | |||||||||
Other assets | (155,300 | ) | (363,000 | ) | (406,300 | ) | ||||||
Accounts payable | (806,200 | ) | 482,200 | (1,827,300 | ) | |||||||
Other current liabilities | (658,000 | ) | 2,129,100 | 83,900 | ||||||||
Deferred tax liability | (866,300 | ) | 789,700 | 103,000 | ||||||||
Other long-term liabilities | (12,300 | ) | 4,400 | — | ||||||||
Net cash flow provided by operating activities | 3,376,500 | 2,268,400 | 2,300,700 | |||||||||
Cash flows from investing activities | ||||||||||||
Purchase of property and equipment | (1,191,200 | ) | (496,300 | ) | (435,100 | ) | ||||||
Purchase of intangible assets | — | — | (600,000 | ) | ||||||||
Proceeds from sale of property and equipment | 809,100 | — | — | |||||||||
Cash paid for BAI, net of cash acquired | — | (27,132,600 | ) | — | ||||||||
Cash paid for ComGlobal, net of cash acquired | (46,300,400 | ) | — | — | ||||||||
Net cash used in investing activities | (46,682,500 | ) | (27,628,900 | ) | (1,035,100 | ) | ||||||
Cash flows from financing activities | ||||||||||||
Proceeds from net borrowings on bank and other loans | 21,146,000 | 1,385,400 | (3,500,300 | ) | ||||||||
Proceeds from sale of common stock | 840,000 | — | — | |||||||||
Proceeds from stock options and warrants exercised | 868,000 | 353,700 | 334,800 | |||||||||
Proceeds from employee stock purchase plan | 435,900 | 321,400 | 190,700 | |||||||||
Proceeds from issuance of Series A Convertible Notes and Warrants | — | — | 10,000,000 | |||||||||
Proceeds from sale of ABS | 115,700 | — | — | |||||||||
Net proceeds from issuance of Series A Preferred Stock and Warrants | — | — | 14,377,300 | |||||||||
Net proceeds from issuance of Series B Senior Subordinated Notes and Warrants | — | 11,325,100 | — | |||||||||
Net proceeds from issuance of Series B-2 Preferred Stock and Warrants | 24,923,400 | — | — | |||||||||
Issuance costs related to financing instruments | (125,600 | ) | (79,900 | ) | — | |||||||
Repurchase of stock, stock options and warrants | — | — | (9,166,800 | ) | ||||||||
Payments of dividends on preferred stock | (2,243,500 | ) | (890,500 | ) | — | |||||||
Net cash provided by financing activities | 45,959,900 | 12,415,200 | 12,235,700 | |||||||||
Net cash flow from discontinued operations, including disposal of discontinued operations | (228,900 | ) | (198,000 | ) | 374,400 | |||||||
Net increase (decrease) in cash and cash equivalents | 2,425,000 | (13,143,300 | ) | 13,875,700 | ||||||||
Cash and cash equivalents at beginning of period | 1,034,200 | 14,177,500 | 301,800 | |||||||||
Cash and cash equivalents at end of period | $ | 3,459,200 | $ | 1,034,200 | $ | 14,177,500 | ||||||
Supplemental disclosure of cash flow information: | ||||||||||||
Cash paid for interest | 1,920,200 | 1,233,100 | 519,800 | |||||||||
Cash paid for income taxes, net of refund | 3,787,100 | 1,339,000 | 255,000 | |||||||||
Supplemental disclosure of non-cash investing and financing activities: | ||||||||||||
Issuance of common stock in acquisition | — | 6,963,300 | — |
See Notes to Consolidated Financial StatementsThe accompanying notes are an integral part of these consolidated financial statements
F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company:Business Overview
Analex Corporation (“Analex” or the “Company”) specializes in providing information technology, engineering and bio-defenseis a provider of mission-critical professional services and solutionsto 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 developing medical defenses and treatments for infectious agents usedproviding a full range of security support services to the U.S. government. The Company specializes in biological warfare and terrorism. Analex has threethe 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 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. units, Homeland Security Group and Systems Engineering Group.
The Homeland Security Group provides information technology services, systems integration, hardwareaerospace engineering services and software engineeringsecurity and independent quality assurance inintelligence support ofservices. The Homeland Security Group provides these services to the U.S. intelligence community, and Department of Defense. The Systems Engineering Group provides engineering, information technology and program management support to NASA,including the National Reconnaissance Office, the Missile Defense Agency, the National Security Agency, the Department of Defense, and major aerospace contractors, such as Lockheed Martin and Northrop Grumman.
The Systems Engineering Group provides aerospace engineering and information technology services. Capabilities include expendable launch vehicle engineering, space systems development, and ground support for space operations. The System Engineering Group provides these services to NASA.
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, 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 Analex and reported as a part of the Company’s Homeland Security Group.
On May 28, 2004, the Company acquired Beta Analytics, Incorporated (“BAI”) in a transaction valued at approximately $37.9 million, including the assumption $1.7 million of BAI’s debt. The Company acquired all of
F-6
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
the issued and outstanding stock of BAI for $27.7 million in cash and 1,832,460 unregistered shares of Analex Common Stock.
During the second quarter of 2004, the Company concluded that Advanced Biosystems, Inc. (ABS), a then wholly owned subsidiary focuses on development of medical defenses against, and treatments for, biological warfare agents that threaten military and civilian populations.
Revenues from services performed under direct and indirect long-term contracts and subcontracts with government defense and intelligence agencies comprise the majority of the Company’s business. The majority ofCompany, did not fit with the Company’s technicallong-term strategic plan and professional services business with governmental departments and agencies is obtained through competitive procurement and through follow-on services relateddecided to existing contracts. In certain instances, however, thedivest ABS. The Company acquires such service contracts becausedisposed of special professional competency or proprietary knowledge in specific subject areas.ABS on November 16, 2004.
2. Summary of significant accounting policies:Significant Accounting Policies
A. Principles of consolidation:Consolidation
The consolidated financial statements include the accounts of Analex Corporation and its two activethree wholly owned subsidiaries, Advanced Biosystems, Inc. (“ABS”),SyCom, ComGlobal and SyCom Services, Inc. (“SyCom”)BAI. The results of operations of ABS, a former wholly owned subsidiary which the Company disposed of on November 16, 2004, are presented as discontinued operations for all periods presented herein (see Note 19). All significant intercompany transactions have been eliminated.eliminated from the consolidated financial statements.
B. Revenue
The Company recognizes revenue when persuasive evidence of an arrangement exists, services have been rendered or goods delivered, the contract price is fixed or determinable, and collectibility is reasonably assured.
The Company’s contracts with customers are typically cost-plus-fee, time and material, or fixed-price contracts. Revenue results from work performed on these contracts by the Company’s employees and from pass-through of costs for material and work performed by subcontractors. Revenue on cost-type contracts is recorded as allowable contract costs are incurred and fees earned. Revenue for time and material contracts is recorded on the basis of allowable contract labor hours worked times the contract defined billing rates, plus the cost of materials used in performance of the contract. Profits on time and materials contracts result from the difference between the cost of services performed and the contract defined billing rates for these services. Revenue on certain fixed-price service contracts is recorded each period based on a monthly amount for services rendered. Revenue on other fixed-price contracts is recorded as costs are incurred, using the percentage-of-completion method of accounting. Profits on fixed-price contracts result from the difference between the incurred costs and the revenue earned. In the normal course of business, the Company may be party to claims and disputes resulting from modifications and change orders and other contract matters. Claims for additional contract compensation are recognized when realization is probable and estimable. When the Company has a contract where multiple units of accounting exist, the Company will apply the appropriate revenue recognition methodology to each separate unit of accounting, as necessary. The Company has contracts containing performance based incentive fees, which are not finalized until the end of predetermined time periods. The Company accrues revenue on these incentive fees based on the amount the Company expects to be awarded. The Company’s estimates are based on, among other things, discussions with the client, actual contract performance to date and historical contract performance trends.
Contract revenue recognition inherently involves estimation. Examples of estimates include the contemplated level of effort to accomplish the tasks under contract, the cost of the effort, and an ongoing assessment of the Company’s progress toward completing the contract. From time to time, as part of the Company’s standard management processes, facts develop that require revision to its estimated total costs or revenue. To the extent that a revised estimate affects contract profit or revenue previously recognized, the Company records the cumulative effect of the revision in the period in which the facts requiring the revision become known. The full amount of an anticipated loss on any type of contract is recognized in the period in which it becomes probable and can be reasonably estimated.
F-7
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
From time to time, the Company may proceed with work based on client direction prior to the completion and signing of formal contract documents. The Company has a formal review process for approving any such work. Revenue associated with such work is recognized only when it can be reliably estimated and realization is probable. The Company bases its estimates on previous experiences with the client, communications with the client regarding funding status, and its knowledge of available funding for the contract or program. This type of revenue is not material to the Company for the years ended December 31, 2005, 2004 and 2003, respectively.
Disputes occasionally arise in the normal course of the Company’s business due to events such as delays, changes in contract specifications, and questions of cost allowability or collectibility. Such matters, whether claims or unapproved change orders in the process of negotiation, are recorded at the lesser of their estimated net realizable value or actual costs incurred, and only when realization is probable and can be reliably estimated. Claims against the Company are recognized where a loss is considered probable and can be reasonably estimated in amount.
C. Cash Equivalents
Cash equivalents represent amounts invested in highly liquid short-term investments with original maturities of three months or less.
D. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition, doubtful accounts receivable, goodwill and other intangible assets, and other contingent liabilities. The Company determines its estimates on historical experience and various other factors that are deemed reasonable at the time the estimates are made.
E. Accounts Receivable and Allowance for Doubtful Accounts
The Company carries its accounts receivable at their face amounts, less an allowance for doubtful accounts. The Company maintains an allowance for doubtful accounts receivable that may arise in the normal course of business. Historically, the Company has not had significant write-offs of doubtful accounts receivable related to work performed for the federal government. However, the Company does perform work on contracts and task orders where on occasion issues arise that lead to accounts receivable not being fully collected. The Company’s allowance for doubtful accounts is established based upon the latest information available to determine whether invoices are ultimately collectible. Whenever judgment is involved in determining the estimates, there is the potential for bad debt expense and the fair value of accounts receivable to be misstated.
F. Risks and uncertainties:Uncertainties
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents,cash-equivalents, and accounts receivable. The Company maintains its cash and cash equivalents principally in one United States (“U.S.”) commercial bank. Cash in excess of daily requirements is invested by the bank in one-day repurchase agreements of securities of U.S. government agencies. To date, the Company has not incurred losses related to cash and cash equivalents.
The Company’s accounts receivable consists principally of accounts receivable from the U.S. Government or prime contractors to agencies and departments of as well as directly from, the U.S. government. The Company extends credit in the normal course of operations and does not require collateral from its customers.
F-8
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company has historically been, and continues to be, heavily dependent upon direct and indirect contracts from various U.S. government agencies. Contracts and subcontracts with the U.S. government are subject to audit by audit agencies of the government. Such audits determine, among other things, whether an adjustment of invoices rendered to the government is appropriate under the underlying terms of the contracts. All U.S. government contracts contain clauses that allow for the termination of contracts at the convenience of the government.
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimatesG. Property and assumptions that affect the reported amounts of assets,
ANALEX CORPORATIONEquipment
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
liabilities and contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
C. Cash equivalents:
Cash equivalents represent amounts invested in highly liquid short-term investments with original maturities of three months or less.
D. Fixed assets:
Furniture andBuilding, furniture, equipment and leasehold improvements are stated at cost or fair value ifless accumulated depreciation. Building, furniture, equipment and leasehold improvements acquired in a business combination.combination are stated at fair value, as determined using the assistance of an outside valuation firm, less accumulated depreciation. The Company uses the straight-line method of depreciation and amortization over the estimated useful lives of the furnitureassets. The estimated useful life for computers and equipment (principallyis three years. The estimated useful life of furniture ranges from five to ten years)years and the estimated useful life for buildings is thirty-nine years. Leasehold improvements are amortized over their estimated useful life or the minimum lease term, whichever is shorter.
Real property classified as held for leasehold improvements, if shorter.sale is measured at the lower of its carrying amount or fair value less cost to sell, which is based on comparable sales amounts of similar property. Gains or losses are recognized for subsequent changes to the fair value less cost to sell; however, gains that may be recognized are limited by cumulative losses previously recognized. Property classified as held for sale is not depreciated.
Maintenance and repairs are charged to expense as incurred, and the cost of additions and betterments are capitalized. When assets are retired or sold, the cost and related accumulated depreciation are removed from the accounts and the gain or loss is included in operations.
PurchasedImplementation costs associated with purchased software is capitalized at cost.are capitalized. Such costs are amortized using the straight-line method for a period of upthree to five years.
E.H. Goodwill and other intangible assets:Intangible Assets
On JanuaryGoodwill, which represents the excess of the cost of an acquired entity over the net fair value of assets acquired and liabilities assumed, is assessed for impairment annually. Impairment is the excess of the carrying value assigned to goodwill over its respective fair value. The Company uses a two-step approach to determine impairment. The Company performs step 1 2002,by comparing the Company adoptedreporting unit’s fair value to its carrying value. If the provisionsfair value of Financial Accounting Standards Board (FASB) Statementthe reporting unit exceeds its carrying value, no further calculation is necessary. A reporting unit with a carrying value in excess of Financial Accounting Standards (SFAS) No. 142, Goodwillits fair value constitutes a step 1 failure and Other Intangible Assets, (SFAS No. 142). SFAS No. 142leads to a step 2 evaluation to determine the goodwill write off. If a step 1 failure occurs, the excess of the carrying value over the fair value does not equal the amount of the goodwill write off. Step 2 requires thatthe calculation of the implied fair value of goodwill by allocating the fair value of the reporting unit to its tangible and intangible assets, with indefinite lives no longer be amortized but reviewed annually (or more frequently if impairment indicators arise) for impairment. Intangible assets that are not deemedother than goodwill, similar to have indefinite lives will continue to be amortized over their useful lives. In accordance with SFAS No. 142 transitional requirements, with respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company adoptedpurchase price allocation.The remaining unallocated fair value represents the provisionsimplied fair value of SFAS No. 142 effective January 1, 2002, and as a result, amortizationthe goodwill. If the implied fair value of goodwill was discontinued. Goodwill acquired after June 30, 2001 has not been amortized. Allexceeds its carrying amount, there is no impairment. If the carrying value of goodwill exceeds its implied fair value, an impairment charge is assignedrecorded for the difference. Further, when performing step 2 and allocating a reporting unit’s fair value, assets having a higher fair value as compared to book value increase any possible write off of impaired goodwill. For the Company’s reportable segment Analex.
F. Accounting for contracts:year ended December 31, 2005 no condition of impairment existed.
The Company’s contracts with customers are typically cost plus fee, time and materials, or fixed-price contracts. Revenues result from work performed on these contracts by the Company’s employees and from pass-through of costs for material and work performed by subcontractors. Revenues on cost-type contracts are recorded as contract allowable costs are incurred and fees earned. Revenues for time and materials contracts are recorded on the basis of contract allowable labor hours worked times the contract defined billing rates, plus the cost of materials used in performance on the contract. Profits on time and materials contracts result from the difference between the cost of services performed and the contract defined billing rates for these services. Revenues on certain fixed-price service contracts are recorded each period based on a monthly amount for services provided. Revenues on other fixed-price contracts are recorded as costs are incurred, using the percentage-of-completion method of accounting. Profits on fixed-price contracts result from the difference between the incurred costs and the revenue earned. In the normal course of business, the Company may be party to claims and disputes resulting from modifications and change orders and other contract matters. Claims for additional contract compensation are recognized when realization is probable and estimable.F-9
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Accounts receivable relatingIntangible assets with finite lives are amortized on a straight-line basis over their useful lives, determined with the assistance of an outside valuation firm, of 3 to long-term contracts9 years. Intangible assets are classified as current assets although an indeterminable portion of these amounts isevaluated for impairment whenever events or changes in circumstances indicate that their carrying value may not expected to be realized within one year.recoverable.
G. Stock-based compensation:I. Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS No. 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has chosen to continue to accountaccounts for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the fair market value of the Company’scompany’s stock at the date of the grant over the exercise price of the related option.
2003 | 2002 | 2001 | 2005 | 2004 | 2003 | ||||||||||||||||
Net income available to common shareholders as reported | $ | 2,453,400 | $ | 2,356,600 | $ | 196,000 | |||||||||||||||
Net (loss) income available to common shareholders, as reported | ($ | 6,656,800 | ) | ($ | 9,209,700 | ) | $ | 2,453,400 | |||||||||||||
Add: Total stock-based employee compensation expense as reported under intrinsic value method (APB No. 25) for all awards, net of related tax effects | 121,900 | 14,600 | 16,500 | $ | 105,000 | $ | — | $ | 6,900 | ||||||||||||
Deduct: Total stock-based compensation expense determined under fair value based method (SFAS No. 123) for all awards, net of related tax effects | 1,097,800 | 947,600 | 516,000 | $ | 943,900 | $ | 549,500 | $ | 764,400 | ||||||||||||
Pro forma net income (loss) | $ | 1,477,500 | $ | 1,423,600 | ($ | 320,600 | ) | ||||||||||||||
Pro forma net (loss) income available to common shareholders | ($ | 7,495,700 | ) | ($ | 9,759,200 | ) | $ | 1,695,900 | |||||||||||||
Earnings (loss) per share: | |||||||||||||||||||||
(Loss) earnings per share: | |||||||||||||||||||||
Basic as reported | $ | 0.16 | $ | 0.16 | $ | 0.03 | ($ | 0.42 | ) | ($ | 0.64 | ) | $ | 0.16 | |||||||
Diluted as reported | $ | 0.14 | $ | 0.14 | $ | 0.02 | ($ | 0.42 | ) | ($ | 0.64 | ) | $ | 0.14 | |||||||
Basic pro forma | $ | 0.10 | $ | 0.10 | $ | (0.03 | ) | ($ | 0.47 | ) | ($ | 0.68 | ) | $ | 0.11 | ||||||
Diluted pro forma | $ | 0.08 | $ | 0.08 | $ | (0.03 | ) | ($ | 0.47 | ) | ($ | 0.68 | ) | $ | 0.10 |
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing fair value model. The following assumptions were used for grants: dividend yield of 0%; expected volatility of 4035 to 112%76%; expected life of the option term of 5 years; and risk-free interest rate of 2.25 to 4.88%5.85%.
H. Long-Lived Assets
In September 2001,To eliminate additional compensation expense following the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). SFAS No. 144 addresses financial accounting and reporting for the impairment and disposal of long-lived assets, including intangible assets with finite lives. The effective date for the Company’s implementationadoption of SFAS No. 144 was123(R)—Share-Based Payment,which will replace SFAS No. 123—Accounting for Stock-Based Compensation, the Company has accelerated vesting of certain options for certain option holders when the exercise price of the option is more than the fair market value. SFAS No. 123(R) is effective as of January 1, 2002.2006. The Company monitors for triggering events that would indicatetable below summarizes the need for impairment analysis.
I. Derivativesaccelerated vesting of options.
Number of options | Exercise price | Original vesting date | Accelerated vesting date | ||||
100,000 | $ | 3.42 | 02/17/06 | 03/02/05 | |||
66,667 | $ | 4.49 | 04/20/06 | 12/21/04 | |||
50,001 | $ | 3.88 | 04/08/06 | 01/26/05 | |||
25,000 | $ | 3.70 | 02/02/06 | 01/31/05 | |||
6,668 | $ | 3.92 | 03/01/06 | 01/19/05 | |||
3,334 | $ | 4.04 | 03/01/06 | 12/21/04 | |||
1,667 | $ | 3.80 | 02/25/06 | 01/26/05 | |||
1,667 | $ | 3.30 | 07/06/06 | 11/30/05 |
The Company utilizes an interest rate swap to manage interest rate exposure. The interest rate swap has been designated as a cash flow hedge, wherein
Compensation expense for other stock based awards is measured using the effective portion of the change inintrinsic value of the derivative instrument, based on market pricing, is reported as a componentaward at the award’s grant date. In March 2005, the Company’s Board of other comprehensive income (loss) and is reclassified into earnings as interest expense inDirectors, including its compensation committee, approved the period when the hedged transaction affects earnings. The ineffective portionsale of up to 300,000 unregistered shares of the change in valueCompany’s common stock to 22 employees of ComGlobal. In April 2005, the derivative instrument, if any, is recognized in current earnings during the periodCompany sold all 300,000 unregistered shares. The Company recorded $105,000 of change. The interest rate swap is carried at fair value in other liabilities.compensation expense related to this award as of December 31, 2005.
F-10
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
J. Impairment of Long-Lived Assets
Whenever events or changes in circumstances indicate that the carrying amount of long-lived assets, and other intangibles, may not be fully recoverable, the Company evaluates the probability that future undiscounted net cash flows, without interest charges, will be less than the carrying amount of the assets. If any impairment were indicated as a result of this analysis, the Company would recognize a loss based on the amount by which the carrying amount exceeds the estimated discounted future cash flows.
In December 2005, the Company concluded that the carrying value of its land and building held for sale in Upper Marlboro, Maryland would not be fully recovered. The Company based its conclusion on comparable local sales data and its estimated costs to sell the facility. The Company recorded a $66,000 impairment loss, included in SG&A for the year ended December 31, 2005. In the event that there are changes in the planned use of the Company’s long-term assets or its expected future undiscounted cash flows are reduced significantly, the Company’s assessment of its ability to recover the carrying value of its assets could change.
K. Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities, less valuation allowances, if required. Enacted statutory tax rates are used to compute the tax consequences of these temporary differences.
L. Inventory
The Company’s inventory consists of finished computer component parts. These parts are used in products sold to selected customers. Inventory is stated at the lower of cost or market determined based on the specific identification method.
M. Discontinued Operations
During the second quarter of 2004, the Company concluded that ABS, a wholly owned subsidiary of the Company, did not fit with the Company’s long-term plan and decided to divest ABS. The Company disposed of ABS on November 16, 2004. The Company reports the results of discontinued operations and any disposal gains or losses, net of applicable income taxes, separately from the results of continuing operations for each year presented in these financial statements.
N. Financial Statement Reclassification
Certain amounts in the prior year financial statements and related notes have been reclassified to conform to the 2005 presentation.
O. Recently Issued Accounting Standards
In August 2001,December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations” (”SFAS No. 143”).123(R)—Share-Based Payment,which will replace SFAS No. 143 addresses financial accounting123—Accounting for Stock-Based Compensation, and reportingsupersede APB Opinion No. 25—Accounting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Stock Issued to Employees.SFAS No. 143123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact, either positive or negative, on future results of operations or financial condition.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21,Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue No. 00-21 did not have a material impactmeasured based on the Company’s financial position or results of operations.
In November 2002, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that upon issuance of certain guarantees, the guarantor must recognize a liability for thegrant-date fair value of the obligation it assumes under that guarantee. FIN 45’s provisions for initial recognition and measurement are requiredequity or liability instruments issued. SFAS No. 123(R) requires liability awards to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure provisions of FIN 45 are effective for financial statements of interim or annual periods that end after December 15, 2002. As the Company has not entered into or modified any guarantees subsequent to December 31, 2002, the implementation of FIN 45 did not impact the Company’s financial position or results of operations. The Company has updated its disclosures to comply with the requirements in FIN 45.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilitiesre-measured each reporting period and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have a significant impact on the Company’s financial position or results of operations.
3. Pequot Transaction:
On December 9, 2003, the Company consummated the transactions contemplated by the Subordinated Note and Series A Convertible Preferred Stock Purchase Agreement (the “Pequot Purchase Agreement”) by and between the Company and Pequot Private Equity Fund III, L.P., a Delaware limited partnership, and Pequot Offshore Private Equity Partners III, L.P., a Cayman Islands limited partnership (“Pequot”). On December 9, 2003, the Company:F-11
In connection with the issuance and sale of the Series A Preferred Stock, issued warrants (the “Preferred Warrants”) exercisable to purchase the Company’s common stock, par value $.02 per share (the
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
|
SFAS No. 123(R) permits companies to adopt its requirements using either the modified prospective method or the modified retrospective method. Under the modified prospective method, compensation cost is recognized beginning with the effective date for all share-based payments granted after the effective date and for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date. The modified retrospective method includes the requirements of the modified prospective method, but also permits entities to restate either all prior periods presented or prior interim periods of the year of adoption for the impact of adopting this standard. It is anticipated the Company will apply the modified prospective method upon adoption. The Company expects that the initial adoption of SFAS 123(R) as of January 1, 2006 will not have a material impact on its Consolidated Statements of Operations. However, the impact on future periods may be material. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company believes this reclassification will not have a material impact on its Consolidated Statements of Cash Flows.
3. Accounts Receivable
The components of accounts receivable as of December 31, are as follows:
2005 | 2004 | |||||||
Trade accounts receivable | ||||||||
U.S. Government: | ||||||||
Amounts billed | $ | 23,599,400 | $ | 14,397,600 | ||||
Recoverable costs and profit—not billed | 7,853,600 | 4,378,300 | ||||||
Subtotal | 31,453,000 | 18,775,900 | ||||||
Commercial, state and local governments: | ||||||||
Amounts billed | 306,400 | 14,000 | ||||||
Recoverable costs and profit—not billed | 52,900 | — | ||||||
Subtotal | 359,300 | 14,000 | ||||||
Total trade accounts receivable | 31,812,300 | 18,789,900 | ||||||
Total employee accounts receivable and other | 136,800 | 276,400 | ||||||
Less: Allowance for doubtful accounts | (881,600 | ) | (715,900 | ) | ||||
Total trade accounts receivable, net | $ | 31,067,500 | $ | 18,350,400 | ||||
The following table summarizes activity in the allowance for doubtful accounts for years ended December 31:
2005 | 2004 | 2003 | ||||||||||
Beginning balance | $ | 715,900 | $ | 345,400 | $ | 852,200 | ||||||
Additions | 226,100 | 664,000 | 49,600 | |||||||||
Write-offs | (60,400 | ) | (293,500 | ) | (556,400 | ) | ||||||
Ending balance | $ | 881,600 | $ | 715,900 | $ | 345,400 | ||||||
Unbilled accounts receivable can be invoiced upon completion of contractual billing cycles, attaining certain milestones under fixed-price contracts, attaining a stipulated level of effort on cost-type contracts for government
F-12
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
agencies, upon completion of federal government overhead audits or upon final approval of design plans for engineering services.
4. Property and Equipment
The components of property and equipment as of December 31 are as follows:
2005 | 2004 | |||||||
Computer hardware and software | $ | 1,880,500 | $ | 1,324,700 | ||||
Leasehold improvements | 1,221,200 | 128,100 | ||||||
Office equipment | 1,159,300 | 425,800 | ||||||
Building | — | 391,000 | ||||||
Land | — | 83,800 | ||||||
Vehicle | — | 13,200 | ||||||
Total property and equipment | 4,261,000 | 2,366,600 | ||||||
Accumulated depreciation and amortization | (1,535,000 | ) | (931,900 | ) | ||||
Total property and equipment, net | $ | 2,726,000 | $ | 1,434,700 | ||||
Depreciation expense for 2005, 2004, and 2003 was $731,700, $308,100 and $90,000, respectively.
Property held for sale at December 31, 2005 consisted primarily of land and a building owned by the Company in Upper Marlboro, Maryland. This property was used by the Company’s BAI wholly-owned subsidiary until December 2005, when that operation was relocated to the Company’s new Corporate headquarters in Fairfax, Virginia. The Company has listed the land and building for sale and anticipates selling the property during 2006. This property is currently under a contract for sale, although there is no assurance that the sale will close. The property is reported as a current asset and is valued at $430,600, which is its estimated recoverable value. The property is reported on the Consolidated Balance Sheet as a current asset and the property is no longer depreciated.
5. Goodwill, Contract Rights and Other Intangible Assets
The Company has recorded goodwill of $77.9 million and $43.2 million as of December 31, 2005 and 2004. Goodwill must be reviewed annually for impairment. The Company performed this review as of October 1, 2005 and concluded there was no impairment. Goodwill increased approximately $34.5 million primarily from the acquisition of ComGlobal in April 2005. As of December 31, 2005, approximately $1.9 million of Goodwill is expected to be deducted for tax purposes.
Identifiable intangible assets, which have finite useful lives, consist of contract rights and non-compete agreements. With the acquisition of ComGlobal in April 2005, the Company recorded $7.4 million of contract right and non-compete intangible assets. With the acquisition of BAI in May 2004, the Company recorded $6.1 million of contract right and non-compete intangible assets. The estimated useful lives of the Company’s intangible assets range from three to nine years.
F-13
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table summarizes the gross carrying amounts, accumulated amortization and net carrying values of the Company’s intangible assets as of December 31,
2005 | 2004 | |||||||||||||||||||
Gross Carrying Value | Accumulated Amortization | Net Carrying Value | Gross Carrying Value | Accumulated Amortization | Net Carrying Value | |||||||||||||||
Amortizable intangible assets | ||||||||||||||||||||
Contract rights | $ | 14,346,300 | $ | (4,245,800 | ) | $ | 10,100,500 | $ | 7,082,300 | $ | (1,184,100 | ) | $ | 5,898,200 | ||||||
Non-compete agreements | 1,105,500 | (801,200 | ) | 304,300 | 1,495,500 | (1,030,200 | ) | 465,300 | ||||||||||||
Total amortizable intangible assets | $ | 15,451,800 | $ | (5,047,000 | ) | $ | 10,404,800 | $ | 8,577,800 | $ | (2,214,300 | ) | $ | 6,363,500 | ||||||
Non-compete agreements are amortized on a straight-line basis over their contractual lives of three to four years. Contract rights are amortized over five to nine years, which is the life of the related contracts. Amortization expense for contract rights and other intangibles for the fiscal years ended 2005, 2004, and 2003 were $3.4 million, $1.4 million and $0.5 million, respectively. The weighted average life of the contract rights and non-compete agreements as of December 31, 2005 is 2 years and 2.7 years, respectively. The estimated aggregate amortization expense for each of the five succeeding years is as follows:
2006 | $ | 3,488,000 | |
2007 | $ | 2,661,000 | |
2008 | $ | 2,004,200 | |
2009 | $ | 785,000 | |
2010 | $ | 588,000 |
6. Other current liabilities
The components of other current liabilities as of December 31, are as follows:
2005 | 2004 | |||||
Payroll and related taxes | $ | 6,031,800 | $ | 4,375,500 | ||
Accrued vacation | 3,119,800 | 2,035,400 | ||||
Self-insured medical expenses | 890,800 | 844,400 | ||||
Accrued subcontractor costs | 937,300 | 583,100 | ||||
Dividends payable | 781,300 | 279,800 | ||||
Other | 2,157,600 | 801,300 | ||||
Total other current liabilities | $ | 13,918,600 | $ | 8,919,500 | ||
F-14
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
7. Debt
The components of debt as of December 31, are as follows:
2005 | 2004 | |||||
Current: | ||||||
Notes Payable to shareholder | $ | 173,500 | $ | 163,400 | ||
Note Payable | 42,600 | 294,600 | ||||
Non-compete Agreements | 156,500 | 446,200 | ||||
Capital leases | 14,900 | — | ||||
Total current debt | $ | 387,500 | $ | 904,200 | ||
Long-term: | ||||||
Line of credit | $ | 27,631,400 | $ | 5,624,100 | ||
Notes Payable to shareholder | — | 173,500 | ||||
Non-compete Agreements | — | 156,100 | ||||
Series A Convertible Notes, net of discount | 6,497,700 | 4,689,500 | ||||
Total long-term debt | 34,129,100 | 10,643,200 | ||||
Total debt | $ | 34,516,600 | $ | 11,547,400 | ||
The Company has a credit agreement with Bank of America, N.A. (“the Credit Facility”). On April 1, 2005, in connection with the issuanceacquisition of ComGlobal, the Credit Facility was amended and salerestated to increase the amount available under the Credit Facility from $20.0 million to $40.0 million, subject to certain borrowing base and other requirements. As of December 31, 2005, the outstanding balance of the Convertible Notes, issued warrants (the “Note Warrants,”Credit Facility was $27.6 million and together with the Preferred Warrants, the “Warrants”) exercisable to purchase Common Stock atinterest rate was 7.39%. The Credit Facility has a ratiomaturity date of one share of Common Stock for every five shares of Common Stock issued or issuable upon conversionMay 31, 2008.
On behalf of the Convertible Notes.
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 December 31, 2005, the Company was in compliance with these covenants. The Credit Facility also restricts the Company’s 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 certain transactions with affiliates. The Credit Facility is generally secured by all assets of the Company.
In addition,January 2002, the Company entered into an interest-rate swap agreement, considered a cash flow hedge, with Bank of America whereby its obligation to pay floating-rate LIBOR on debt was swapped into a fixed rate obligation at 4.25%. The purpose of the swap was to protect the Company from potential rising interest rates on debt with variable interest rate features. During the term of the swap agreement, comprehensive income or loss related to the swap agreement was recorded as a current liability with an offset to accumulated other comprehensive income (loss), which is a component of shareholders’ equity. The swap agreement matured on December 1, 2004.
The Company’s comprehensive loss available to common shareholders for the year ended December 31, 2004 was $4,302,400 which includes the net loss available to common shareholders of $4,346,200 and other comprehensive income of $43,800 arising from the interest rate swap. The Company’s comprehensive income available to common shareholders for the year ended December 31, 2003 was $2,793,200 which includes the net income available to common shareholders of $2,746,400 and other comprehensive income of $46,800 arising from the interest rate swap.
F-15
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company also has outstanding an aggregate $10.0 million of Series A Convertible Notes issued on December 9, 2003 (see Note 8).
On November 2, 2001, the Company consummatedissued promissory notes to certain Analex sellers totaling $772,600 with a Securities Repurchase Agreement (the “Stout Repurchase Agreement”) withfive-year term, bearing interest at 6%. As of December 31, 2005 and 2004 the Company’s former Chairman Jon M. Stout, certain membersoutstanding balance of Mr. Stout’s immediate family including former Company director Shawna Stout,the promissory notes was $173,500 and certain entities controlled by Mr. Stout and his family (collectively, the “Stout Parties”), pursuant to which$336,900, respectively. In addition, the Company purchased an aggregateentered into non-competition agreements with former employees totaling $352,000, on a discounted basis. As of 2,625,451 sharesDecember 31, 2005 and 2004 the outstanding balance of Common Stockthe non-competition agreements was $11,000 and warrants and options exercisable to purchase an aggregate of 1,209,088 shares of Common Stock from the Stout Parties for aggregate consideration of $9,166,844.$93,000, respectively.
The transactions contemplated byCompany’s future debt maturities at December 31, 2005 are summarized below:
Year | Debt Maturities | |||
2006 | $ | 387,500 | ||
2007 | 10,000,000 | |||
2008 | 27,631,400 | |||
Total Minimum Debt Payments | $ | 38,018,900 | ||
Less: Current Maturities | (387,500 | ) | ||
$ | 37,631,400 | |||
Less: Unamortized discount | (3,502,300 | ) | ||
Total Long-Term Debt | $ | 34,129,100 | ||
8. Convertible Preferred Stock and Convertible Notes
Series A Convertible Preferred Stock and Convertible Notes
In December 2003, the Pequot Purchase AgreementCompany 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 exercisable at $3.28 per share. The Series A Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Dividend expense for the Stout Repurchase Agreement are collectively referred to as the “Pequot Transaction.” The proceeds from the saleSeries A Preferred Stock for each of the Convertible Notes were used to repurchase the securities from the Stout Partiesyears ended December 31, 2005, 2004 and pay expenses incurred by the Company in connection with the Pequot Transaction. Subsequent to year end, the Company used a portion of the proceeds from the sale2003 was $0.9 million, $0.9 million, and $0.1 million, respectively.
Upon issuance of the Series A Preferred Stock, to pay in full the outstanding promissory note issuedCompany allocated relative fair value of approximately $3.9 million to the Department of Justice underCommon Stock Warrants and recorded a Settlement Agreement between the former Analex Corporation and the Department of Justice. Remaining proceeds from the sale ofbeneficial conversion charge related to the Series A Preferred Stock will be used to finance all or a portion of the cost of future acquisitions by the Company.
Series A Preferred Stock
The Series A Preferred Stock bears a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s senior credit facility, in additional shares of Series A Preferred Stock. Holdersapproximately $11.1 million. These amounts are being recorded as accretion of Series A Preferred Stock are entitled to vote together with all other classes and seriesthrough the earliest redemption date of voting stockDecember 9, 2007. For each of the Company on all actions to be taken by the stockholders of the Company. In addition, as long as 50% of the Series A Preferred Stock originally issued remains outstanding,years ended December 31, 2005, 2004 and 2003, the Company may not take numerous actions without obtaining the written consentrecorded $3.8 million, $3.8 million and $0.2 million of the holdersaccretion related to these charges. The unamortized discount as of a majority of the Series A Preferred Stock.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series A Preferred Stock are entitled to receive, out of the Company’s assets available for shareholder distributions and prior to distributions to junior securities (including the Common Stock), an amount equal to the Series A Purchase Price plus any accrued but unpaid dividends thereon.December 31, 2005 was $7.3 million.
The Series A Preferred Stock is convertible into Common Stock at any time at the election of its holders, initially at a ratio of one share of Common Stock for every share of Series A Preferred Stock. The Series A Preferred Stock is convertible at a per share conversion price of $2.23. The Series A Preferred Stock will automatically convert into Common Stock if, any time following June 9, 2005, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds $5.58 (calculated as 2.5 times $2.23, the conversion price then in effect ($2.23 as of December 31, 2003) for the Series A Preferred Stock.Stock). In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into
F-16
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
the conversion price will automatically convert into Common Stock. The Series A Preferred Stock willcan also automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.
Holders of the Series A Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after December 9, 2007,September 15, 2008, at the Series A Purchase Price of $2.23 per share, as adjusted for stock splits, stock dividends and similar events, plus accrued but unpaid dividends.
Convertible Notes
The Convertible Notes mature onIn December 9, 2007. The Convertible Notes bear interest at an annual rate of 7%, payable quarterly2003, the Company also issued, in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s senior credit facility, such interest will be accrued and added to the outstanding principal.
The Convertible Notes may not be prepaid prior to June 9, 2005 without the consent of the holders of a majority of the outstandingaggregate, $10,000,000 principal amount of theSeries A Secured Subordinated Convertible Notes. Any subsequent prepayment will be made, at the option of thePromissory Notes (the “Series A Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum, or by conversion of the principalNotes”) convertible into 3,321,707 shares of Series A Preferred Stock and 664,341 Common Stock Warrants exercisable at $3.28 per share.
Upon issuance of the paymentSeries 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 each of the years ended December 31, 2005, 2004 and 2003, the Company recognized $1.8 million, $1.8 million and $0.1 million of amortization of that discount. The unamortized discount as of December 31, 2005 was $3.5 million.
Series B-1 and B-2 Convertible Preferred Stock
In May 2004, the Company issued in cash or inaggregate $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”) exercisable at $4.32 per share. In September 2004, the Series B-1 Notes were converted into 3,428,571 shares of Series AB Convertible Preferred Stock. Holders of the Convertible Notes may convert the outstanding principal and accrued interestStock (“Series B-1 Preferred Stock”). The Series B-1 Common Stock Warrants will expire on the NotesMay 28, 2014.
The Series B-1 Preferred Stock is convertible into Series A PreferredCommon Stock at any time. Thetime at the election of its holders at a per share conversion price for the Convertible Notes is $3.01 per share.of $2.80 (the “Series B-1 Conversion Price”). The Company may cause the automatic conversion of the Convertible NotesSeries B-1 Preferred Stock will automatically convert into Common Stock if, any time following June 9, 2005,March 15, 2006, the average closing price forof the Common Stock over athe immediately preceding 20 consecutive trading day period exceeds $5.58 per share.$8.75 (calculated as 2.5 times the Series B-1 Original Issue Price of $3.50). In addition, any holders that do not accept an offer by the Company to purchase the Series B-1 Preferred Stock for at least 2.5 times the Series B-1 Original Issue Price will automatically convert into Common Stock. The Series B-1 Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of 75% of the then outstanding Series B Preferred Stock.
Holders of two-thirds of the then outstanding Series B Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after September 15, 2008 (the fourth anniversary of the Series B Original Issue Date) at the Series B Original Issue Price, plus accrued but unpaid dividends.
The Company’s obligations underCompany had the Convertible Notes are secured byoption 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 lien on substantially all of the assets ofCompany acquisition. In April 2005, the Company exercised this option and its subsidiariesissued for $25.0 million, an additional 7,142,856 shares of Series B Convertible Preferred Stock (“Series B-2 Preferred Stock”) and are guaranteed by the Company’s subsidiaries. Such obligations are subordinated to the rights of the Company’s present and future senior secured lenders.1,785,713 Common Stock Warrants (the “Series B-2 Common Stock Warrants”) exercisable at $4.29 per share. The Series B-2 Common Stock Warrants will expire on April 1, 2015.
Warrants
The Warrants are exercisable at any time before December 9, 2013. The Preferred Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Series A Preferred Stock. The Note Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Convertible Notes. The initial exercise price of the Warrants is $3.28.F-17
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
4. Accounts receivable: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 resulted in the recognition of a discount on the Series B-2 Preferred Stock, which is being recorded as accretion of Series B-2 Preferred Stock through the earliest redemption date of September 15, 2008. For the year ended December 31, 2005 the Company recorded $2.0 million, of accretion related to these charges. The unamortized discount as of December 31, 2005 was $8.5 million.
The componentsSeries B-2 Preferred Stock is convertible into Common Stock at any time at the election of accounts receivable areits holders at a per share conversion price of $2.80 (the “Series B-2 Conversion Price”). The Series B-2 Preferred Stock will automatically convert into Common Stock if, any time following March 15, 2006, the average closing price of the Common Stock over the immediately preceding 20 consecutive trading day period exceeds $8.75 (calculated as follows:2.5 times the Series B-2 Original Issue Price of $3.50). In addition, any holders that do not accept an offer by the Company to purchase the Series B-2 Preferred Stock for at least 2.5 times the Series B-2 Original Issue Price of $3.50 will automatically convert into Common Stock. The Series B-2 Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of 75% of the then outstanding Series B-2 Preferred Stock.
December 31, | ||||||||
2003 | 2002 | |||||||
Trade accounts receivable: | ||||||||
U.S. Government: | ||||||||
Amounts billed | $ | 9,170,900 | $ | 10,312,900 | ||||
Recoverable costs and profits—not billed | 1,790,400 | 2,609,200 | ||||||
Total | 10,961,300 | 12,922,100 | ||||||
Commercial, state and local governments: | ||||||||
Amounts billed | 103,500 | 334,800 | ||||||
Recoverable costs and profits—not billed | — | 151,400 | ||||||
Total | 103,500 | 486,200 | ||||||
Total accounts receivable | 11,064,800 | 13,408,300 | ||||||
Less: Allowance for doubtful accounts | (345,400 | ) | (852,200 | ) | ||||
Total accounts receivable, net | $ | 10,719,400 | $ | 12,556,100 | ||||
Holders of Series B Preferred Stock will be entitled to vote together with all other classes and series of voting stock of the Company as a single class on all actions to be taken by the stockholders of the Company. As long as at least 25% of the shares of the Series B Preferred Stock issued pursuant to the Series B Purchase Agreement remain outstanding, the Company may not take numerous specified actions without first obtaining the written consent of holders of at least a majority of the then outstanding shares of Series B Preferred Stock voting separately as a class.
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 years ended December 31, 2005 and 2004 was $1.8 million and $0.2 million, respectively.
Summary of Charges
The following table summarizes activity inprovides the allowance for doubtful accounts for years endedface value and carrying value of the the Series A, Series B-1 and B-2 Preferred Stock as of December 31:31, 2005 and 2004 and the remaining period of amortization as of December 31, 2005.
2003 | 2002 | 2001 | |||||||||
Beginning balance | $ | 852,200 | $ | 926,400 | $ | 151,200 | |||||
Additions | 49,600 | — | 775,200 | ||||||||
Write-offs | (556,400 | ) | (74,200 | ) | — | ||||||
Ending balance | $ | 345,400 | $ | 852,200 | $ | 926,400 | |||||
2005 | 2004 | ||||||||||||||||
Face Value | Carrying Value | Remaining Amount to be Accreted | Carrying Value | Remaining Amount to be Accreted | Remaining Period of Amortization | ||||||||||||
Series A Preferred Stock | $ | 15,000,000 | $ | 7,736,300 | $ | 7,263,700 | $ | 3,986,300 | $ | 11,013,700 | 2.00 years | ||||||
Series B-1 Preferred Stock | $ | 12,000,000 | $ | 12,000,000 | — | $ | 12,000,000 | — | — | ||||||||
Series B-2 Preferred Stock | $ | 25,000,000 | $ | 16,493,300 | $ | 8,506,700 | — | — | 2.75 years |
Unbilled accounts receivable can be invoiced upon completion of contractual billing cycles, attaining certain milestones under fixed-price contracts, attaining a stipulated level of effort on cost-type contracts for government agencies, upon completion of federal government overhead audits or upon final approval of design plans for engineering services.F-18
5. Fixed assets:
The components of fixed assets are as follows:
December 31 | ||||||||
2003 | 2002 | |||||||
Computer hardware and software | $ | 904,400 | $ | 515,700 | ||||
Leasehold improvements | 68,200 | 36,400 | ||||||
Laboratory | 141,300 | 141,400 | ||||||
Office equipment | 159,300 | 125,000 | ||||||
Total fixed assets | 1,273,200 | 818,500 | ||||||
Accumulated depreciation and amortization | (720,300 | ) | (601,800 | ) | ||||
Total fixed assets, net | $ | 552,900 | $ | 216,700 | ||||
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
6. GoodwillThe following table provides the face value and other intangible assets:
As discussed in Note 2,carrying value of the Company adopted SFAS No. 142 in January 2002, which required the Company to stop amortizing goodwill and certain intangible assets with an indefinite useful life. Instead, SFAS No. 142 requires that goodwill and intangible assets deemed to have an indefinite life be reviewed for impairment upon adoption of SFAS No. 142 and annually, thereafter. The Company’s goodwill balance was approximately $15.3 million and $15.5 millionSeries A convertible debt as of December 31, 2003 and 2002, respectively. remaining period of amortization as of December 31, 2005:
2005 | 2004 | ||||||||||||||||
Face Value | Carrying Value At December 31, 2005 | Remaining Amount to be Accreted | Carrying Value At December 31, 2005 | Remaining Amount to be Accreted | Remaining Period of Amortization | ||||||||||||
Series A Convertible Note | $ | 10,000,000 | $ | 6,497,700 | $ | 3,502,300 | $ | 4,689,500 | $ | 5,310,500 | 2.00 years |
9. Acquisitions
ComGlobal Systems, Incorporated
Analex acquired ComGlobal on April 1, 2005. Under the terms of the Agreement and Plan of Merger dated April 1, 2005, by and among Analex, Alpha-N Acquisition Corp., a wholly-owned subsidiary of Analex (“Merger Sub”) and ComGlobal, along with certain designated ComGlobal stockholder representatives, Analex acquired ComGlobal by merging the Merger Sub with and into ComGlobal, with ComGlobal as the surviving corporation (the “Merger”). As a result of the Merger, ComGlobal has become a wholly-owned subsidiary of Analex.
The decreasefinancial consideration for the acquisition of approximately $0.2the ComGlobal business was $47 million was duein 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 8). Any remaining purchase price consideration to be recorded against goodwill is still preliminary, pending resolution of the 2003 realizationHKSBS matter (see Note 12). The Agreement and Plan of net operating losses belongingMerger contains certain financial representations, secured by $8.0 million in escrow, which is scheduled to be released to the former Analex Corporation. shareholders of ComGlobal, net of any indemnification obligations, starting in December 2006 and continuing through April 2010.
The Company performed its annual impairment testallocation of the $47 million purchase price was as of October 1, 2003 and concluded that the goodwill was not impaired. The Company’sfollows:
Cash purchase price | $ | 47,000,000 | ||
Transaction fees | 909,000 | |||
47,909,000 | ||||
Cash | 1,608,500 | |||
Accounts receivable | 8,275,600 | |||
Prepaid expenses and other | 2,062,100 | |||
Inventory | 459,000 | |||
Property and equipment | 1,025,700 | |||
Contract rights and other intangible assets | 7,414,000 | |||
Other assets | 53,400 | |||
Accounts payable | (231,400 | ) | ||
Other current liabilities | (5,240,600 | ) | ||
Other long-term liabilities | (41,300 | ) | ||
Net deferred tax liability | (2,272,900 | ) | ||
Goodwill | $ | 34,796,900 | ||
ComGlobal’s results of operations, prior to 2002 do not reflectsince the provisionsApril 1, 2005 closing date, are included as part of SFAS No. 142. A reconciliationthe Company’s Consolidated Statements of previously reported net income with the amounts adjustedOperations for the exclusion of goodwill amortization net of related income tax effects for year ended December 31, 2001 is as follows:2005, reported herein. The
2001 | |||
Net income attributable to common shareholders | $ | 196,000 | |
Add back goodwill amortization, net of tax | 337,000 | ||
Adjusted net income to common stockholders | $ | 533,000 | |
Basic earnings per common share: | |||
As reported | $ | 0.03 | |
Goodwill amortization, net of tax | 0.04 | ||
Adjusted basic earnings per common share | $ | 0.07 | |
Diluted earnings per common share: | |||
As reported | $ | 0.02 | |
Goodwill amortization, net of tax | 0.04 | ||
Adjusted basic earnings per common share | $ | 0.06 |
F-19
The gross carrying amounts and accumulated amortization of the Company’s intangible assets as of December 31, 2003 and 2002, were as follows:
December 31 | ||||||||||||
2003 | 2002 | |||||||||||
Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | |||||||||
Non-compete agreements | $ | 1,411,800 | $ | 536,300 | $ | 892,000 | $ | 283,600 | ||||
Contract rights | $ | 1,053,200 | $ | 175,700 | $ | 1,053,200 | $ | 44,600 | ||||
Patents | $ | — | $ | — | $ | 153,200 | $ | — |
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Non-compete agreements are amortized on a straight-line basis over their contractual lives of three to four years. Contract rights are amortized over ten years, which isfollowing table provides the lifeunaudited pro forma results of the related contract. All patent development costs capitalized in priorCompany for the years which were included in the ABS segment, haveended December 31, 2005 and 2004 as if ComGlobal had been written off during 2003 due to uncertaintyacquired on January 1, 2005 and 2004, respectively. These combined results are not necessarily indicative of future revenues. The write-off is includedoperating results of the Company.
Years Ended December 31, | ||||||||
2005 | 2004 | |||||||
Revenue | $ | 150,755,600 | $ | 133,955,300 | ||||
Income from continuing operations | 1,674,200 | 1,176,200 | ||||||
Net income (loss) | 1,578,100 | (4,543,800 | ) | |||||
Net loss available to common shareholders | (7,968,000 | ) | (13,503,700 | ) | ||||
Basic and diluted loss per share available to common shareholders | $ | (0.50 | ) | $ | (0.94 | ) |
Beta Analytics, Inc.
Analex acquired BAI on May 28, 2004. Under the terms of a Stock Purchase Agreement, dated May 6, 2004, Analex acquired all of the issued and outstanding stock of BAI for approximately (i) $27.7 million in selling, generalcash, and administrative expense in(ii) 1,832,460 unregistered shares of Analex Common Stock, valued at $3.80 per share. Analex financed the accompanying statementcash portion of operations. Amortization expense for contract rights and other intangiblesthe consideration for the fiscal years ended 2003acquisition through its cash on hand, senior debt from Bank of America, N.A. and 2002 was $450,800 and $307,600, respectively. the Series B Senior Subordinated Notes, subsequently converted to the Series B-1 Preferred Stock (see Note 8).
The weighted average life of all intangible assets is 6.17 years as of December 31, 2003. The estimated aggregate amortization expense for eachtotal cost of the five succeeding years is as follows:acquisition of BAI was approximately $37.9 million, including the assumption of BAI’s debt of $1.7 million. The Stock Purchase Agreement contains certain financial representations, which will survive until May 28, 2006.
2004 | $ | 527,700 | |
2005 | $ | 375,800 | |
2006 | $ | 311,600 | |
2007 | $ | 113,200 | |
2008 | $ | 113,200 |
7. Debt:10. Earnings Per Share
The componentsfollowing table sets forth the computation of debt are as follows:basic and diluted earnings per share for the years ended December 31:
December 31, | ||||||
2003 | 2002 | |||||
Current: | ||||||
Line of credit | — | $ | 2,187,700 | |||
Bank term note | 700,000 | 700,000 | ||||
Notes payable-shareholder | 154,000 | 145,100 | ||||
Note payable-other | 333,300 | 333,300 | ||||
Non-compete agreements | 461,900 | 261,900 | ||||
Note to DOJ | 538,200 | 260,500 | ||||
Other | — | 11,300 | ||||
Total current debt | 2,187,400 | 3,899,800 | ||||
Long-term: | ||||||
Bank term note | 1,341,700 | 2,041,700 | ||||
Notes payable-shareholder | 336,800 | 490,900 | ||||
Note payable-other | 250,000 | 583,300 | ||||
Non-compete agreements | 622,500 | 534,700 | ||||
Note to DOJ | — | 685,900 | ||||
Convertible notes, net of discount of $7,118,600 | 2,881,400 | — | ||||
Other | — | 2,400 | ||||
Total long-term debt | 5,432,400 | 4,338,900 | ||||
Total debt | $ | 7,619,800 | $ | 8,238,700 | ||
2005 | 2004 | 2003 | |||||||||
Net (loss) income from continuing operations available to common shareholders | $ | (6,543,600 | ) | $ | (8,672,900 | ) | $ | 2,437,900 | |||
Income from discontinued operations, net of income taxes | — | 8,200 | 15,500 | ||||||||
Loss on disposal of discontinued operations, net of income taxes | (113,200 | ) | (545,000 | ) | — | ||||||
Net (loss) income available to common shareholders | $ | (6,656,800 | ) | $ | (9,209,700 | ) | $ | 2,453,400 | |||
Weighted average shares outstanding | 15,931,936 | 14,435,676 | 14,878,312 | ||||||||
Less: dilutive effect of outstanding warrants and stock options | |||||||||||
Warrants | — | — | 1,551,000 | ||||||||
Employee Stock Options | — | — | 1,240,689 | ||||||||
Diluted weighted average shares outstanding | 15,931,936 | 14,435,676 | 17,670,001 | ||||||||
Net (loss) income available to common shareholders per share: | |||||||||||
Continuing operations: | |||||||||||
Basic | $ | (0.41 | ) | $ | (0.60 | ) | $ | 0.16 | |||
Diluted | $ | (0.41 | ) | $ | (0.60 | ) | $ | 0.14 | |||
Discontinued operations: | |||||||||||
Basic | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.00 | |||
Diluted | $ | (0.01 | ) | $ | (0.04 | ) | $ | 0.00 | |||
Net income (loss) available to common shareholders: | |||||||||||
Basic | $ | (0.42 | ) | $ | (0.64 | ) | $ | 0.16 | |||
Diluted | $ | (0.42 | ) | $ | (0.64 | ) | $ | 0.14 |
F-20
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
On December 9, 2003,Shares issuable upon the Company issued Convertible Notes to Pequot, which mature on December 9, 2007 (see Note 3). The Company allocated the proceedsexercise of stock options or warrants or upon conversion of convertible preferred stock and convertible debt have been excluded from the sale of the Convertible Notes between the Convertible Notes and the Note Warrants based on their relative fair values, which resulted in the recording of a discount on the Convertible Notes. After allocating the Convertible Notes proceeds, the Company calculated the embedded conversion price and used it to measure the intrinsic value of the embedded conversion option. As the embedded conversion price was less than the fair market value of the Company’s common stock as of the date of the transaction, beneficial conversion was recorded. The table below details the accounting treatment of the Convertible Notes.
Allocation of Convertible Notes Proceeds | |||
Proceeds of the convertible notes | $ | 10,000,000 | |
Allocated relative fair value of convertible notes | 8,094,700 | ||
Allocated relative fair value of note warrants | 1,905,300 | ||
Balance sheet presentation of Convertible Notes at December 31, 2003 | |||
Allocated relative fair value of convertible notes | $ | 8,094,700 | |
Less: discount from beneficial conversion | 5,327,200 | ||
Net carrying value of convertible notes prior to amortization and accretion | $ | 2,767,500 | |
Accretion of discount | 113,900 | ||
Net carrying value of convertible notes at December 31, 2003 | $ | 2,881,400 | |
The discount on the Convertible Notes created as a result of the allocation of fair valuecomputation to the Note Warrants and the beneficial conversion willextent that their inclusion would be amortized to interest expense over the four-year period to the maturity of the Convertible Notes using the effective yield method. Issuance costs of $415,000 are recorded as deferred financing costs and will also be amortized to interest expense over the four-year period to the maturity of the Convertible Notes. The Convertible Notes accrue interest at 7% per annum, which is payable quarterly in cash.
On November 2, 2001, to finance the acquisition of Analex, the Company entered into a Credit Agreement (“Agreement”) with Bank of America, N.A. The Agreement provides the Company with a $4,000,000 revolving credit facility (the “Credit Facility”) through November 2, 2006 and a five-year $3,500,000 term loan (“Term Loan”). The Credit Facility has an annual renewal occurring April 30 of each year. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. In August 2002 the credit limit on the Credit Facility was increased to $8,000,000. Interest on each of the facilities is at the LIBOR Rate plus an applicable margin as specified in a pricing grid. The interest rate at December 31, 2003 was 3.63% for the Credit Facility and 4.12% for the Term Loan.anti-dilutive. As of December 31, 2003, $8,000,000 was available under the Credit Facility. The Company is subject to certain financial covenants pursuant to the Agreement, including a funded debt to EBITDA ratio and a fixed charge coverage ratio. The Company is in compliance with all financial covenants. The Credit Facility and Term Loan2005, shares issuable upon conversion or exercise of such instruments are secured by the accounts receivable and other assetsas follows:
Instrument | Common shares issuable upon conversion or exercise | Conversion or exercise price | Proceeds from conversion or exercise | ||||
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 | 981,858 | 0.69 – 1.99 | 1,317,576 | ||||
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 | ||||
Total | 31,717,705 | $ | 27,790,789 | ||||
As of the Company.December 31, 2004, shares issuable upon conversion or exercise of such instruments are as follows:
Instrument | Common shares issuable upon conversion or exercise | Conversion or exercise price | Proceeds from conversion or exercise | |||||
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 Preferred Stock | 4,285,714 | 2.80 | — | |||||
Series B Senior Subordinated Notes 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 | 1,153,225 | 0.50 – $ | 1.375 | 1,517,517 | ||||
Options issued under Incentive Stock Option Plans | 1,456,546 | 1.60 – $ | 2.55 | 3,352,330 | ||||
Options issued under Incentive Stock Option Plans | 972,500 | 2.79 – $ | 4.49 | 3,677,425 | ||||
Total | 20,815,423 | $ | 18,866,092 | |||||
11. Income Taxes
The Company’s $3.5 million term loan facility from Bank of America carries interest comprised of two components: floating-rate LIBOR plus a credit performance margin. The Company has entered into an interest-rate swap agreement with Bank of America whereby its obligation to pay floating-rate LIBOR on debt totaling $2,950,000 was swapped at a fixed rate obligation at 4.25% beginning in January 2002. The Company continues to haveprovision for income taxes for the obligation to pay the credit performance margin in addition to its swapped 4.25% payment obligation. The fair value of the swap of $43,800 is included in other liabilities. The total effective interest rate on the swapped portion of the Term Loan amounted to 7.25% atyears ended December 31, 2003.2005, 2004, and 2003 has been limited to state and federal taxes. The provision for income taxes for the year ended December 31, 2003 has to some extent been offset by net operating loss carryforwards.
F-21
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In addition,The provision for income tax from continuing operations before income tax consisted of the Company was required by Bank of America to obtain personal guarantees infollowing for the amount of $2,000,000, which the Company procured from two individuals, the Company’s former Board member Gerald R. McNichols, and J. Richard Knop. The compensation during the period of guaranty was in the form of cash and warrants. Onyears ended December 20, 2002, both Mr. McNichols and Mr. Knop were released from the guarantees.31:
On November 2, 2001, the Company issued promissory notes to certain Analex sellers totaling $772,600 with a five-year term, bearing interest at 6%. The Company also entered into non-compete agreements with these sellers for total payments of $540,000 over a three-year period. In addition, the Company entered into non-compete agreements with former employees totaling $352,000, on a discounted basis, payable over various periods.
On May 29, 2002, Analex announced that it had been awarded a $164 million Expendable Launch Vehicle Integrated Support (“ELVIS”) prime contract by NASA. In conjunction with this award the Company issued promissory notes to certain Analex sellers totaling $1,000,000 with a three-year term, bearing interest at prime plus 1%. At December 31, 2003, the outstanding balance on these notes was $583,300.
With its purchase of Analex, the Company assumed a note payable to the Department of Justice (“DOJ”). The agreement provides for quarterly payments of $80,000 consisting of principal and interest at 7% through February 2006, with a final payment due in May 2006. As required by the terms of the Pequot Transaction, the DOJ note was paid in full with proceeds from the Pequot Transaction. An audit was requested by the DOJ prior to acceptance of the note repayment. The audit was completed by the government subsequent to year-end, and the payment was accepted.
2005 | 2004 | 2003 | |||||||||
Current Taxes: | |||||||||||
Federal | $ | 3,267,700 | $ | 230,900 | $ | 399,800 | |||||
State | 682,300 | 172,800 | 61,400 | ||||||||
Total current income tax expense | $ | 3,950,000 | 403,700 | 461,200 | |||||||
Deferred Taxes: | |||||||||||
Federal | (632,000 | ) | 647,800 | (128,600 | ) | ||||||
State | (69,200 | ) | 141,900 | (21,400 | ) | ||||||
Total deferred income tax (benefit) expense | (701,200 | ) | 789,700 | (150,000 | ) | ||||||
Total provision for income taxes | $ | 3,248,800 | $ | 1,193,400 | $ | 311,200 | |||||
The Company’s future debt maturities atincome tax expense (benefit) from discontinued operations, including disposal of discontinued operations, consisted of the following for the years ended December 31, 2003 are summarized below:31:
Year | Debt Maturities | |||
2004 | $ | 2,187,300 | ||
2005 | 1,555,700 | |||
2006 | 981,600 | |||
2007 | 10,013,700 | |||
Total Minimum Debt Payments | $ | 14,738,300 | ||
Less: Current Maturities | (2,187,300 | ) | ||
12,551,000 | ||||
Less: Unamortized Discount | (7,118,600 | ) | ||
Total Long-Term Debt | $ | 5,432,400 | ||
2005 | 2004 | 2003 | ||||||||
Current Taxes: | ||||||||||
Federal | $ | 164,400 | $ | (303,800 | ) | $ | 9,000 | |||
State | 44,000 | (65,900 | ) | 700 | ||||||
Total current income tax expense (benefit) | 208,400 | (369,700 | ) | 9,700 | ||||||
Deferred Taxes: | ||||||||||
Federal | 16,100 | — | — | |||||||
State | 4,300 | — | — | |||||||
Total deferred income tax expense | 20,400 | — | — | |||||||
Total income tax expense (benefit) | $ | 228,800 | $ | (369,700 | ) | $ | 9,700 | |||
The effective income tax expense from continuing operations before income taxes differs from the income tax computed using the statutory federal income tax rate. The following table summarizes these differences for the years ended December 31:
2005 | 2004 | 2003 | |||||||
Expected federal income tax at the statutory rate | 31.8 | % | 35.0 | % | 31.3 | % | |||
State and local taxes net of federal taxes | 5.4 | (8.7 | ) | 3.6 | |||||
Nondeductible expenses | 1.0 | (2.3 | ) | 4.8 | |||||
Utilization of NOL carryforward | 0.0 | 0.0 | (25.0 | ) | |||||
Beneficial conversion | 18.9 | (83.4 | ) | 0.0 | |||||
Permanent differences | 3.5 | 13.8 | 0.0 | ||||||
Other | 2.4 | 0.0 | (4.5 | ) | |||||
Tax expense at effective rate | 63.0 | % | (45.6 | )% | 10.2 | % | |||
F-22
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets and liabilities consist primarily of the following, as of December 31,:
2005 | 2004 | |||||||
Allowance for doubtful accounts | $ | 380,000 | $ | 276,100 | ||||
Accrued vacation | 1,026,100 | 642,400 | ||||||
Intangible assets | 385,300 | 71,900 | ||||||
Depreciation | 3,400 | — | ||||||
Accrued expenses and reserves | 170,100 | 23,500 | ||||||
Other | 203,600 | 71,600 | ||||||
Net gross deferred tax assets | 2,168,500 | 1,085,500 | ||||||
Property and equipment | (341,900 | ) | (217,300 | ) | ||||
Unbilled receivables | (2,304,500 | ) | (1,688,900 | ) | ||||
Customer intangibles | (3,776,900 | ) | (1,980,400 | ) | ||||
Prepaid expenses | (202,700 | ) | (249,800 | ) | ||||
Net gross deferred tax liabilities | (6,626,000 | ) | (4,136,400 | ) | ||||
Net deferred tax liability | $ | (4,457,500 | ) | $ | (3,050,900 | ) | ||
As of December 31, 2005 and 2004, the Company had no remaining net operating loss carryforwards for federal income tax purposes.
8. Equity Capital:12. Commitments and Contingencies
The Company allocated the proceeds from the sale of the Series A Preferred Stock between the Series A Preferred Stock and the Preferred Warrants based on their relative fair values, which resulted in the recording of a discount on the Series A Preferred Stock. In accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible InstrumentsGuarantees, after allocating the Series A Preferred Stock proceeds, the Company calculated the embedded conversion price and used it to measure the intrinsic value of the embedded conversion option. The amount of the beneficial conversion was recorded as additional paid in capital, resulting in a further discount on the Series A Preferred Stock. The table below details the accounting treatment of the Series A Preferred Stock.
Allocation of Series A Preferred Stock Proceeds | |||
Proceeds of Series A Preferred Stock | $ | 15,000,000 | |
Allocated relative fair value of preferred stock | 11,142,400 | ||
Allocated relative fair value of preferred warrants | 3,857,600 | ||
Balance sheet presentation of Series A Preferred Stock at December 31, 2003 | |||
Allocated relative fair value of preferred stock | $ | 11,142,400 | |
Less: discount on preferred stock | 10,519,800 | ||
Less: issuance costs of preferred stock | 622,600 | ||
Net carrying value of preferred stock prior to accretion | $ | — | |
Accretion of discount on preferred stock | 236,300 | ||
Net carrying value of preferred stock at December 31, 2003 | $ | 236,300 | |
The discount on the Series A Preferred Stock is being accreted to the redemption amount over a four-year period to the earliest redemption date. Accrued dividends at December 31,2003 were $56,700.
Pursuant to the November 2, 2001 acquisition of the former Analex, the Company issued 3,572,143 shares of the Company’s Common Stock to the shareholders representing all of the outstanding equity of Analex (the “Sellers”). Of the 3,572,143 shares, 857,143 shares are subject to a provision by which the Company guarantees for a five-year period to reimburse the Sellers the difference between the price at which they sell such shares and a guaranteed sales price. The agreement phases in portions of the total shares subjectprice ranging from $1.60 to the guarantee over a period of two years following the acquisition in increments of 25% of the total guaranteed shares covered by the agreement. Of the total shares guaranteed, 25% (214,286 shares) are guaranteed from the acquisition date through November 5, 2006, at a price of $1.60. An additional 214,286$2.20 per share, if such shares are guaranteed beginning November 5, 2002 through November 5, 2006 at a pricesold within such period and if certain other conditions are satisfied. As of $1.80. An additional 214,286 shares are guaranteed beginning May 5, 2003 through November 5, 2006 at a price of $2.00 per share. On November 5, 2003,September 30, 2005, the final portion of shares (214,286 additional shares) became guaranteed at a price of $2.20 per share. These shares will be guaranteed through November 5, 2006, resulting in a maximum amount of $1,628,571 payable under the terms of the guaranteed shares as of December 31, 2003.was $1,628,600. As the fair market value of the Company’s common stockCommon Stock was in excess of the guaranteed share prices as of December 31, 2003,2005, no amounts were accrued under the guarantee.
To finance the acquisition of Analex, the Company issued 3,961,060 shares of common stock for aggregate consideration of approximately $3,868,000 through a private placement consisting of (i) Common Stock at a price of $1.14 per share to purchasers who purchased less than $500,000 worth thereof or (ii) units consisting of Common Stock and warrants to purchase 0.2061 shares of Common Stock at an exercise price of $0.02 per share for each share purchased at a price of $1.14 per unit for purchasers who purchased $500,000 or more of theF-23
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Company’s equity. Two such purchasers were directors or affiliates of a director. The warrants were exercised concurrent with the stock purchase.
9. Other current liabilities:
Other current liabilities include the following major classifications:
December 31, | ||||||
2003 | 2002 | |||||
Payroll and related taxes | $ | 2,786,700 | $ | 2,675,200 | ||
Accrued vacation | 1,216,900 | 1,138,000 | ||||
Self-insured medical expense | 930,300 | 640,500 | ||||
Accrued subcontractor costs | 482,000 | 30,700 | ||||
Other | 47,600 | 774,000 | ||||
Total other current liabilities | $ | 5,463,500 | $ | 5,258,400 | ||
10. Acquisitions:
Effective November 2001, the Company acquired Analex, a professional services and program management firm whose principal customers are NASA and the U.S. intelligence community, for approximately $13,898,000. The purchase price was satisfied with cash payments of $6,510,000, 3,520,339 shares of Common Stock valued at $4,664,000, the issuance of promissory notes of $1,773,000, non-compete agreements of $892,000, and the satisfaction of other certain liabilities of Analex. The fair value of the assets acquired and liabilities assumed approximated their book value of $6,092,400 and $5,730,000, respectively. The Company incurred financial, legal and accounting costs associated with the Analex purchase of approximately $570,000.During 2002, certain contingencies were finalized including the settlement of the Analex closing balance sheet requirements and the award of the ELVIS contract.
Non-compete agreements and contractual relationships identified in connection with the acqusition are amortized on a straight-line basis over their estimated lives ranging from three to ten years.
11. Net income per share:
The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31:
2003 | 2002 | 2001 | |||||||
Numerator: | |||||||||
Net income available to common shareholders | $ | 2,453,400 | $ | 2,356,900 | $ | 196,000 | |||
Denominator: | |||||||||
Denominator for basic earnings per share: | |||||||||
Weighted average shares outstanding | 14,878,312 | 14,412,554 | 7,721,779 | ||||||
Effect of dilutive securities: | |||||||||
Warrants | 1,551,031 | 1,860,811 | 1,413,289 | ||||||
Employee stock options | 1,240,658 | 808,286 | 452,961 | ||||||
Denominator for diluted earnings per share | 17,670,001 | 17,081,651 | 9,588,029 | ||||||
Basic earnings per share | $ | 0.16 | $ | 0.16 | $ | 0.03 | |||
Diluted earnings per share | $ | 0.14 | $ | 0.14 | $ | 0.02 | |||
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Shares issuable upon the exercise of stock options or warrants or upon conversion of convertible preferred stock and convertible debt have been excluded from the computation to the extent that their inclusion would be anti-dilutive.
12. Income taxes:
The provision for income taxes for the years ended December 31, 2003, 2002 and 2001 has been limited to state and federal taxes and has to some extent been offset by net operating loss carryforwards. The income tax provision (benefit) consisted of the following for the years ended December 31:
2003 | 2002 | 2001 | ||||||||
Current Taxes: | ||||||||||
Federal | $ | 408,800 | $ | 128,900 | $ | 19,600 | ||||
State | 62,100 | 20,200 | — | |||||||
Total current income tax expense | 470,900 | 149,100 | 19,600 | |||||||
Deferred Taxes: | ||||||||||
Federal | (128,600 | ) | — | — | ||||||
State | (21,400 | ) | — | — | ||||||
Total deferred income tax benefit | (150,000 | ) | — | — | ||||||
Total provision for income taxes | $ | 320,900 | $ | 149,100 | $ | 19,600 | ||||
The tax provision differs from the amounts computed using the statutory federal income tax rate are as follows for the years ended December 31:
2003 | 2002 | 2001 | |||||||
Tax expense at statutory rate-federal | 35 | % | 35 | % | 35 | % | |||
State tax expense, net of federal taxes | 4 | 4 | 13 | ||||||
Permanent differences | 5 | 3 | 63 | ||||||
Utilization of NOL carryforward | (28 | ) | (36 | ) | (102 | ) | |||
Other | (5 | ) | — | — | |||||
Tax expense at effective rate | 12 | % | 6 | % | 9 | % | |||
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets (liabilities) at December 31, 2003 and 2002 consist primarily of the following:
2003 | 2002 | |||||||
Net operating loss carryforward | $ | 0 | $ | 826,100 | ||||
Allowance for doubtful accounts | 103,100 | 328,700 | ||||||
Accrued vacation | 478,600 | 378,900 | ||||||
Fixed assets | 27,900 | 21,200 | ||||||
Unbilled receivables | (690,600 | ) | (789,800 | ) | ||||
Intangible assets | 138,300 | — | ||||||
Other | 92,700 | 5,600 | ||||||
Gross tax asset | 150,000 | 770,700 | ||||||
Valuation allowance | — | (770,700 | ) | |||||
Net deferred tax asset | $ | 150,000 | — | |||||
At December 31, 2003, the Company has no remaining net operating loss carryforwards for federal income tax purposes.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax asset will not be realized. Management considers projected future taxable income, the scheduled reversal of deferred tax liabilities and available tax planning strategies that can be implemented by the Company in making this assessment. Based upon the recent level of taxable income and projections for future taxable income over the periods in which the deferred tax assets will be realized during 2003, management reversed the valuation allowance recorded as of December 31, 2002. While analyzing the decision to reverse the valuation allowance, portions of the tax asset relating to the former Analex Corporation were reviewed and certain adjustments were made to goodwill to reflect the benefit provided by the realization of these assets.
13. Commitments and contingencies:
Operating leases:leases
The Company leases real property and personal property under various long-term operating leases and sublease agreements expiring at various dates through 2006.2012. Certain of the leases contain renewal options and require payment of property taxes, insurance and maintenance costs. The Company’s future minimum operating lease commitments inclusive of property taxes, insurance and maintenance costs at December 31, 20032005 are summarized below:
Year | Lease Commitments | ||
2004 | $ | 1,053,600 | |
2005 | 783,400 | ||
2006 | 56,200 | ||
Total future minimum lease payments | $ | 1,893,200 | |
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Year | Lease Commitments | ||
2006 | $ | 2,919,600 | |
2007 | 1,521,900 | ||
2008 | 1,393,300 | ||
2009 | 1,192,900 | ||
2010 | 985,600 | ||
Thereafter | 2,034,900 | ||
Total future minimum payments | $ | 10,048,200 | |
Rent expense, included in the consolidated statements of operations is as follows:
Year | Rent Expense | Rent Expense | ||||
2005 | $ | 2,527,700 | ||||
2004 | 1,152,700 | |||||
2003 | $ | 1,064,800 | 998,500 | |||
2002 | 1,143,100 | |||||
2001 | 572,900 |
U.S. government contract audits:
In August 2005 the Company entered into a lease agreement, considered an operating lease, with a property management company to lease approximately 28,500 square feet of office space to be used as the Company’s new corporate headquarters. The Company’s revenueslease commenced on January 1, 2006 and costs related to contracts with agencies and departmentsthe initial term of the U.S. government are subject to audit bylease is seven years with one optional renewal period of five years. The lease agreement included a tenant improvement allowance of approximately $1.1 million, which the Defense Contract Audit Agency, which has completedCompany is amortizing against rent expense over the majority of its audits for the Company’s fiscal years through fiscal year 2000. It is the opinion of management that the results of future audits will not have a material effect on the financial condition or results of operationsseven-year lease term. The Company took occupancy of the Company.new facility in mid December 2005. Future minimum lease payments over the seven-year lease term will be approximately $5.6 million.
Litigation:U.S. government contract audits
Cost-plus-fee 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-plus-fee 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.
Legal Proceedings
The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. in the Maryland Circuit Court for Prince George’s County(“Swales”) alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. Management believesThe Company entered into a Settlement Agreement dated July 22,
F-24
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 allegationunreimbursed 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 is vigorously contestingscheduled for trial on March 20 and 21, 2006. In the complaint. Management believes and will assertevent that it validly exercised its contractual rightHKSBS prevails, the Company could be held liable for up to terminate the subcontract for Analex’s conveniencefull amount of the damages sought; and that termination of Swales occurred only after NASA was informed of Swales’ cost overruns and negotiations with Swales failed to yield an acceptable alternative. The Company will assert that Swales entered into the subcontract after it had hired incumbent ELVIS personnel at cost-prohibitive rates, knowing that its actual costs would greatly exceed the subcontract’s funding limitations. Under the complaint, Swales is seeking damages in excess of $4.0 million. Management believes that any liability that may ultimately result from the resolution of this matter will notcould have a material adverse effect on its operating results and cash flows.
13. Accumulated Other Comprehensive Income
Comprehensive income is composed of net income and other comprehensive income, which arises from the financial position or resultsinterest rate swap, which ended in December 2004. The following table outlines the components of operations of the Company.other comprehensive (loss) income:
Accumulated other comprehensive (loss) income | ||||
Balance December 31, 2002 | $ | (90,600 | ) | |
Net change | 46,800 | |||
Balance December 31, 2003 | (43,800 | ) | ||
Net change | 43,800 | |||
Balance December 31, 2004 | — | |||
Net change | — | |||
Balance December 31, 2005 | $ | — |
F-25
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
14. Benefit plans:Plans
Employee savings plan:plan
The Company sponsors a defined contribution savings planplans under section 401(k) of the Internal Revenue Code. The Company’s contributions to the 401(k) planplans are based upon a percentage of employee contributions. The Company’s discretionary contributions to the Planplan were $1,108,200, $1,067,200,$2.2 million, $1.3 million, and $432,000$1.2 million for 2003, 2002,the years ended December 31, 2005, 2004, and 2001,2003, respectively.
Employee stock purchase plan:plan
In December 1997, shareholders approved the Hadron, Inc.Analex Corporation 1997 Employee Stock Purchase Plan (the “Plan”). The number of shares currently reserved for issuance under the Plan is 500,000.650,000. 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 APB 25. Under the terms of the Plan, individual employees may pay up to $10,000$14,000 for the purchase of the Company’s common shares, at 85%95% of the determined market price. In 2005, the Company amended the Plan, offering individual employees to purchase the Company’s common shares at 95% of the determined market price. The previously offered discount in the Plan was 85%. During 2003, 2002,2005, 2004, and 2001,2003, employees paid approximately $190,700, $141,000,$858,500, $317,800 and $41,000,$190,700, respectively, for the purchase of common stockCommon Stock under the Plan.
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Collective Bargaining Agreement:Agreement
The companyCompany has two collective bargaining agreements (“CBA”). The CBA with the International Brotherhood of Electrical Workers expires January 31, 2006,2009, and covers 1110 employees at John F. Kennedy Space Center, Florida, and Cape Canaveral Air Force Station, Florida. The CBA with the Teamsters and Warehousemen Union covers 3738 employees at Vandenberg Air Force Base and expires October 31, 2005.2008. Both CBAs cover less than 10% of the Company’s total workforce.
15. Stock option plan:Incentive Plans
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 2,000,0003,000,000 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 stockCommon 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 yearthree-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,
F-26
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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.
Information with respect to incentive and non-qualified stock options issued under bothall plans for the years ended December 31, are as follows:
2003 | 2002 | 2001 | 2005 | 2004 | 2003 | ||||||||||||||||||||||||||||||||||
Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | ||||||||||||||||||||||||||||
Outstanding at beginning of period | 2,456,100 | $ | 1.55 | 1,672,500 | $ | 1.20 | 479,300 | $ | 0.98 | 3,582,200 | $ | 2.11 | 2,860,800 | $ | 1.88 | 2,456,100 | $ | 1.55 | |||||||||||||||||||||
Granted | 799,500 | 2.51 | 813,100 | 2.20 | 1,292,800 | 1.29 | 970,000 | 3.42 | 920,000 | 3.82 | 809,500 | 2.51 | |||||||||||||||||||||||||||
Exercised | (274,500 | ) | 0.88 | (21,200 | ) | 0.90 | (64,300 | ) | 1.31 | (441,100 | ) | 2.02 | (122,700 | ) | 1.67 | (274,500 | ) | 0.88 | |||||||||||||||||||||
Expired | (130,300 | ) | 1.70 | (8,300 | ) | 1.60 | (35,300 | ) | 1.01 | (308,300 | ) | 3.45 | (75,900 | ) | 2.32 | (130,300 | ) | 1.70 | |||||||||||||||||||||
Outstanding at end of period | 2,850,800 | 1.88 | 2,456,100 | 1.55 | 1,672,500 | 1.20 | 3,802,800 | $ | 2.59 | 3,582,200 | $ | 2.37 | 2,860,800 | $ | 1.88 | ||||||||||||||||||||||||
Options exercisable at end of period | 2,070,100 | $ | 1.69 | 1,485,100 | $ | 1.38 | 743,300 | $ | 1.12 | 3,797,800 | $ | 2.59 | 2,814,000 | $ | 2.11 | 2,070,100 | $ | 1.69 | |||||||||||||||||||||
Weighted average fair value of options granted during the period | $ | 1.05 | $ | 1.58 | $ | 1.24 | |||||||||||||||||||||||||||||||||
Weighted average exercise price of outstanding options | $2.88 | $2.39 | $1.88 |
The weighted average remaining contractual life of options outstanding at December 31, 20032005 was 6.75.0 years. The range of exercise prices of options outstanding at December 31, 20032005 was $0.25$0.69 to $2.87.
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)$4.49.
The following table summarizes information about the stock options outstanding at December 31, 2003:2005:
Outstanding | Exercisable | |||||||||
Exercise Price | Number of Shares | Weighted- Average Exercise Price | Weighted - Average Remaining Contractual Life (years) | Number of Shares | Weighted - Average Exercise | |||||
$0.25 - 1.00 | 101,000 | $0.75 | 4.53 | 101,000 | $0.75 | |||||
1.02 - 1.99 | 1,163,900 | 1.34 | 7.21 | 1,163,900 | 1.34 | |||||
2.20 - 2.87 | 1,585,900 | 2.35 | 6.38 | 805,200 | 2.30 | |||||
2,850,800 | 2,070,100 | |||||||||
Outstanding | Weighted- Average Remaining Contractual Life (years) | Exercisable | ||||||||||
Exercise Price | Number of Shares | Weighted- Average Exercise Price | Number of Shares | Weighted- Average Exercise Price | ||||||||
$0.69 – 1.99 | 981,900 | $ | 1.35 | 0.47 | 981,900 | $ | 1.35 | |||||
2.20 – 2.49 | 1,148,400 | 2.27 | 3.30 | 1,148,400 | 2.27 | |||||||
2.79 – 4.49 | 1,672,500 | 4.58 | 8.84 | 1,667,500 | 4.58 | |||||||
3,802,800 | 3,797,800 | |||||||||||
16. Warrants:Warrants
The Company has issued warrants to certain parties to purchase its Common Stock in connection with certain debt and equity transactions. The warrants are exercisable at any time at the election of the holders. The range of exercise prices for warrants outstanding at December 31, 20032005 was between $0.02 to $3.28.$4.32.
F-27
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Information with respect to warrants issued is as follows:follows as of December 31:
2003 | 2002 | 2001 | 2005 | 2004 | 2003 | ||||||||||||||||||||||||||||
Warrants | Price | Warrants | Price | Warrants | Price | Warrants | Price | Warrants | Price | Warrants | Price | ||||||||||||||||||||||
Outstanding at beginning of period | 2,475,800 | 2,277,300 | 2,467,100 | 2,899,300 | 2,365,000 | 2,475,800 | |||||||||||||||||||||||||||
Granted | 2,009,700 | $ | 3.28 | 198,500 | $ | 0.02 | 31,100 | $ | 0.02 | 1,785,700 | $ | 4.29 | 857,200 | $ | 4.32 | 2,009,700 | $ | 3.28 | |||||||||||||||
Exercised | 42,500 | 0.75 | — | — | 220,900 | 0.72 | (32,500 | ) | 0.75 | (208,100 | ) | 0.72 | (42,500 | ) | 0.75 | ||||||||||||||||||
429,000 | 0.72 | — | — | — | — | — | — | (429,000 | ) | 0.72 | |||||||||||||||||||||||
400,000 | 0.25 | — | — | — | — | — | — | (400,000 | ) | 0.25 | |||||||||||||||||||||||
114,800 | 0.02 | — | — | — | — | — | (114,800 | ) | 0.02 | (114,800 | ) | 0.02 | |||||||||||||||||||||
Expired | — | — | — | ||||||||||||||||||||||||||||||
Retired | 1,134,200 | — | — | — | — | (1,134,200 | ) | ||||||||||||||||||||||||||
Outstanding at end of period | 2,365,000 | 2,475,800 | 2,277,300 | 4,652,500 | 2,899,300 | 2,365,000 | |||||||||||||||||||||||||||
17. Fair valueValue of financial instruments:Financial Instruments
Accounts receivable, accounts payable, accrued expenses convertible notes, convertible preferred stock, warrants and other current assets and liabilities are carried at amounts whichthat reasonably approximate their fair value. The estimated fair value of the Company’s variable rate debt approximates its carrying value of $291,700.$27,631,400. Based on the contractual rights and preferences of the Company’s Convertible Notes and Convertible Preferred Stock, it is impractical to determine the fair value of these instruments due to their unique and individual nature.
18. Statement of cash flows—supplemental disclosures:
During 2003, 2002, and 2001, the Company paid income taxes of $255,000, $208,300, and $23,000, respectively. The Company paid interest of $519,800, $672,900, and $165,000 during those same periods.
19. Business segments and major customers:
Business segments:Segment Reporting
The Company hasconsiders 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 these units into one reportable segment consisting of two reportable segments, ABS and Analex. Thestrategic business units: the Homeland Security Group and the Systems Engineering Group. Both Homeland Security Group have been aggregated to form the reportable segment Analex. This aggregation is
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
due to the fact that both groups perform similar services, operate in similar regulatory environments, and have similar customers. Each of the operating segments providesSystems Engineering Group provide aerospace engineering, information technology, medical researchsecurity, intelligence support or technical services to federal government agencies or major defense contractors.
19. Discontinued Operations
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 reportable segmentsCompany disposed of ABS on November 16, 2004. Therefore, the results of operations of this business are distinguished by their individual clients, prior experiencereported 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 $0.1 million against these notes during the year ended December 31, 2005. The Company reviewed the future viability of ABS and technical skills.its underlying credit worthiness and determined a full reserve against the remaining outstanding notes was still necessary.
Operating results are measured at the net income/(loss) level for each segment. The accounting policies of the reportable segments arediscontinued business, which exclude the sameCompany’s loss on disposal of ABS, were as those described infollows for the summary of significant accounting policies. Interest on debt incurred in connection with an acquisitionyears ended December 31:
2005 | 2004 | 2003 | |||||||||
Revenue | $ | — | $ | 1,994,400 | $ | 3,794,600 | |||||
Income before tax from discontinued operations | — | 13,400 | 25,200 | ||||||||
Income tax expense | — | (5,200 | ) | (9,700 | ) | ||||||
Income from discontinued operations, net of tax | $ | — | $ | 8,200 | $ | 15,500 |
Tax rates vary between discontinued operations and applicable associated intangible amortization is chargedthe Company’s effective tax rate due to the reportable segment.non-deductibility of certain non-cash amortization expenses for tax purposes.
December 31 | ||||||||||
2003 | 2002 | 2001 | ||||||||
Revenues: | ||||||||||
ABS | $ | 3,799,600 | $ | 6,803,000 | $ | 4,761,300 | ||||
Analex | 62,326,700 | 52,514,000 | 17,174,700 | |||||||
Total revenues | $ | 66,126,300 | $ | 59,317,000 | $ | 21,936,000 | ||||
Interest expense: | ||||||||||
ABS | $ | — | $ | — | $ | — | ||||
Analex | 519,800 | 1,018,300 | 225,200 | |||||||
Total interest expense | $ | 519,800 | $ | 1,018,300 | $ | 225,200 | ||||
Depreciation and amortization expense: | ||||||||||
ABS | $ | 28,400 | $ | 31,000 | $ | 47,300 | ||||
Analex | 540,900 | 388,000 | 476,900 | |||||||
Total depreciation and amortization expense | $ | 569,300 | $ | 419,000 | $ | 524,200 | ||||
Income tax expense: | ||||||||||
ABS | $ | — | $ | — | $ | — | ||||
Analex | 320,900 | 149,100 | 19,600 | |||||||
Total income tax expense | $ | 320,900 | $ | 149,100 | $ | 19,600 | ||||
Net income (loss): | ||||||||||
ABS | $ | (143,100 | ) | $ | 365,200 | $ | 186,200 | |||
Analex | 2,889,500 | 1,991,400 | 9,800 | |||||||
Total net income (loss) | $ | 2,746,400 | $ | 2,356,600 | $ | 196,000 | ||||
Assets: | ||||||||||
ABS | $ | 658,300 | $ | 1,920,800 | $ | 1,017,200 | ||||
Analex | 42,973,800 | 28,863,400 | 24,607,900 | |||||||
Total assets | $ | 43,632,100 | $ | 30,784,200 | $ | 25,625,100 | ||||
Fixed assets, net: | ||||||||||
ABS | $ | 6,800 | $ | 83,600 | $ | 116,400 | ||||
Analex | 546,100 | 133,100 | 144,200 | |||||||
Total fixed assets, net | $ | 552,900 | $ | 216,700 | $ | 260,600 | ||||
Costs of revenues: | ||||||||||
ABS | $ | 3,944,000 | $ | 6,437,900 | $ | 4,565,700 | ||||
Analex | 51,826,400 | 43,998,800 | 13,592,100 | |||||||
Total costs of revenues | $ | 55,770,400 | $ | 50,436,700 | $ | 18,157,800 | ||||
F-28
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
20. Major Customers:Customers
Gross revenue from contracts and subcontracts with U.S. government agencies amounted to $65,672,400, $58,059,000,for the years ended December 31, 2005, 2004 and $21,885, in 2003 2002were $133.9 million, $94.1 million, and 2001,$61.9 million, respectively.
RevenuesRevenue earned on sales to the Company’s major customers are as follows:
Year | Department of Defense | NASA | Department of Defense | NASA | ||||||||
2005 | $ | 98,092,800 | $ | 41,774,900 | ||||||||
2004 | $ | 52,286,400 | $ | 41,775,200 | ||||||||
2003 | $ | 29,247,300 | $ | 35,253,100 | $ | 26,402,300 | $ | 35,253,100 | ||||
2002 | 30,668,000 | 27,488,400 | ||||||||||
2001 | 14,019,000 | 2,412,000 |
21. Selected quarterly information (Unaudited)(unaudited):
The following is a summary of the quarterly results of operations for the years 20032005 and 2002:2004. The Cost of Revenue reported for the fiscal quarters ended March 31, June 30 and September 30, 2005 have been adjusted from amounts originally reported for each respective period. The Company reclassed certain amounts in these periods to be consistent with amounts reported in the prior years fiscal quarters.
Quarter Ended: | ||||||||||||
31-Mar-03 | 30-Jun-03 | 30-Sep-03 | 31-Dec-03 | |||||||||
Revenues | $ | 16,631,200 | $ | 16,602,900 | $ | 16,589,800 | $ | 16,302,400 | ||||
Costs of Revenues | 13,860,100 | 13,922,800 | 14,091,000 | 13,896,500 | ||||||||
Operating Income | 1,139,900 | 1,026,700 | 895,900 | 524,600 | ||||||||
Net Income | 735,400 | 674,200 | 581,000 | 462,800 | ||||||||
Net Income per share, basic | $ | 0.05 | $ | 0.05 | $ | 0.04 | $ | 0.03 | ||||
Shares used in per share calculation, basic | 14,445,356 | 14,577,663 | 14,971,765 | 14,747,777 | ||||||||
Net Income per share, diluted | $ | 0.04 | $ | 0.04 | $ | 0.03 | $ | 0.03 | ||||
Shares used in per share calculation, diluted | 17,565,684 | 17,169,313 | 17,811,841 | 17,319,623 | ||||||||
Quarter Ended: | ||||||||||||
31-Mar-02 | 30-Jun-02 | 30-Sep-02 | 31-Dec-02 | |||||||||
Revenues | $ | 13,035,500 | $ | 12,928,200 | $ | 16,318,600 | $ | 17,034,700 | ||||
Costs of Revenues | 11,028,900 | 11,231,100 | 13,800,100 | 14,376,600 | ||||||||
Operating Income | 673,100 | 450,000 | 1,193,300 | 1,207,600 | ||||||||
Net Income | 395,200 | 204,400 | 914,000 | 843,000 | ||||||||
Net Income per share, basic | $ | 0.03 | $ | 0.01 | $ | 0.06 | $ | 0.06 | ||||
Shares used in per share calculation, basic | 14,385,725 | 14,395,177 | 14,238,707 | 14,221,237 | ||||||||
Net Income per share, diluted | $ | 0.02 | $ | 0.01 | $ | 0.05 | $ | 0.05 | ||||
Shares used in per share calculation, diluted | 16,796,764 | 16,997,139 | 17,013,845 | 17,077,120 |
Quarters ended in 2005: | ||||||||||||||||
March 31 | June 30 | September 30 | December 31 | |||||||||||||
Revenue | $ | 28,438,200 | $ | 38,148,600 | $ | 37,858,000 | $ | 36,717,000 | ||||||||
Cost of Revenue | 23,227,600 | 30,403,100 | 29,519,100 | 29,223,800 | ||||||||||||
Operating Income | 2,043,900 | 2,765,700 | 2,140,100 | 2,052,600 | ||||||||||||
Income from continuing operations | 666,100 | 482,700 | 311,200 | 446,900 | ||||||||||||
Income (loss) on disposal of discontinued operations | 23,600 | 6,700 | (135,900 | ) | (7,600 | ) | ||||||||||
Net Income | 689,700 | 489,400 | 175,300 | 439,300 | ||||||||||||
Dividends on convertible preferred stock | (399,500 | ) | (781,900 | ) | (783,600 | ) | (780,000 | ) | ||||||||
Accretion of convertible preferred stock | (937,500 | ) | (1,588,800 | ) | (1,588,800 | ) | (1,590,400 | ) | ||||||||
Net loss available to common shareholders | (647,300 | ) | (1,881,300 | ) | (2,197,100 | ) | (1,931,100 | ) | ||||||||
Net loss per share, basic and diluted | $ | (0.04 | ) | $ | (0.12 | ) | $ | (0.14 | ) | $ | (0.12 | ) | ||||
Shares used in per share calculation, basic and diluted | 15,423,286 | 15,821,971 | 16,146,431 | 16,320,978 |
Quarters ended in 2004: | ||||||||||||||||
March 31 | June 30 | September 30 | December 31 | |||||||||||||
Revenue | $ | 16,631,700 | $ | 22,215,200 | $ | 27,852,000 | $ | 27,717,800 | ||||||||
Cost of Revenue | 14,004,900 | 17,310,100 | 22,540,300 | 21,749,700 | ||||||||||||
Operating Income | 627,100 | 2,028,200 | 2,042,300 | 1,608,300 | ||||||||||||
Income (loss) from continuing operations | 16,500 | (100,600 | ) | (5,040,900 | ) | 1,315,600 | ||||||||||
(Loss) income from discontinued operations | (28,500 | ) | (50,700 | ) | 76,100 | 11,400 | ||||||||||
(Loss) income on disposal of discontinued operations | — | (521,800 | ) | 214,700 | (237,900 | ) | ||||||||||
Net (loss) income | (12,000 | ) | (673,100 | ) | (4,750,100 | ) | 1,089,100 | |||||||||
Dividends on convertible preferred stock | (225,000 | ) | (225,000 | ) | (254,600 | ) | (408,900 | ) | ||||||||
Accretion of convertible preferred stock | (937,500 | ) | (939,100 | ) | (937,600 | ) | (935,800 | ) | ||||||||
Net loss available to common shareholders | (1,174,500 | ) | (1,837,200 | ) | (5,942,300 | ) | (255,600 | ) | ||||||||
Net loss per share, basic and diluted | $ | (0.09 | ) | $ | (0.13 | ) | $ | (0.39 | ) | $ | (0.02 | ) | ||||
Shares used in per share calculation, basic and diluted | 13,044,691 | 14,049,715 | 15,295,773 | 15,333,209 |
F-25F-29