UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31,June 30, 2004
| ¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the period from to
Commission file number 0-5404
ANALEX CORPORATION
(Exact name of registrant as specified in its charter)
| Delaware | 71-0869563 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
5904 Richmond Highway
Suite 300
Alexandria, Virginia 22303
(Address of principal executive offices)
Registrant’s Telephone number including area code
(703) 329-9400
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)
Yes¨ Nox
As of May 10,August 11, 2004, 13,416,78915,292,512 shares of the common stock of the registrant were outstanding.
Page No. | ||||||
Part I Financial Information: | ||||||
| Item 1. | Financial Statements | ||||
Consolidated Balance Sheets at | 3 | |||||
| 5 | ||||||
| 6 | ||||||
| 7 | ||||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | ||||
| Item 3. | Quantitative and Qualitative Disclosure About Market Risk | ||||
| Item 4. | Controls and Procedures | ||||
Part IIOther Information: | ||||||
| Item 1.Legal Proceedings | |||||
| ||||||
MARCH 31,JUNE 30, 2004 AND DECEMBER 31, 2003
June 30, 2004 (unaudited) | December 31, 2003 | |||||||||||
March 31, 2004 (unaudited) | December 31, 2003 | |||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 11,774,500 | $ | 14,177,500 | $ | 1,276,900 | $ | 14,177,500 | ||||
Accounts receivable, net | 13,924,200 | 10,719,400 | 20,303,800 | 10,068,100 | ||||||||
Deferred tax asset | 226,800 | 150,000 | 556,100 | 150,000 | ||||||||
Prepaid expenses and other | 387,500 | 483,600 | 643,300 | 483,600 | ||||||||
Current assets of business held for sale | 93,200 | 658,100 | ||||||||||
Total current assets | 26,313,000 | 25,530,500 | 22,873,300 | 25,537,300 | ||||||||
Fixed assets, net | 552,800 | 552,900 | 1,108,400 | 546,100 | ||||||||
Contract rights and other intangibles, net | 1,603,800 | 1,753,000 | 7,353,500 | 1,753,000 | ||||||||
Goodwill | 15,281,600 | 15,281,600 | 41,648,100 | 15,281,600 | ||||||||
Other assets | 484,800 | 514,100 | 874,000 | 514,100 | ||||||||
Total other assets | 17,923,000 | 18,101,600 | 50,984,000 | 18,094,800 | ||||||||
Total assets | $ | 44,236,000 | $ | 43,632,100 | $ | 73,857,300 | $ | 43,632,100 | ||||
See Notes to Consolidated Financial Statements
3
ANALEX CORPORATION
CONSOLIDATED BALANCE SHEETS
MARCH 31,JUNE 30, 2004 AND DECEMBER 31, 2003
March 31, 2004 (unaudited) | December 31, 2003 | June 30, 2004 (unaudited) | December 31, 2003 | |||||||||||||
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 1,326,300 | $ | 776,200 | $ | 915,700 | $ | 736,200 | ||||||||
Note payable - line of credit | 8,254,700 | — | ||||||||||||||
Note payable - convertible note | 8,398,700 | — | ||||||||||||||
Note payable - bank term note | 700,000 | 700,000 | — | 700,000 | ||||||||||||
Notes payable - other | 949,200 | 1,487,400 | 953,900 | 1,487,400 | ||||||||||||
Other current liabilities | 6,399,500 | 5,463,500 | 8,870,000 | 5,387,500 | ||||||||||||
Current liabilities of business held for sale | 93,200 | 116,000 | ||||||||||||||
Total current liabilities | 9,375,000 | 8,427,100 | 27,486,200 | 8,427,100 | ||||||||||||
Note payable - bank term note | 1,225,000 | 1,341,700 | — | 1,341,700 | ||||||||||||
Notes payable - other | 695,500 | 1,209,300 | 651,700 | 1,209,300 | ||||||||||||
Convertible debt | 3,333,400 | 2,881,400 | ||||||||||||||
Deferred tax liability | 2,325,300 | — | ||||||||||||||
Convertible note | 3,785,500 | 2,881,400 | ||||||||||||||
Other | 32,900 | 43,800 | 17,700 | 43,800 | ||||||||||||
Total long-term liabilities | 5,286,800 | 5,476,200 | 6,780,200 | 5,476,200 | ||||||||||||
Total liabilities | 14,661,800 | 13,903,300 | 34,266,400 | 13,903,300 | ||||||||||||
Commitments and contingencies | ||||||||||||||||
Series A convertible preferred stock | 1,173,800 | 236,300 | 2,112,900 | 236,300 | ||||||||||||
Shareholders’ equity: | ||||||||||||||||
Common stock $.02 par; authorized 65,000,000 shares; issued and outstanding - March 31, 2004, 13,061,175 shares and December 31, 2003, 13,036,666 shares | 261,200 | 260,700 | ||||||||||||||
Common stock $.02 par; authorized 65,000,000 shares; issued and outstanding - June 30, 2004, 15,292,512 shares and December 31, 2003, 13,036,666 shares | 305,900 | 260,700 | ||||||||||||||
Additional paid in capital | 28,590,300 | 28,519,100 | 38,725,200 | 28,519,100 | ||||||||||||
Warrants outstanding | 5,762,900 | 5,762,900 | 6,482,800 | 5,762,900 | ||||||||||||
Accumulated other comprehensive loss | (32,900 | ) | (43,800 | ) | (17,700 | ) | (43,800 | ) | ||||||||
Accumulated deficit | (6,181,100 | ) | (5,006,400 | ) | (8,018,200 | ) | (5,006,400 | ) | ||||||||
Total shareholders’ equity | 28,400,400 | 29,492,500 | 37,478,000 | 29,492,500 | ||||||||||||
Total liabilities, convertible preferred stock and shareholders’ equity | $ | 44,236,000 | $ | 43,632,100 | $ | 73,857,300 | $ | 43,632,100 | ||||||||
| �� | ||||||||||||||||
See Notes to Consolidated Financial Statements
4
ANALEX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED MARCH 31,JUNE 30, 2004 AND 2003
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||
March 31, 2004 | March 31, 2003 | (unaudited) | ||||||||||||||||||||||
Revenues | $ | 17,110,100 | $ | 16,631,200 | $ | 22,215,200 | $ | 15,425,200 | $ | 38,846,600 | $ | 30,703,500 | ||||||||||||
Operating costs and expenses: | ||||||||||||||||||||||||
Costs of revenue | 14,451,700 | 13,860,100 | 17,357,200 | 12,924,600 | 31,408,600 | 25,731,500 | ||||||||||||||||||
Selling, general and administrative | 1,909,800 | 1,531,000 | 2,552,500 | 1,432,800 | 4,353,900 | 2,750,500 | ||||||||||||||||||
Amortization of intangible assets | 149,200 | 100,200 | 277,300 | 104,300 | 426,500 | 204,500 | ||||||||||||||||||
Total operating costs and expenses | 16,510,700 | 15,491,300 | 20,187,000 | 14,461,700 | 36,189,000 | 28,686,500 | ||||||||||||||||||
Operating income | 599,400 | 1,139,900 | 2,028,200 | 963,500 | 2,657,600 | 2,017,000 | ||||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||
Interest income | 13,300 | 1,100 | 29,600 | — | 42,900 | 1,100 | ||||||||||||||||||
Interest expense | (701,100 | ) | (112,400 | ) | (1,698,900 | ) | (84,200 | ) | (2,400,000 | ) | (196,600 | ) | ||||||||||||
Total other expense, net | (687,800 | ) | (111,300 | ) | (1,669,300 | ) | (84,200 | ) | (2,357,100 | ) | (195,500 | ) | ||||||||||||
Income (loss) before income taxes | (88,400 | ) | 1,028,600 | |||||||||||||||||||||
Provision (benefit) for income taxes | (76,300 | ) | 293,200 | |||||||||||||||||||||
Income from continuing operations before income taxes | 358,900 | 879,300 | 300,500 | 1,821,500 | ||||||||||||||||||||
Provision for income taxes | 459,500 | 250,300 | 384,700 | 518,900 | ||||||||||||||||||||
Income (loss) from continuing operations | (100,600 | ) | 629,000 | (84,200 | ) | 1,302,600 | ||||||||||||||||||
Income (loss) from discontinued operations, net of income taxes | (50,700 | ) | 45,200 | (79,200 | ) | 107,000 | ||||||||||||||||||
Loss on disposal of discontinued operations, net of income taxes | (521,800 | ) | — | (521,800 | ) | — | ||||||||||||||||||
Net income (loss) | $ | (12,100 | ) | $ | 735,400 | (673,100 | ) | 674,200 | (685,200 | ) | 1,409,600 | |||||||||||||
Dividends on convertible preferred stock | (225,000 | ) | — | (225,000 | ) | — | (450,000 | ) | — | |||||||||||||||
Accretion of convertible preferred stock | (937,500 | ) | — | (939,100 | ) | — | (1,876,600 | ) | — | |||||||||||||||
Net income (loss) available to common shareholders | $ | (1,174,600 | ) | $ | 735,400 | $ | (1,837,200 | ) | $ | 674,200 | $ | (3,011,800 | ) | $ | 1,409,600 | |||||||||
Net income (loss) per share: | ||||||||||||||||||||||||
Net income (loss) available to common shareholders per share: | ||||||||||||||||||||||||
Continuing operations | ||||||||||||||||||||||||
Basic | $ | (0.09 | ) | $ | 0.05 | $ | (0.18 | ) | $ | 0.09 | ||||||||||||||
Diluted | $ | (0.09 | ) | $ | 0.04 | $ | (0.18 | ) | $ | 0.07 | ||||||||||||||
Discontinued operations | ||||||||||||||||||||||||
Basic | $ | (0.04 | ) | $ | 0.00 | $ | (0.04 | ) | $ | 0.01 | ||||||||||||||
Diluted | $ | (0.04 | ) | $ | 0.00 | $ | (0.04 | ) | $ | 0.01 | ||||||||||||||
Net income (loss) available to common shareholders: | ||||||||||||||||||||||||
Basic | $ | (0.09 | ) | $ | 0.05 | $ | (0.13 | ) | $ | 0.05 | $ | (0.22 | ) | $ | 0.10 | |||||||||
Diluted | $ | (0.09 | ) | $ | 0.04 | $ | (0.13 | ) | $ | 0.04 | $ | (0.22 | ) | $ | 0.08 | |||||||||
Weighted average number of shares: | ||||||||||||||||||||||||
Basic | 13,044,691 | 14,445,356 | 14,049,715 | 14,577,663 | 13,547,203 | 14,511,875 | ||||||||||||||||||
Diluted | 13,044,691 | 17,565,684 | 14,049,715 | 17,169,313 | 13,547,203 | 17,496,504 | ||||||||||||||||||
See Notes to Consolidated Financial Statements
5
ANALEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREESIX MONTHS ENDED MARCH 31,JUNE 30, 2004 AND 2003
March 31, 2004 | March 31, 2003 | June 30 2004 | June 30 2003 | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | (12,100 | ) | $ | 735,400 | $ | (685,200 | ) | $ | 1,409,600 | ||||||
Adjustments to reconcile net income (loss) to net cash used in operating activities: | ||||||||||||||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||||||
Depreciation | 46,500 | 24,300 | 96,300 | 37,100 | ||||||||||||
Amortization of intangible assets | 149,200 | 100,200 | 426,500 | 204,500 | ||||||||||||
Amortization of debt discount and deferred financing costs | 482,900 | — | ||||||||||||||
Amortization of deferred financing costs | 1,762,400 | — | ||||||||||||||
Loss on disposal of discontinued operations | 521,800 | — | ||||||||||||||
Stock-based compensation expense | — | 3,800 | — | 7,700 | ||||||||||||
Write-off of patent related costs | — | 6,500 | ||||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Deferred tax benefit | (556,100 | ) | — | |||||||||||||
Changes in operating assets and liabilities net of effect of business combination: | ||||||||||||||||
Accounts receivable, net | (3,204,800 | ) | (731,500 | ) | (5,101,100 | ) | 366,000 | |||||||||
Deferred tax asset | (76,800 | ) | — | |||||||||||||
Prepaid expenses and other | 96,100 | (12,700 | ) | 962,600 | (50,600 | ) | ||||||||||
Other assets | (1,600 | ) | 3,300 | (168,900 | ) | 28,700 | ||||||||||
Accounts payable | 550,100 | (1,654,500 | ) | (88,100 | ) | (1,613,000 | ) | |||||||||
Other current liabilities | 711,000 | 207,000 | 1,506,000 | 1,936,500 | ||||||||||||
Other long term liabilities | (10,200 | ) | — | |||||||||||||
Net cash used in operating activities | (1,259,500 | ) | (1,318,200 | ) | ||||||||||||
Net cash provided by (used in) operating activities | (1,334,000 | ) | 2,326,500 | |||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Property additions | (46,500 | ) | (45,500 | ) | (144,600 | ) | (197,300 | ) | ||||||||
Intangible additions | — | (4,000 | ) | — | (6,100 | ) | ||||||||||
Cash paid for BAI, net of cash acquired | (27,049,200 | ) | — | |||||||||||||
Net cash used in investing activities | (46,500 | ) | (49,500 | ) | (27,193,800 | ) | (203,400 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||||||
Proceeds from borrowings on bank and other loans | — | 1,829,000 | 6,554,700 | 1,829,000 | ||||||||||||
Proceeds from stock options and warrants exercised | 71,700 | 10,300 | 305,800 | 59,200 | ||||||||||||
Proceeds from employee stock purchase plan | 126,700 | — | ||||||||||||||
Proceeds from issuance of Senior Subordinated Notes and warrants | 12,000,000 | — | ||||||||||||||
Payments on bank and other loans | (1,168,700 | ) | (708,200 | ) | (3,143,300 | ) | (3,744,200 | ) | ||||||||
Net cash provided by (used in) financing activities | (1,097,000 | ) | 1,131,100 | 15,843,900 | (1,856,000 | ) | ||||||||||
Net decrease in cash and cash equivalents | (2,403,000 | ) | (236,600 | ) | ||||||||||||
Net cash from discontinued operations | (216,700 | ) | 323,300 | |||||||||||||
Net (decrease) increase in cash and cash equivalents | (12,900,600 | ) | 590,400 | |||||||||||||
Cash and cash equivalents at beginning of period | 14,177,500 | 301,800 | 14,177,500 | 301,800 | ||||||||||||
Cash and cash equivalents at end of period | $ | 11,774,500 | $ | 65,200 | $ | 1,276,900 | $ | 892,200 | ||||||||
See Notes to Consolidated Financial Statements
6
ANALEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1.Business Groups
Analex Corporation (the “Company”) provides information technology and systems engineering services to the United States government through two groups: the Homeland Security Group, supporting intelligence systems; and the Systems Engineering Group, supporting the development of space-based systems, the operation of terrestrial assets, and the launch of unmanned rockets by NASA under the Company’s Expendable Launch Vehicle Integrated Support (“ELVIS”) contract. In addition, its discontinued subsidiary, Advanced Biosystems, Inc. subsidiary (“ABS”), is engaged in biomedical research for broad spectrum defenses against toxic agents capable of being used as bioterrorist weapons, such as anthrax and smallpox (Seesmallpox. During the second quarter of 2004, the Company decided to divest ABS. Therefore, the results of operations of ABS are reported as discontinued operations for all periods presented herein (see note 11)12).
The Homeland Security Group has accounted for approximately 42%48% of the Company’s 2004 year-to-date revenue. This group provides engineering, scientific and information technology services and solutions to assist in the development, implementation and support of intelligence systems. Analex provides these services to the intelligence community, 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 has accounted for approximately 55%52% of the Company’s 2004 year-to-date revenues. This group provides engineering and information technology services and solutions to assist in the development of space-based systems and support operations of terrestrial assets. Capabilities include expendable launch vehicle engineering, space systems development, and ground support for space operations.
ABS has accounted for approximately 3%On May 28, 2004, Analex acquired Beta Analytics, Inc. (“BAI”). BAI is reported as a part of the Company’s 2004 year-to-date revenues. ABS pursues researchHomeland Security Group. BAI provides information and technology asset protection solutions, intelligence analysis, and security services to federal government and Department of Defense agencies. BAI’s services cover a range of life cycle protection and physical security services specifically in the areas of defenses against,information protection, physical security, intelligence threat assessment and treatments for, biological warfare agentsanalysis, technology protection, security management and other infectious diseases. ABS also provides consulting services regarding biological weapons, threats,security education and defensive strategies.training.
2.Basis of Presentation
The interim consolidated financial statements for the Company are unaudited, but in the opinion of management, reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of results for such periods. The results of operations for any interim period are not
necessarily indicative of results for the full year. The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 (“2003 Form 10-K”) filed with the Securities and Exchange Commission on March 30, 2004.
The Company pursues acquisitions to complement its Analex segment.business. In accordance with the provisions of Statement of Financial Accounting Standards No. 141,Business Combinations, the direct costs associated with these acquisitions are accounted for as additional purchase consideration. Costs associated with transactions for which we discontinue our pursuit are expensed in the period in which the transaction is abandoned.
3.Acquisition of Beta Analytics, Inc.
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 cash, and (ii) 1,832,460 unregistered shares of Analex common stock. These shares were valued at $3.332 per share. This value was determined based on the average closing stock price of the Company’s common stock for the five days prior to the acquisition. Analex financed the cash portion of the consideration for the acquisition through its cash on hand, senior debt from Bank of America, N.A. and new debt in the initial principal amount of $12 million Senior Subordinated Notes (see note 9).
Management believes that the acquisition of BAI will yield additional significant yearly revenues and operating income, enhanced attractiveness to institutional investors and an enhanced ability to compete effectively within the government services industry. Value associated with BAI’s intangible assets including contract rights and customer relationships was the primary factor contributing to a purchase price in excess of net assets acquired. These intangible assets have an estimated useful life of five years.
The acquisition of BAI, which was valued at approximately $35.2 million, was accounted for using the purchase method of accounting. Under the purchase method of accounting, the purchase price is allocated to the underlying tangible and intangible assets acquired and liabilities assumed based on their respective fair market values, with the excess recorded as goodwill. The financial statements as of June 30, 2004 reflect preliminary estimates of the fair market value for the purchased
intangible assets. The allocation of the purchase price is summarized as follows:
Cash purchase price | $ | 27,726,500 | ||
Stock purchase price | 6,102,100 | |||
Transaction fees | 1,383,200 | |||
| 35,211,800 | ||||
Cash | 2,060,500 | |||
Accounts receivable | 5,134,600 | |||
Fixed assets | 533,300 | |||
Intangible assets | 6,028,000 | |||
Other assets | 869,800 | |||
Accounts payable | (267,600 | ) | ||
Line of credit | (1,700,000 | ) | ||
Other current liabilities | (152,600 | ) | ||
Other liabilities | (1,336,300 | ) | ||
Deferred tax liability | (2,325,000 | ) | ||
Goodwill | $ | 26,367,100 | ||
On November 2, 2001, to financeThe unaudited pro forma financial information reflects the acquisitionresults of Analex, the Company entered intofor the three and six months ended June 30, 2004, as if BAI had been acquired on April 1, 2004 and January 1, 2004, respectively. These combined results are not necessarily indicative of future operating results of the Company.
Three Months June 30, 2004 | Six Months June 30, 2004 | |||||||
Revenues | $ | 29,046,800 | $ | 54,002,200 | ||||
Income from continuing operations | 206,200 | 728,900 | ||||||
Net income (loss) | (366,500 | ) | 127,900 | |||||
Net loss available to common shareholders | (1,530,600 | ) | (2,198,700 | ) | ||||
Basic earnings per share available to common shareholders | $ | (0.11 | ) | $ | (0.16 | ) | ||
Diluted earnings per share available to common shareholders | $ | (0.11 | ) | $ | (0.16 | ) | ||
4.Debt
The Company has a Credit Agreement (“Credit Agreement”)credit agreement with Bank of America, N.A. The(“the Credit Agreement originally providedFacility”). On May 28, 2004, in connection with the Company withacquisition of BAI, the Credit Facility was amended and restated to provide a $4,000,000$20,000,000 revolving credit facility, (the “Credit Facility”) through November 2, 2006 and a five-year $3,500,000the remaining outstanding balance on the Company’s term loan (“Term Loan”).of $1,750,000 was consolidated into the Credit Facility. An uncommitted annual
guidance facility not to exceed an additional $20,000,000 is available to fund future acquisitions upon application by the Company and approval by Bank of America. The Credit Facility has an annual renewal occurring April 30 of each year. To fund additional working capital requirements generated by the award of the ELVIS contract, the Company negotiated an increase ofInterest on the Credit Facility to $8,000,000 in August 2002. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. Interest on each of the facilities is at the LIBOR Rate plus an applicable margin as specified in a pricing grid. As of March 31,June 30, 2004, the Credit Facility and Term Loan balances were zero and $1,925,000, respectively.outstanding balance was $8,254,700. The interest rate at March 31,June 30, 2004 was 3.59%3.84% for the Credit Facility and 4.10% for the Term Loan.Facility.
Upon the Closing of the Pequot Transaction, Bank of America and the Company entered into a modification of theThe Credit Agreement amendingFacility contains financial covenant requirements including thecovenants setting forth maximum ratios for total funded debt to EBITDA ratio and theminimum ratios for fixed charge coverage ratio.coverage. As of March 31,June 30, 2004, the Company was in compliance with these covenants. The Credit AgreementFacility also restricts the Company’s ability to dispose of properties other than ABS, incur additional indebtedness, pay dividends (except to holders of the Series A and Series B Preferred Stock) or other distributions, create liens on assets, enter into sale and leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. The Credit Facility and
Term Loan areis secured by the accounts receivable and other assets of the Company.
The Company’s $3.5 million Term Loan from Bank of America carries interest comprised of two components: floating-rate LIBOR plus a credit performance margin. In January 2002, the Company entered into an interest-rate swap agreement with Bank of America whereby its obligation to pay floating-rate LIBOR on debt, now totaling $1,600,000,$1,450,000, was swapped into a fixed rate obligation at 4.25%. The Company continues to have the obligation to pay the credit performance margin in addition to its swapped 4.25% payment obligation. The total effective interest rate on the swapped portion of the Term Loanrevolving credit facility amounted to 7.25%6.75% at March 31,June 30, 2004.
The Company’s comprehensive loss available to common shareholders for the three months ended March 31,June 30, 2004 was $1,163,700$1,822,000 which includes the net loss available to common shareholders of $1,174,600$1,837,200 and other comprehensive income of $10,900$15,200 arising from the interest rate swap. The Company’s comprehensive incomeloss for the threesix months ended March 31, 2003June 30, 2004 was $742,600,$2,985,700, which includes the net incomeloss available to common shareholders of $735,400$3,011,800 and other comprehensive income of $7,200$26,100 arising from the interest rate swap.
The Company has outstanding a $10,000,000 Convertible Note issued on December 9, 2003 in connection with the Pequot Transaction (see note 8). In connection with the BAI acquisition and the Series B Financing, the Company issued $12,000,000 Senior Subordinated Notes on May 28, 2004 (see note 9).
5.Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
| Three Months Ended March 31, | Three Months Ended June 30 | Six Months Ended June 30 | ||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||||||
Income (loss) from continuing operations | (100,600 | ) | 629,000 | (84,200 | ) | 1,302,600 | ||||||||||||||
Income (loss) from discontinued operations, net of income taxes | (50,700 | ) | 45,200 | (79,200 | ) | 107,000 | ||||||||||||||
Loss on disposal of discontinued operations, net of income taxes | (521,800 | ) | — | (521,800 | ) | — | ||||||||||||||
Income (loss) from discontinued operations, net of income taxes | (572,500 | ) | 45,200 | (601,000 | ) | 107,000 | ||||||||||||||
| 2004 | 2003 | |||||||||||||||||||
Net income (loss) available to common shareholders | ($1,174,600 | ) | $ | 735,400 | $ | (1,837,200 | ) | $ | 674,200 | $ | (3,011,800 | ) | $ | 1,409,600 | ||||||
Weighted average shares outstanding | 13,044,691 | 14,445,356 | 14,049,715 | 14,577,663 | 13,547,203 | 14,511,875 | ||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||||
Warrants | — | 1,956,858 | — | 1,560,693 | — | 1,882,978 | ||||||||||||||
Employee stock options | — | 1,163,470 | — | 1,030,957 | — | 1,101,651 | ||||||||||||||
Diluted weighted average shares outstanding | 13,044,691 | 17,565,684 | 14,049,715 | 17,169,313 | 13,547,203 | 17,496,504 | ||||||||||||||
Basic earnings per share | ($0.09 | ) | $ | 0.05 | ||||||||||||||||
Diluted earnings per share | ($0.09 | ) | $ | 0.04 | ||||||||||||||||
Net income (loss) available to common shareholders per share: | ||||||||||||||||||||
Continuing operations: | ||||||||||||||||||||
Basic | $ | (0.09 | ) | $ | 0.05 | $ | (0.18 | ) | $ | 0.09 | ||||||||||
Diluted | $ | (0.09 | ) | $ | 0.04 | $ | (0.18 | ) | $ | 0.07 | ||||||||||
Discontinued operations: | ||||||||||||||||||||
Basic | $ | (0.04 | ) | $ | 0.0 | $ | (0.04 | ) | $ | 0.01 | ||||||||||
Diluted | $ | (0.04 | ) | $ | 0.0 | $ | (0.04 | ) | $ | 0.01 | ||||||||||
Net income (loss) available to common shareholders: | ||||||||||||||||||||
Basic | $ | (0.13 | ) | $ | 0.05 | $ | (0.22 | ) | $ | 0.10 | ||||||||||
Diluted | $ | (0.13 | ) | $ | 0.04 | $ | (0.22 | ) | $ | 0.08 | ||||||||||
Shares issuable upon the exercise of stock options or warrants or upon conversion of debt have been excluded from the computation to the extent that their inclusion would be anti-dilutive.
6.Stock-based compensation
The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the fair market value of the Company’s stock at the date of the grant over the exercise price of the related option. The following table is a computation of the proformapro forma earnings had the Company accounted for stock option grants based on their fair value as determined under SFAS No. 123:
Three Months Ended June 30 | Six Months Ended June 30 | ||||||||||||||||||||
Three Months Ended March 31, 2004 | Three Months March 31, 2003 | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||
Net income (loss) available to common shareholders, as reported | $ | (1,174,600 | ) | $ | 735,400 | $ | (1,837,200 | ) | $ | 674,200 | $ | (3,011,800 | ) | $ | 1,409,600 | ||||||
Add: Total stock-based employee compensation expense as reported under intrinsic value method (APB No. 25) for all awards, net of related tax effects | — | 2,700 | — | 3,100 | — | 6,900 | |||||||||||||||
Deduct: Total stock-based compensation expense determined under fair value based method (SFAS No. 123) for all awards, net of related tax effects | 514,500 | 557,100 | 200,800 | 65,200 | 715,300 | 622,300 | |||||||||||||||
Pro forma net income (loss) | $ | (1,689,100 | ) | $ | 181,000 | ||||||||||||||||
Pro forma net income (loss) available to common shareholders | $ | (2,038,000 | ) | $ | 612,100 | $ | (3,727,100 | ) | $ | 794,200 | |||||||||||
Earnings per share: | |||||||||||||||||||||
Basic as reported | $ | (0.09 | ) | $ | 0.05 | $ | (0.13 | ) | $ | 0.05 | $ | (0.22 | ) | $ | 0.10 | ||||||
Diluted as reported | $ | (0.09 | ) | $ | 0.04 | (0.13 | ) | 0.04 | (0.22 | ) | 0.08 | ||||||||||
Basic pro forma | $ | (0.13 | ) | $ | 0.01 | ||||||||||||||||
Diluted pro forma | $ | (0.13 | ) | $ | 0.01 | ||||||||||||||||
Basic proforma | (0.15 | ) | 0.04 | (0.28 | ) | 0.05 | |||||||||||||||
Diluted proforma | (0.15 | ) | 0.04 | (0.28 | ) | 0.05 | |||||||||||||||
7.Concentration of Business
Almost all of the Company’s revenues are derived either directly from the U.S. government as prime contractor or indirectly as a subcontractor to other government prime contractors. Approximately 55%47% of the Company’s 2004 year-to-date revenues have been derived from various Department of Defense agencies. Approximately 52% of the Company’s 2004 year-to-date revenues have been derived, directly andor indirectly, from NASA. Approximately 43% of the Company’s 2004 year-to-date
revenues have been derived from various Department of Defense agencies.8.Pequot Transaction
On December 9, 2003, the Company consummated the transactiontransactions (the “Pequot Transaction”) 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”). The Company:
In addition, on December 9, 2003, the Company consummated a Securities Repurchase Agreement (the “Stout Repurchase Agreement”) with the 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 purchased 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 are collectively referred to as the “Pequot Transaction.”
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. 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.
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,Credit Facility, in additional shares of Series A Preferred Stock. Holders of Series A Preferred Stock are entitled to vote together with all other classes and series of voting stock of the Company on all actions to be taken by the stockholders of the Company. In addition, as long as 50% of the Series A Preferred Stock originally issued remains outstanding, the Company may not take numerous actions without obtaining the written consent of the holders of a majority of the Series A Preferred Stock.
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 Stockcommon stock at any time at the election of its holders, initially at a ratio of one share of Common Stockcommon stock for every share of Series A Preferred Stock. The Series A Preferred Stock will automatically convert into Common Stock if, any time following June 9, 2005, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the conversion price then in effect for the Series A Preferred Stock. In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into Common Stock. The
Series A Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.
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, at the Series A Purchase Price, as adjusted for stock splits, stock dividends and similar events, plus accrued but unpaid dividends.
Upon issuance of the Series A Preferred Stock, the Company allocated relative fair value of $3,857,600 to the preferred warrantsPreferred Warrants and recorded a beneficial conversion charge of $11,142,400. These amounts are being recorded as accretion of Series A Preferred Stock over the period to the earliest redemption date, which is December 9, 2007. For the three months and six months ended March 31,June 30, 2004, the Company recorded $937,500$0.9 million and $1.9 million, respectively, of accretion related to thosethese charges.
Convertible Notes
The Convertible Notes mature on December 9, 2007. The Convertible Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s senior credit facility,Credit Facility, such interest will be accrued and added to the outstanding principal.
The Convertible Notes may not be prepaid prior to June 9, 2005 without the consent of the holders of a majority of the outstanding principal amount of the Convertible Notes. Any subsequent prepayment will be made, at the option of the Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum; or by conversion of the principal into shares of Series A Preferred Stock and the payment of interest in cash or in shares of Series A Preferred Stock. Holders of the Convertible Notes may convert the outstanding principal and accrued interest on the Notes into Series A Preferred Stock at any time. The conversion price for the Convertible Notes is $3.01 per share. The Company may cause the automatic conversion of the Convertible Notes into Common Stock if, any time following June 9, 2005, the average closing price for the Common Stock over a 20 consecutive trading day period exceeds $5.58 per share.
The Company’s obligations under the Convertible Notes are secured by a lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. Such obligations are subordinated to the rights of the Company’s present and future senior secured lenders.
Upon issuance of the Convertible Notes, the Company allocated fair value of $1,905,300
to the note warrantsNote Warrants and recorded a beneficial conversion charge of $5,327,200. The discount created by these charges is being amortized to interest expense over the life of the Convertible Notes. For the three months and six months ended March 31,June 30, 2004, the Company recognized $452,000$0.5 million and $0.9 million, respectively, of amortization of that discount. The unamortized discount as of March 31,June 30, 2004 was $4,761,300.$4.3 million.
Warrants
The Warrants are exercisable at any time before December 9, 2013. The Preferred Warrants are exercisable to purchase one share of Common Stockcommon stock for every five shares of Common Stockcommon stock issued or issuable upon conversion of the Series A Preferred Stock. The Note Warrants are exercisable to purchase one share of Common Stockcommon stock for every five shares of Common Stockcommon stock issued or issuable upon conversion of the Convertible Notes. The initial exercise price of the Warrants is $3.28.
9.Series B Financing
Pursuant to a Stock Purchase Agreement among the Company and General Electric Pension Trust (“GEPT”), New York Life Capital Partners II, L.P. (“NYL”), Pequot Private Equity Fund III, L.P., and Pequot Offshore Private Equity Partners III, L.P., (collectively, “Pequot,” together with GEPT and NYL, collectively, the “Investors”), dated May 28, 2004 (the “Series B Purchase Agreement”), the Company:
A significant portion of the funds obtained on the First Closing Date was used to pay the cash portion of the consideration for the acquisition of BAI.
Subject to certain approval rights by the holders of the Series A Preferred Stock and the Series B Preferred Stock, the Series B Purchase Agreement also provides that the Company has an option to require the Investors to purchase up to an additional $25 million of Senior Subordinated Notes or Series B Preferred Stock, with additional Common Stock Warrants (the “Company Option”), at any one or more times on or prior to May 27, 2005 for the purpose of paying the cost of acquisition of the stock or assets of one or more other companies in each case with an acquisition value of at least $10 million.
Senior Subordinated Notes
The Senior Subordinated Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s Credit Facility, accrued and added to the outstanding principal. Upon a payment default, the interest rate on the Senior Subordinated Notes will be increased to 14% per annum during the term of the default.
The outstanding principal and accrued interest on the Senior Subordinated Notes will be automatically converted into Series B Preferred Stock upon stockholders’ approval at the annual meeting. The per share conversion price of the Senior Subordinated Notes is $3.50 (the “Series B Original Issue Price”).
If the Senior Subordinated Notes have not already converted into Series B Preferred Stock, they will mature on the “Maturity Date” which is 120 days from the date of issuance (the “Series B Issue Date”). In the event that stockholders’ approval is not obtained on or before the Maturity Date, (i) the rate of interest payable on the Senior Subordinated Notes will be increased to 14% per annum and will continue to increase 3% per annum (but in no event shall be increased above the rate of interest lawfully payable) for each calendar quarter thereafter that the Senior Subordinated Notes remain unpaid and (ii) the Company will issue to Investors additional warrants to purchase $3.5 million of the Company’s common stock, exercisable at any time following the stockholders’ approval, at an exercise price equal to the Series B conversion price.
The Company’s obligations under the Senior Subordinated Notes are secured by a second lien on substantially all of the
assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. These obligations are subordinated only to those under the Credit Facility and are senior to the existing obligations to Pequot under the Convertible Notes. The Company is subject to certain financial and operational covenants.
Upon issuance of the Senior Subordinated Notes, the Company allocated fair value of $720,000 to the Common Stock Warrants based on a preliminary independent valuation, and recorded a beneficial conversion charge of $3,720,000. The discount created by these charges is being amortized to interest expense over the life of the Senior Subordinated Notes. For the three and six months ended June 30, 2004, the Company recognized $0.8 million of amortization of that discount. The unamortized discount as of June 30, 2004 was $3.6 million.
Series B Preferred Stock
An aggregate of 3,428,571 shares of Series B Preferred Stock will be issued to the Investors upon stockholders’ approval of the conversion of the $12 million Senior Subordinated Notes into the Series B Preferred Stock. The Series B Preferred Stock will rank senior to the Company’s existing Series A Preferred Stock. The Series B Preferred Stock will bear a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s Credit Facility, in additional shares of Series B Preferred Stock.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series B Preferred Stock will be entitled to receive, in preference to holders of Series A Preferred Stock and common stock, out of the Company’s assets available for stockholder distributions, an amount per share equal to the Series B Original Issue Price plus any accrued but unpaid dividends thereon. Certain mergers, acquisitions or asset sales involving the Company are treated as a liquidation event unless the holders of 66 2/3% of the then outstanding Series B Preferred Stock and Series A Preferred Stock voting together as a class elect not to treat such transactions as liquidation events.
The Series B Preferred Stock will be convertible into common stock at any time at the election of its holders. The per share conversion price (the “Conversion Price”) of the Series B Preferred Stock will be the lowest of (i) $3.10; (ii) the price that reflects a 20% discount to the trailing average closing price of the Company’s common stock for the 20 consecutive trading days immediately preceding the date of the conversion or the Series B Issue Date, but in no event less than $2.80; and (iii) the closing price of the Company’s common stock on the day
immediately preceding the Series B Issue Date; provided that if stockholder approval for the conversion of the Senior Subordinated Notes occurs during certain uncured events of default, the Conversion Price will not be subject to the $2.80 floor price under (ii) above.
The Series B Preferred Stock will automatically convert into common stock if, any time following 18 months after the Series B Issue Date, (i) the average closing price of the common stock over the immediately preceding 20 consecutive trading day period exceeds 2.5 times the Series B Original Issue Price (as adjusted for certain dilutive equity issuances and for stock splits, stock dividends and similar events related to the Series B Preferred Stock); or (ii) with respect to any holder’s shares of Series B Preferred Stock, such holder does not accept, within 60 days of notice to such holder, the Company’s offer to purchase the Series B Preferred Stock for at least 2.5 times the Series B Original Issue Price. The Series B Preferred Stock will automatically convert into common stock upon the agreement of the holders of 75% of the then outstanding Series B Preferred Stock.
Holders of two-thirds of the Series B Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of the Series B Issue Date at the Series B Original Issue Price plus accrued but unpaid dividends.
Holders of Series B Preferred Stock will be entitled to vote together with all other classes and series of voting stock of the Company as a single class, on all actions to be taken by the stockholders of the Company. As long as at least 25% of the shares of the Series B Preferred Stock issued pursuant to the Series B Purchase Agreement remain outstanding, the Company may not take numerous specified actions (including certain changes to the Company’s Certificate of Incorporation) without first obtaining the written consent of holders of at least a majority of the then outstanding shares of Series B Preferred Stock voting separately as a class. In addition, as long as the Company Option is in effect, holders of 100% of the Series A Preferred Stock and the Series B Preferred Stock, voting together as a single class, shall have the right to veto (i) any Company Acquisition, and (ii) the issuance of any securities ranking senior to or pari passu with the Series A Preferred Stock or the Series B Preferred Stock, with respect to voting, dividend, liquidation or redemption rights, including the issuance of subordinated debt.
Common Stock Warrants
The Common Stock Warrants issued in connection with the Series B Financing will expire on May 28, 2014. They are not exercisable at the time of issuance. Upon stockholders’ approval at the annual meeting, the Common Stock Warrants will become exercisable at the option of the Investors to purchase one share of common stock for every five shares of common stock issued or issuable upon conversion of the Series B Preferred Stock that is issued or issuable upon the conversion of the principal amount of the Senior Subordinated Notes. The exercise price of the Common Stock Warrants is $4.32 per share.
10.Guarantees
Pursuant to the November 2, 2001 acquisition of the former Analex, the Company issued 3,572,143 shares of the Company’s Common Stockcommon stock to the shareholders representing all of the outstanding equity of Analex (the “Sellers”). Of the 3,572,143 shares, 857,143 shares are subject to a provision by which the Company guarantees for a five-year period to reimburse the Sellers the difference between the price at which they sell such shares and a guaranteed sales price ranging from $1.60 to $2.20 per share, if such shares are sold within such period and if certain other conditions are satisfied. As of March 31,June 30, 2004, the maximum amount payable under the terms of the guaranteed shares was $3,428,600.$1,628,600. As the fair market value of the Company’s common stock was in excess of the guaranteed share prices as of March 31,June 30, 2004, no amounts were accrued under the guarantee.
11.Segment Reporting
The Company has twoone reportable segments, Analex and ABS. The Analex segment consistsconsisting of the Homeland Security Group and the Systems Engineering Group. Each of the operating segments providesBoth Homeland Security Group and Systems Engineering Group provide engineering, information technology, medical research or technical services to federal government agencies or major defense contractors. BAI is reported as part of the Homeland Security Group. In prior reporting periods, ABS was reported as a reportable segment. Results for ABS are now reported as discontinued operations.
12.Discontinued Operations
During the second quarter of 2004, the Company concluded that ABS, a wholly owned subsidiary of the Company, did not fit with the Company’s long-term plan and decided to divest ABS. The reportable segmentsCompany is in the process of disposing of ABS and intends to conclude either a sale or another form of disposition by December 31, 2004. Therefore, the results of operations of
this business are distinguished by their individual clients, prior experience and technical skills.reported as discontinued operations, net of applicable income taxes, for all periods presented in accordance with SFAS 144,Accounting for the Impairment of Disposal of Long-Lived Assets. The Company has written down the assets of ABS to the fair value of the expected proceeds to be received from the disposition of ABS.
The Company’s historical financial statements have been restated to reflect ABS as discontinued operations for the periods presented.
Operating results are measured at the net income level for each segment. The accounting policies of the reportable segmentsdiscontinued business are as follows:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||
Revenues | $ | 500,039 | $ | 1,177,700 | $ | 978,700 | $ | 2,530,600 | ||||||
Income (loss) from discontinued operations | (99,000 | ) | 63,200 | (128,900 | ) | 149,600 | ||||||||
Income tax expense (benefit) | (48,300 | ) | 18,000 | (49,700 | ) | 42,600 | ||||||||
Income (loss) from discontinued operations, net of tax | $ | (50,700 | ) | $ | 45,200 | $ | (79,200 | ) | $ | 107,000 | ||||
Tax rates vary between discontinued operations and the same as those described in the summary of significant accounting policies contained in Note 2Company’s effective tax rate due to the 2003 Form 10-K. The Company’s corporate amounts consist primarilynon-deductibility of certain activities and assets not attributable to the reportable segments.goodwill for tax purposes.
THREE MONTHS ENDED March 31, 2004 THREE MONTHS March 31, 2003 Revenues: ABS Analex Total revenues: Net income: ABS Analex Total net income: Assets: ABS Analex Total assets:
ENDED (unaudited) (unaudited) $ 478,600 $ 1,353,000 16,631,500 $ 15,278,200 $ 17,110,100 $ 16,631,200 $ (29,900 ) $ 86,400 17,800 649,000 $ (12,100 ) $ 735,400 $ 423,800 $ 1,625,000 43,812,200 29,582,100 $ 44,236,000 $ 31,207,100
The major classes of assets and liabilities for this discontinued business were as follows:
| June 30, 2004 | December 31, 2003 | |||||
Accounts receivable, net | $ | 93,200 | $ | 651,300 | ||
Fixed assets, net | — | 6,800 | ||||
Total assets of business held for sale | $ | 93,200 | $ | 658,100 | ||
Accounts payable | $ | 10,400 | 40,000 | |||
Other current liabilities | 82,800 | 76,000 | ||||
Total liabilities of business held for sale | $ | 93,200 | $ | 116,000 | ||
13.Litigation and Claims
The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) 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. Under the complaint, Swales is seekingsought damages of $4 million. To minimize the expense, effort, uncertainty and inconvenience entailed in excess of $4.0 million. Management believes that any liability that may ultimately result fromproceeding with the resolution of this matter will not have a material adverse effect on the financial position or results of operations of the Company.
Subsequent to March 31, 2004 the Company’s Board of Directors decided to sell or otherwise divest its ABS subsidiary no later than December 31, 2004. ABS will therefore be treated as discontinued operations for accounting purposes beginning the fiscal quarter ended June 30, 2004.
On May 6, 2004 the Company entered into an agreement to acquire Beta Analytics, Inc. (BAI), a security and intelligence support services firm, primarily providing services to federal government agencies and organizations. Consideration for the transaction will consist of approximately $26 million in cash and approximately 1.8 million shares of Analex’s unregistered common stock. The agreement contains customary closing conditions, including regulatory approval.
Also on May 6, 2004,litigation, the Company entered into a binding commitment letterSettlement Agreement dated July 22, 2004 with PequotSwales. Under the terms of the Settlement Agreement, the Company paid $1,000,000 to Swales in July 2004. Legal fees incurred amounted
to approximately $325,000. Based on a legal opinion from the Company’s outside counsel, the Company believes that the amount of the settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs that are reimbursable under which Pequotthe ELVIS contract with NASA. However, on July 28, 2004, the Company received from NASA a Notice of Intent to Disallow Costs. Discussions with NASA are still ongoing. Notwithstanding the Notice of Intent to Disallow Costs, the Company continues to believe that the costs of the settlement will provide Analex with $6.5 millionbe reimbursed by NASA. Therefore, no amounts have been accrued for this claim as of investment capitalJune 30, 2004. However, there can be no assurance that the Company will in fact be reimbursed in part or in full by NASA in the form of convertible debt. The convertible debt will be converted into new Series B Preferred Stock upon stockholders’ approval. A significant portion of the proceeds will be used as consideration for the acquisition of BAI.foreseeable future.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Analex specializes in developing intelligence, system engineering, technology protection, operations security, and bio-defense servicesintelligence analysis 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 medialmedical defenses and treatments for infectious agents such as anthrax and smallpox used in biological warfare and terrorism.
On May 28, 2004, Analex acquired Beta Analytics, Inc. (“BAI”). BAI is reported as a part of the Homeland Security Group. BAI provides information and technology asset protection solutions, intelligence analysis, and security services to federal government and Department of Defense agencies. BAI’s services cover a range of life cycle protection and physical security services specifically in the areas of information protection, physical security, intelligence threat assessment and analysis, technology protection, security management and security education and training. We believe that our acquisition of BAI will yield additional significant yearly revenues and strong operating income, enhanced attractiveness to institutional investors and an enhanced ability to compete effectively within our industry.
During the second quarter of 2004, the Company concluded that Advanced Biosystems, Inc., (“ABS”), a wholly owned subsidiary of the Company, did not fit with the Company’s long-term plan and decided to divest ABS. The Company is in the process of disposing of ABS and intends to conclude either a sale or another form of disposition
by December 31, 2004. Therefore, the results of operations of this business are reported as discontinued operations, net of applicable income taxes, for all periods presented in accordance with SFAS 144,Accounting for the Impairment of Disposal of Long-Lived Assets. The Company has written down the assets of ABS to the fair value of the expected proceeds to be received from the disposition of ABS.
Sales to U.S. federal government agencies and their prime contractors represented approximately 99.5%98% of our total net sales during the threesix months ended March 31,June 30, 2004 and 98%99% during the threesix months ended March 31,June 30, 2003. The Department of Defense accounted for approximately 43%47% and 45%42% of our revenues in the threesix months ended March 31,June 30, 2004 and 2003, respectively. With the acquisition of the former Analex Corporation in November 2001, NASA becameis our largest customer, generating 55%52% and 52%57% of our revenues for the threesix months ended March 31,June 30, 2004 and 2003, respectively. Approximately 20%19% of our revenuerevenues and 156%79% of our operating income for the threesix months ended March 31,June 30, 2004 came from one prime contract with an agency within the Department of Defense. Approximately 32% of our revenuerevenues for the threesix months ended March 31,June 30, 2004 came from one prime contract with NASA, which has a potential nine-year and four-month contract termwill continue until September 2011 if all options are exercised. We expect that federal government contracts will continue to be the source of substantially all of our revenue for the foreseeable future.
In the threesix months ended March 31,June 30, 2004, a majority of our revenues were generated as a prime contractor to 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:
Three months ended March 31, | ||||||
| 2004 | 2003 | |||||
Prime contract revenue | 59 | % | 58 | % | ||
Subcontract revenue | 41 | % | 42 | % | ||
Total revenue | 100 | % | 100 | % | ||
| Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||
Prime contract revenues | 67 | % | 55 | % | 64 | % | 55 | % | ||||
Subcontract revenues | 33 | 45 | 36 | 45 | ||||||||
Total revenues | 100 | % | 100 | % | 100 | % | 100 | % | ||||
We have twoone reportable segments: (1) Analex,segment, 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 (2) Advanced Biosystems (ABS), which is engaged in biomedical research for medical defenses against toxic agents capable of being used as bioterrorist weapons, such as anthrax and smallpox. The AnalexDefense. This segment consists of two business groups: the Homeland Security Group and the Systems Engineering Group. The Homeland Security Group provides information technology services, systems
integration, hardware and software engineering and independent quality assurance in support of the U.S. intelligence community and Department of Defense. With BAI included as a part of the Homeland Security Group, the latter also provides information and technology asset protection
solutions, intelligence analysis, and security services to federal government and Department of Defense agencies. We expect our Homeland Security Group to benefit from the country’s shifting priorities and new emphasis on enhanced intelligence capabilities. The Systems Engineering Group provides engineering, information technology and program management support to NASA, the Department of Defense, and major aerospace contractors such as Lockheed Martin and Northrop Grumman. In previous reporting periods, ABS was disclosed as a separate segment.
Our services are provided under three types of contracts: cost-plus-fees, time-and-materials, and fixed price contracts.
The following table shows our revenues from each of these types of contracts as a percentage of our total revenue for the past two years:following periods:
Three months ended March 31, | Three Months Ended June 30 | Six Months Ended June 30 | ||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||
Cost plus fees | 48 | % | 53 | % | ||||||||||||||
Time and materials | 37 | % | 34 | % | ||||||||||||||
Cost-plus-fees | 40 | % | 50 | % | 43 | % | 49 | % | ||||||||||
Time-and-materials | 43 | 36 | 41 | 37 | ||||||||||||||
Fixed price | 15 | % | 13 | % | 17 | 14 | 16 | 14 | ||||||||||
Total | 100.0 | % | 100.0 | % | 100 | % | 100 | % | 100 | % | 100 | % | ||||||
Our objective is to grow sales organically and through acquisitions. In order to assist in accomplishing this objective, we have continued to increase our sales,selling, general and administrative expenditures so as to increase our efforts in new business development and to provide the necessary infrastructure to support rapid growtha larger organization resulting from organic growth and from acquisitions. It is also our objective to increase our operating profit margins.
Our ABS segment, focusing on biodefense research, is dependent upon continued funding 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, we are uncertain of our ability to continue to obtain funding sources for ABS. Subsequent to March 31, 2004, the Board of Directors decided to sell or otherwise divest of ABS no later than December 31, 2004. ABS will therefore be treated as discontinued operations for accounting purposes beginning the fiscal quarter ended June 30, 2004.
In addition, one of our key strategies following the Pequot Transaction in December 2003 is to pursue growth through acquisitions. We plan to selectively acquire companies that complement and enhance our existing businesses, and are currently reviewing potential targets. We anticipate that we will need to obtain additional financing through sale of equity and debt securities to fund our acquisitions. Subsequent to March 31, 2004, the Company entered into an agreement to acquire Beta Analytics, Inc. (BAI) and entered into a binding commitment letter with Pequot under which Pequot will provide the Company with $6.5 million of investment capital in the form of convertible debt.
The Company’s backlog of orders, based on remaining contract value, believed to be firm as of March 31,June 30, 2004 was approximately $176 million, of which approximately $175.5 million was attributable to the Analex segment and $0.5 million was attributable to ABS. The portion of the total backlog expected to be realized within 2004 is $68$209 million. Funded backlog as of March 31,June 30, 2004 was approximately $33 million, of which approximately $0.1 million was attributable to the ABS segment.$51 million. Included in the backlog approximation are amounts from future years of government contracts under which the government has the right to exercise an option for the Company to perform services.
All of our U.S. government contracts are subject to audit and various cost controls, and include standard provisions for termination for the convenience of the 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.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31,JUNE 30, 2004
TO THE THREE MONTHS ENDED MARCH 31,JUNE 30, 2003
| Three Months Ended March 31, | |||||||||||||
| 2004 | 2003 | ||||||||||||
Revenues | $ | 17,110,100 | 100 | % | 16,631,200 | 100 | % | ||||||
Operating costs and expenses: | |||||||||||||
Costs of revenues | 14,451,700 | 84.4 | 13,860,100 | 83.3 | |||||||||
Selling, general and administrative | 1,909,800 | 11.2 | 1,531,000 | 9.2 | |||||||||
Amortization of intangible assets | 149,200 | 1.0 | 100,200 | 0.6 | |||||||||
Total operating costs and expenses | 16,510,700 | 96.5 | 15,491,300 | 93.1 | |||||||||
Operating income | 599,400 | 3.4 | 1,139,900 | 6.9 | |||||||||
Interest expense, net | 687,800 | 4.0 | 111,300 | 0.7 | |||||||||
Income (loss) before income taxes | (88,400 | ) | (0.5 | ) | 1,028,600 | 6.2 | |||||||
Provision (benefit) for income taxes | (76,300 | ) | (0.4 | ) | 293,200 | 1.8 | |||||||
Net income (loss) | (12,100 | ) | (0.1 | ) | 735,400 | 4.4 | |||||||
Dividends on convertible preferred stock | 225,000 | 1.3 | — | — | |||||||||
Accretion of convertible preferred stock | 937,500 | 5.5 | — | — | |||||||||
Net income (loss) available to common shareholders | ($1,174,600 | ) | (6.9 | %) | $ | 735,400 | 4.4 | % | |||||
REVENUES AND PERCENT OF REVENUES BY SEGMENTGROUP
| Three Months Ended March 31, | Three Months Ended June 30 | |||||||||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||
Analex Segment | ||||||||||||||||||||||||
Homeland Security Group | $ | 7,221,400 | 42 | % | $ | 6,684,100 | 40 | % | $ | 11,404,800 | 51 | % | $ | 6,601,200 | 43 | % | ||||||||
Systems Engineering Group | 9,410,000 | 55 | % | 8,594,100 | 52 | % | 10,810,400 | 49 | % | 8,824,000 | 57 | % | ||||||||||||
ABS Segment | 478,700 | 3 | % | 1,353,000 | 8 | % | ||||||||||||||||||
Total | $ | 17,110,100 | 100 | % | $ | 16,631,200 | 100 | % | $ | 22,215,200 | 100 | % | $ | 15,425,200 | 100 | % | ||||||||
PERCENTAGE REVENUE GROWTH QUARTER OVER QUARTER BY SEGMENTGROUP
| 2004 vs. 2003 | |||
| |||
Homeland Security Group | % | ||
Systems Engineering Group | % | ||
| |||
Total | % |
Revenues for the three months ended March 31,June 30, 2004 were $17.1$22.2 million, an increase of $0.5$6.8 million from the $16.6$15.4 million in revenues for the three months ended March 31,June 30, 2003. This increase is primarily due to increases in revenues in the Homeland Security Group and the Systems Engineering Group, offset by a decrease in revenues in ABS. RevenuesGroup.Revenues of the Homeland Security Group increased 8.0%72.8%, or approximately $0.5$4.8 million. This increase was primarily due to the acquisition of BAI, which contributed $3.2 million in revenues, and the remainder is due to growth in services provided to the intelligence community and related agencies. Revenues of the Systems Engineering Group increased 9.5%22.5%, or approximately $0.8$2 million, primarily due to an approximate $0.5a $1.8 million increase in revenues under the ELVIS contract, as compared to the firstsecond quarter of 2003. In addition, under the Glenn Engineering Support Services contract with NASA, revenues increased approximately $0.5 million as compared to the same period of 2003 due to additional tasking from the customer. These increases were offset by a reduction in revenues of $0.3 million due to the planned step-down in activities under the Microgravity Research Development and Operations contract with NASA related to designing and building experiments to be run on the International Space Station. In addition, ABS experienced a $0.9 million, or 65%, decline in revenues.
Costs of revenue for the quarter ended March 31,June 30, 2004 were $14.5$17.4 million, an increase of $0.6$4.4 million from the same period of the prior year. The increase is dueCosts of revenue for recently acquired BAI
accounted for $2.4 million of the increase. Growth in services provided to the costscustomers of revenue generated by growth in the Homeland Security Group and the Systems Engineering Group.Group as noted in the preceding paragraph, accounted for $0.6 million and $1.4 million of the increase, respectively. Costs of revenue as a percentage of revenues were approximately 84%78% for the quarter ended March 31,June 30, 2004 and 83% for the same period of 2003.
Selling, general and administrative expenses totaled $1.9$2.6 million for the quarter ended March 31,June 30, 2004, compared with $1.5$1.4 million for the same period of the prior year. This 25%78% increase is due to increased expenses related to merger and acquisition activities which accounted for $0.6 million and investments made to expand the Company’s infrastructure and management team to accommodate an expected increase in the scope of business operations from acquisitions later this year.acquisitions. These investments include upgrading our financial accounting system and additional staff members in the accounting, contracts, marketing and corporate management departments.
Operating income for the three months ended March 31,June 30, 2004 was $0.6$2.0 million, compared to operating income of $1.1$1.0 million for the period ended March 31,June 30, 2003. This $0.5 million decreaseThe increased operating income is primarily attributable to the increasegrowth of the Homeland Security Group of $1.4 million, of which $0.6 million is attributable to BAI, and $0.8 million is attributable to growth in selling, generalservices provided to the intelligence community and administrative expenses discussed inrelated agencies. In addition, operating income of the previous paragraph.Systems Engineering Group increased $0.4 million due to additional tasking from customers. These increases are offset by an additional $0.5 million of expense related to merger and acquisition activities and $0.2 million of additional amortization related to the BAI acquisition.
Interest expense totaled $0.7$1.7 million for the quarter ended March 31,June 30, 2004, compared with $0.1 million for the same period in the prior year. The $0.6$1.6 million increase is due to cash and non-cash interest expense related to the convertible debt issued as part of the Pequot investment.Transaction and the Series B Financing. Cash interest payments on the convertible debt were $0.2$0.3 million and non-cash amortization recorded as interest expense was $0.5$1.3 million.
Income tax benefitexpense for the quarter ended March 31,June 30, 2004 was $0.08$0.5 million, compared with $0.3 million expense for the same period in the prior year. The Company received a tax benefit due to the net loss incurred during the quarter ended March 31, 2004. The Company will experience an increase in the effective tax rate in 2004. This increase is due to the recognition of certain amortization costs related to the Pequot Transaction and the Series B Financing which are not deductible for tax purposes, in addition to the Company consuming all net operating loss carryforwardscarry forwards during 2003.
In the quarter ended March 31,June 30, 2004, the Company recorded a net loss from continuing operations of approximately $0.01$0.1 million and EBITDA, as defined below, of $0.8$2.4 million, after add-backs for interest of $0.7$1.7 million, depreciation of $0.05$0.04 million, amortization of $0.15$0.3 million, and income tax benefitexpense of $0.08$0.5 million. EBITDA as a percent of revenuerevenues was 4.6%10.6% for the quarter ended March 31,June 30, 2004, compared to 7.6%7.2% for the quarter ended March 31,June 30, 2003.
EBITDA, or earnings before interest, taxes, depreciation and amortization, is considered a non-GAAP financial measure under applicable SEC rules. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with U.S. generally accepted accounting principles.
EBITDA is a widely used measure of operating performance. It is presented as supplemental information that management of the Company believes is useful to investors to evaluate the Company’s results because it excludes certain items that are not directly
related to the Company’s core operating performance. EBITDA is calculated by adding back net interest expense, income taxes, depreciation and amortization to net income. EBITDA should not be considered as a substitute either for net income, as an indicator of the Company’s operating performance, or for cash flow, as measures of the Company’s liquidity. In addition, because EBITDA is not calculated identically by all companies, the Company’s presentation of EBITDA may not be comparable to other similarly titled measures of other companies.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2004
TO THE SIX MONTHS ENDED JUNE 30, 2003
REVENUES AND PERCENT OF REVENUES BY GROUP
| Six Months Ended June 30 | ||||||||||||
| 2004 | 2003 | |||||||||||
Homeland Security Group | $ | 18,626,200 | 48 | % | $ | 13,285,300 | 43 | % | ||||
Systems Engineering Group | 20,220,400 | 52 | % | 17,418,200 | 57 | % | ||||||
Total | $ | 38,846,600 | 100 | % | $ | 30,703,500 | 100 | % | ||||
PERCENTAGE REVENUE GROWTH SIX MONTHS OVER SIX MONTHS BY GROUP
| 2004 vs. 2003 | |||
Homeland Security Group | 40 | % | |
Systems Engineering Group | 16 | % | |
Total | 26.5 | % |
Revenues for the six months ended June 30, 2004 were $38.8 million, an increase of $8.1 million from the $30.7 million in
revenues for the six months ended June 30, 2003. This increase is primarily due to increases in revenues in the Homeland Security Group and the Systems Engineering Group. Revenues of the Homeland Security Group increased 40%, or approximately $5.3 million, of which $3.2 million was attributable to the acquisition of BAI and $2.1 million was due to growth in services provided to the intelligence community and related agencies. Revenues of the Systems Engineering Group increased 16.1%, or approximately $2.8 million primarily due to a $2.3 million increase in revenues under the ELVIS contract, as compared to the first six months of 2003. In addition, under the Glenn Engineering Support Services contract with NASA, revenues increased approximately $1 million as compared to the same period of 2003 due to additional tasking from the customer. These increases were offset by a reduction in revenues of $0.5 million due to the planned step-down in activities under the Microgravity Research Development and Operations contract with NASA related to designing and building experiments to be run on the International Space Station.
Costs of revenue for the six months ended June 30, 2004 were $31.4 million, an increase of $5.7 million from the same period of the prior year. Costs of revenue for the recently acquired BAI accounted for $2.4 million of the increase. Growth in services to the customers of the Homeland Security Group and Systems Engineering Group as noted in the preceding paragraph, accounted for $1.0 million and $2.2 million of the increase, respectively. Costs of revenue as a percentage of revenues were approximately 81% for the six months ended June 30, 2004 and 84% for the same period of 2003.
Selling, general and administrative expenses totaled $4.4 million for the six months ended June 30, 2004, compared to $2.8 million for the same period of the prior year. This 57% increase is due to increased expenses related to merger and acquisition expenses which accounted for $0.6 million, while the remainder of the increase is attributable to investments made to expand the Company’s infrastructure and management team to accommodate an expected increase in the scope of business operations from acquisitions. These investments include upgrading our financial accounting system and additional staff members in the accounting, contracts, marketing and corporate management departments.
Operating income for the six months ended June 30, 2004 was $2.7 million, compared to operating income of $2.0 million for the period ended June 30, 2003. This $0.7 million increase is primarily attributable to growth in the Homeland Security Group of $1.3 million, of which $0.6 million is attributable to BAI and $0.7 million is attributable to growth in the services provided to the intelligence community and related agencies. In addition, operating income of the Systems Engineering Group increased $0.1 million due to additional tasking from customers. These increases are offset by an additional $0.5 million of expense related to merger and acquisition activity and $0.2 million of additional amortization related to the BAI acquisition.
Interest expense totaled $2.4 million for the six months ended June 30, 2004, compared with $0.2 million for the same period in the prior year. The $2.2 million increase is due to cash and non-cash interest expense related to the convertible notes issued. Cash interest payments on the convertible notes were $0.4 million and non-cash amortization recorded as interest expense was $1.8 million.
Income tax expense for the six months ended June 30, 2004 was $0.4 million, compared with $0.5 million for the same period in the prior year. The Company will experience an increase in the effective tax rate in 2004. This increase is due to the recognition of certain amortization costs related to the Pequot Transaction, which are not deductible for tax purposes, in addition to the Company consuming all net operating loss carryforwards during 2003.
For the six months ended June 30, 2004, the Company recorded a net loss from continuing operations of approximately $0.1 million and EBITDA, as defined below, of $3.2 million, after add-backs for interest of $2.4 million, depreciation of $0.1 million, amortization of $0.4 million, and income tax expense of $0.4 million. EBITDA as a percent of revenue was 8.2% for the six months ended June 30, 2004, compared to 7.4% for the six months ended June 30, 2003.
CAPITAL RESOURCES AND LIQUIDITY
While the Company experienced decreaseda net incomeloss on a quarterly comparison to a net income for the same period of 2003, the majority of the decrease relatesnet loss can be attributed to non-cash amortization and accretion charges associated with the Pequot investment.Transaction and Series B Financing. Borrowing availability under the Company’s Credit Facility continues to be sufficient to fund normal operations. The table below details the convertible debt and remaining amortization expense which will be recognized as interest expense.
Convertible Debt | Face Value | Carrying Value At June 30, | Remaining Amount to be Amortized | Quarterly Expenses | Remaining Period of Amortization | ||||||||||||
| Cash | Non - Cash | ||||||||||||||||
Convertible Notes | $ | 10,000,000 | $ | 3,785,500 | $ | 6,570,100 | $ | 175,000 | $ | 480,000 | 3 1/2 Years | ||||||
Senior Subordinated Notes | $ | 12,000,000 | $ | 8,398,700 | $ | 3,763,100 | $ | 210,000 | $ | 2,320,000 | * | ||||||
| $ | 385,000 | $ | 2,800,000 | ||||||||||||||
| * | The discount on the Senior Subordinated Notes will be fully amortized during the third quarter of 2004, as the Senior Subordinated Notes will be converted into Series B Preferred Stock upon shareholders’ approval at the annual meeting on September 15, 2004. |
The table below details the Series A Preferred Stock and the associated dividends and accretion.
Preferred Stock | Face Value | Carrying Value At June 30, | Remaining Amount to be Accreted | Quarterly Dividends and Accretion | Remaining Period of Amortization | ||||||||||||
| Cash | Non - Cash | ||||||||||||||||
Series A | $ | 15,000,000 | $ | 2,112,900 | $ | 12,887,100 | $ | 225,000 | $ | 937,500 | 3 1/2 Years | ||||||
For the six months ended June 30, 2004, net loss available to common shareholders of $3.0 million included $0.4 million of non-cash amortization, $1.8 million of non-cash interest accretion, and $1.9 million of non-cash preferred stock accretion. Available borrowing capacity on the Company’s Credit Facility amounted to $11.7 million. The Company had a standby financing capacity for acquisitions of $45 million, consisting of an annual guidance bank facility of $20 million and the option to draw down on a second round of Series B Preferred Stock financing of $25 million.
Working capital at March 31,June 30, 2004 decreased by $0.2$21.7 million from December 31, 2003 primarily due to an increasethe purchase of BAI which included the use of $12 million of cash from the Pequot Transaction, a draw from our Credit Facility of $8.3 million and the issuance of the Senior Subordinated Notes for $12 million. In addition, accounts receivable increased $10.2 million over the prior year due to accounts receivable acquired in tradethe acquisition of BAI and the timing of receipt of certain accounts payable and other current liabilities.receivable.
Net cash used in operating activities during the threesix months ended March 31,June 30, 2004 and 2003 was $1.3 million. Net cash provided by operating activities was $2.3 million for the six months ended June 30, 2003. This $3.6 million decrease is due to increased accounts receivable of $5.5 million over the prior year due to the acquisition of BAI and timing of receipt of certain accounts receivable. This was offset by a decrease in cash used for accounts payable of $1.5 million, and a decrease in cash provided by other current liabilities of $0.4 million as compared to the prior year.
Net cash used in investing activities during the threesix months ended March 31,June 30, 2004 and 2003 was $0.05 million.$27.2 million in comparison to $0.2 million for the same period of the prior year. Net cash used in investing activities during both periods2004 was primarily used for fixed asset purchases.
On November 2, 2001, to finance the acquisition of Analex,BAI, net cash used during 2003 was primarily used for the purchase of fixed assets.
The Company enteredhas a credit agreement with Bank of America, N.A. (the “Credit Facility”). On May 28, 2004, in connection
with the acquisition of BAI, the Credit Facility was amended and restated to provide a $20,000,000 revolving credit facility, and the remaining outstanding balance on the Company’s term loan of $1,750,000 was consolidated into the Credit Agreement which originally providedFacility. An uncommitted annual guidance facility not to exceed an additional $20,000,000 is available to fund future acquisitions upon application by the Company with a $4,000,000 Credit Facility through November 2, 2006 and a five-year $3,500,000 Term Loan.approval by Bank of America. The Credit Facility has an annual renewal occurring April 30 of each year. To fund additional working capital requirements generated by the award of the ELVIS contract, the Company negotiated an increase ofInterest on the Credit Facility to $8,000,000 in August 2002. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. Interest on each of the facilities is at the LIBOR Rate plus an applicable margin as specified in a pricing grid. As of March 31,June 30, 2004, the Credit Facility and the Term Loan balances were zero and $1,925,000, respectively.outstanding balance was $8,254,700. The interest rate at March 31,June 30, 2004 was 3.59%3.84% for the Credit Facility and 4.10% for the Term Loan.Facility.
Upon the Closing of the Pequot Transaction, Bank of America and the Company entered into a modification of theThe Credit Agreement amendingFacility contains financial covenant requirements including thecovenants setting forth maxiumum ratios for total funded debt to EBITDA ratio and theminimum ratios for fixed charge coverage ratio.coverage. As of March 31,June 30, 2004, the Company was in compliance with these covenants. The credit agreementCredit Facility also restricts our
the Company’s ability to dispose of properties other than ABS, incur additional indebtedness, pay dividends (except to holders of the Series A and Series B Preferred Stock) or other distributions, create liens on assets, enter into sale and leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. The Credit Facility and Term Loan areis secured by the accounts receivable and other assets of the Company.
Pursuant to the November 2, 2001 acquisition of the former Analex, the Company issued 3,572,143 shares of the Company’s Common Stockcommon stock to the shareholders representing all of the outstanding equity of Analex (the “Sellers”). Of the 3,572,143 shares, 857,143 shares are subject to a provision by which the Company guarantees for a five-year period to reimburse the Sellers the difference between the price at which they sell such shares and a guaranteed sales price. As of March 31,June 30, 2004, the maximum amount payable under the terms of the guaranteed shares was $3,428,600.$1,628,600. As the fair market value of the Company’s common stock was in excess of the guaranteed share prices as of March 31,June 30, 2004, no amounts were accrued under the guarantee.
Pequot TransactionSeries B Financing
On December 9, 2003,May 28, 2004, the Company consummated the transaction contemplated by the Subordinated Note and Series A Convertible Preferreda Stock Purchase Agreement (the “Pequot“Series B Purchase Agreement”) by and betweenamong the Company and General Electric Pension Trust (“GEPT”), New York Life Capital Partners II, L.P. (“NYL”), 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”(collectively, “Pequot,” together with GEPT and NYL, collectively, the
“Investors”). ThePursuant to the Series B Purchase Agreement the Company:
In connection with the issuance and sale of the Convertible Notes, issued warrants (the “Note Warrants,” and together
|
In addition, on December 9, 2003, the Company consummated a Securities Repurchase Agreement (the “Stout Repurchase Agreement”) with the 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 purchased 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 are collectively referred to as the “Pequot Transaction.”
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. The Company used aA significant portion of the proceeds fromfunds obtained on the sale ofFirst Closing Date under the Series A Preferred StockPurchase Agreement was used 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 acash portion of the consideration for the acquisition of BAI.
Subject to certain approval rights by the holders of Series A convertible preferred stock of the Company (the “Series A Preferred Stock”) and the Series B Preferred Stock, when issued, the Series B Purchase Agreement also provides that the Company has an option to require the Investors to purchase up to an additional $25 million of Senior Subordinated Notes or Series B Preferred Stock, with additional Common Stock Warrants (the “Company Option”), at any one or more times on or prior to May 27, 2005 for the purpose of paying the cost of future acquisitions byacquisition of the Company.stock or assets of one or more other companies in each case with an acquisition value of at least $10 million.
Series A Preferred StockSenior Subordinated Notes
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. 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 June 9, 2005, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the conversion price then in effect for the Series A Preferred Stock. In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into Common Stock. The Series A Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.
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, 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 ConvertibleSenior Subordinated Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event ofa default under the Company’s senior credit facility, such interest will be accrued and added to the outstanding principal. Upon a payment default, the interest rate on the Senior Subordinated Notes will be increased to 14% per annum during the term of the default.
The Convertible Notes may not be prepaid prior to June 9, 2005 without the consent of the holders of a majority of the outstanding principal amount of the Convertible Notes. Any subsequent prepayment will be made, at the option of the Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum; or by conversion of the principal into shares of Series A Preferred Stock and the payment of interest in cash or in shares of Series A Preferred Stock. Holders of the Convertible Notes may convert the outstanding principal and accrued interest on the Senior Subordinated Notes will be automatically converted into Series AB Preferred Stock upon stockholders’ approval at any time.the annual
meeting. The per share conversion price forof the ConvertibleSenior Subordinated Notes is $3.01$3.50 (the “Series B Original Issue Price”).
If the Senior Subordinated Notes have not already converted into Series B Preferred Stock, they will mature on the “Maturity Date” which is 120 days from the date of issuance (the “Series B Issue Date”). In the event that stockholders’ approval is not obtained on or before the Maturity Date, (i) the rate of interest payable on the Senior Subordinated Notes will be increased to 14% per share. Theannum and will continue to increase 3% per annum (but in no event shall be increased above the rate of interest lawfully payable) for each calendar quarter thereafter that the Senior Subordinated Notes remain unpaid and (ii) the Company may cause the automatic conversionwill issue to Investors additional warrants to purchase $3.5 million of the Convertible Notes intoCompany’s Common Stock, if,exercisable at any time following June 9, 2005, the average closingstockholders’ approval, at an exercise price
for equal to the Common Stock over a 20 consecutive trading day period exceeds $5.58 per share.Series B Conversion Price (as defined below).
The Company’s obligations under the ConvertibleSenior Subordinated Notes are secured by a second lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. SuchThese obligations are subordinated only to those under the Credit Facility and are senior to the rightsexisting obligations to Pequot under the convertible debt issued pursuant to the Convertible Note and Series A Convertible Preferred Stock Purchase Agreement dated July 18, 2003 (the “Series A Purchase Agreement”). The Company is subject to certain financial and operational covenants.
Upon issuance of the Senior Subordinated Notes, the Company allocated fair value of $720,000 to the Common Stock Warrants based on a preliminary valuation, and recorded a beneficial conversion charge of $3,720,000. The discount created by these charges is being amortized to interest expense over the life of the Senior Subordinated Notes. For the three and six months ended June 30, 2004, the Company recognized $0.8 million of amortization of that discount. The unamortized discount as of June 30, 2004 was $3.6 million.
Series B Preferred Stock
An aggregate of 3,428,571 shares of Series B Preferred Stock will be issued to the Investors upon stockholders’ approval of the conversion of the $12 million Senior Subordinated Notes into the Series B Preferred Stock. The Series B Preferred Stock will rank senior to the Company’s existing Series A Preferred Stock. The Series B Preferred Stock will bear a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in a default under the Company’s Credit Facility, in additional shares of Series B Preferred Stock.
Upon any liquidation, dissolution or winding up of the Company, holders of the Series B Preferred Stock will be entitled to receive, in preference to holders of Series A Preferred Stock and Common Stock, out of the Company’s presentassets available for stockholder distributions, an amount per share equal to the Series B Original Issue Price plus any accrued but unpaid dividends thereon. Certain mergers, acquisitions or asset sales involving the Company are treated as a liquidation event unless the holders of 66 2/3% of the then outstanding Series B Preferred Stock and future senior secured lenders.
WarrantsSeries A Preferred Stock voting together as a class elect not to treat such transactions as liquidation events.
The Warrants are exercisableSeries B Preferred Stock will be convertible into Common Stock at any time before December 9, 2013.at the election of its holders. The per share conversion price (the “Conversion Price”) of the Series B Preferred Stock will be the lowest of (i) $3.10; (ii) the price that reflects a 20% discount to the trailing average closing price of the Company’s Common Stock for the 20 consecutive trading days immediately preceding the date of the conversion or the Series B Issue Date, but in no event less than $2.80; and (iii) the closing price of the Company’s Common Stock on the day immediately preceding the Series B Issue Date; provided that if stockholder approval for the conversion of the Senior Subordinated Notes occurs during certain uncured events of default, the Conversion Price will not be subject to the $2.80 floor price under (ii) above.
The Series B Preferred Stock will automatically convert into Common Stock if, any time following 18 months after the Series B Issue Date, (i) the average closing price of the Common Stock over the immediately preceding 20 consecutive trading day period exceeds 2.5 times the Series B Original Issue Price (as adjusted for certain dilutive equity issuances and for stock splits, stock dividends and similar events related to the Series B Preferred Stock); or (ii) with respect to any holder’s shares of Series B Preferred Stock, such holder does not accept, within 60 days of notice to such holder, the offer to purchase the Series B Preferred Stock for at least 2.5 times the Series B Original Issue Price. The Series B Preferred Stock will automatically convert into Common Stock upon the agreement of the holders of 75% of the Series B Preferred Stock.
Holders of two-thirds of the Series B Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of the Series B Issue Date at the Series B Original Issue Price plus accrued but unpaid dividends.
Holders of Series B Preferred Stock will be entitled to vote together with all other classes and series of voting stock of the Company on all actions to be taken by the stockholders of the Company. As long as at least 25% of the shares of the Series B Preferred Stock issued pursuant to the Series B Purchase Agreement remain outstanding, the Company may not take numerous specified actions (including certain changes to the Company’s Certificate of Incorporation) without first obtaining the written consent of holders of at least a majority of the then outstanding shares of Series B Preferred Stock voting separately as a class. In addition, as long as the Company Option is in effect, holders of 100% of the Series A Preferred Stock and the Series B Preferred Stock, voting together as a single class, shall have the right to veto (i) any Company Acquisition, and (ii) the issuance of any securities ranking senior to or pari passu with the Series A Preferred Stock or the Series B Preferred Stock, with respect to voting, dividend, liquidation or redemption rights, including the issuance of subordinated debt.
Common Stock Warrants
The Common Stock Warrants issued in connection with the Series B Financing will expire on May 28, 2014. They are not exercisable at the time of issuance. Upon stockholders’ approval at the annual meeting, the Common Stock Warrants will become exercisable at the option of the Investors to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Series AB Preferred Stock. The Note Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stockthat is issued or issuable upon the conversion of the Convertibleprincipal amount of the Senior Subordinated Notes. The initial exercise price of the Common Stock Warrants is $3.28.$4.32 per share.
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-Q. We assume no obligation to update any such forward-looking statements.
Item 3.Quantitative and Qualitative Disclosure about Market Risk
Market Risks and Hedging Activities
The Company’s outstanding bank debt bears interest at variable interest rates tied to LIBOR. The use of variable-rate debt to finance operations and capital improvements exposes the Company to variability in interest payments due to changes in interest rates. The Company uses an interest rate swap to reduce the interest rate exposure on these variable rate obligations. The Company does not hold any derivatives for trading or speculative purposes.
The Company’s $3.5 million term loan facility from Bank of America carries interest comprised of two components: floating-rate LIBOR plus a credit performance margin. The Company entered into an interest-rate swap agreement with Bank of America whereby its obligation to pay floating-rate LIBOR was swapped into a fixed rate obligation at 4.25% beginning in January 2002. The
Company continues to have the obligation to pay the credit performance margin in addition to its swapped 4.25% payment obligation. The total effective interest rate on the swapped portion of the Term Loan amounted to 7.25% at March 31, 2004.
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 | Effective | Expiration | ||||
| $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 March 31,June 30, 2004 the notional value of the swap was $1,600,000.$1,450,000. Increases in prevailing interest rates could increase the Company’s interest payment obligations relating to variable rate debt, which includes the portion of the term note not covered by the interest rate swap agreement and the Credit Facility. For example, a 100 basis points increase in interest rates would increase annual interest expense by $3,250,$68,300, based on debt levels at March 31,June 30, 2004.
Item 4.Controls and Procedures
The Company has established and maintains disclosure controls and procedures that are designed to ensure that material information required to be disclosed by the Company in the reports that it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is
accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of disclosure controls and procedures as of the end of the period covered in this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective, at the reasonable assurance level, as of March 31,June 30, 2004, 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.
The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) 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 seekingsought damages of $4 million. To minimize the expense, effort, uncertainty and inconvenience entailed in excessproceeding with the litigation, the Company entered into a Settlement Agreement dated July 22, 2004 with Swales.
Under the terms of $4.0 million. Managementthe Settlement Agreement, the Company paid $1,000,000 to Swales in July 2004. Legal fees incurred amounted to approximately $325,000. Based on a legal opinion from the Company’s outside counsel, the Company believes that any liability that may ultimately result from the resolution of this matter will not have a material adverse effect on the financial position or results of operationsamount of the Company.settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs reimbursable under the ELVIS contract with NASA. However, on July 28, 2004, the Company received from NASA a Notice of Intent to Disallow Costs. Discussions with NASA are still ongoing. Notwithstanding the Notice of Intent to Disallow Costs, the Company continues to believe that the costs of the settlement will be reimbursed by NASA. Therefore, no amounts have been accrued for this claim as of June 30, 2004. However, there can be no assurance that the Company will in fact be reimbursed in part or in full by NASA in the foreseeable future.
Item 6.Exhibits and Reports on Form 8-K
| (a) | Exhibits |
| 31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
| 31.2 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
| 32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |
| (b) | Reports on Form 8-K |
A currentCurrent Report on a Form 8-K, dated February 25,May 7, 2004 and filed with the Securities and Exchange Commission on May 10, 2004, reported (i) its financial results for the first quarter ended March 31, 2004; (ii) its agreement to acquire Beta Analytics, Incorporated; (iii) its binding commitment letter from Pequot to provide investment capital; and (iv) its intention to divest the ABS subsidiary by December 31, 2004.
A Current Report on Form 8-K, dated May 28, 2004 and filed with the Securities and Exchange Commission on June 1, 2004, reported the consummation of the acquisition of BAI and its Stock Purchase Agreement with certain investors in connection with the Series B Financing.
A Current Report on Form 8-K, dated June 7, 2004 and filed with the Securities and Exchange Commission on June 15, 2004 reported that the Company hadhas appointed a new memberMr. Thomas L. Hewitt to the Board of Directors and that the Audit Committee and reportedCompany has amended its financial results forBylaws to increase the fourth fiscal quarter and fiscal year ended December 31, 2003.size of the Board of Directors.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.
Date: May 14,August 16, 2004
Analex Corporation
| ||||||||
(Registrant) | ||||||||
By: | /S/ Sterling E. Phillips, Jr. | By: | /S/ Ronald B. Alexander | |||||
Sterling E. Phillips, Jr. | Ronald B. Alexander | |||||||
Chairman and Chief Executive Officer | Chief Financial Officer | |||||||
(Principal Executive Officer) |
(Principal Financial Officer and Principal Accounting Officer) | |||||||
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