Deltek (PROJ) 10-Q 2001 Q2 Quarterly report

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 June 30, 2001

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            .

Commission File Number: 000-22001

DELTEK SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization)	54-1252625 (I.R.S. Employer Identification No.)
8280 Greensboro Drive, McLean, Virginia (Address of principal executive offices)	22102 (Zip Code)

Registrant’s telephone number, including area code:(703) 734-8606

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  [X]           No  [   ]

      Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Class	Outstanding at June 30, 2001
Common Stock, $.001 par value	15,210,849

TABLE OF CONTENTS

PART I -- FINANCIAL INFORMATION
	ITEM 1 -- FINANCIAL STATEMENTS
	ITEM 2 -- MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PART II -- OTHER INFORMATION
	ITEM 1 -- LEGAL PROCEEDINGS
	ITEM 2 -- CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 3 -- DEFAULTS UPON SENIOR SECURITIES
	ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5 -- OTHER INFORMATION
	ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K

DELTEK SYSTEMS, INC.

TABLE OF CONTENTS

		PAGE NO.
PART I  FINANCIAL INFORMATION
ITEM 1 —	Financial Statements (unaudited)
	Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000		3
	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2001 and June 30, 2000		4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and June 30, 2000		5
	Notes to Unaudited Consolidated Financial Statements		6
ITEM 2 —	Management’s Discussion and Analysis of Financial Condition and Results of Operations		8
ITEM 3 —	Quantitative and Qualitative Disclosures about Market Risk		15
PART II  OTHER INFORMATION
ITEM 1 —	Legal Proceedings		15
ITEM 2 —	Changes in Securities and Use of Proceeds		15
ITEM 3 —	Defaults upon Senior Securities		15
ITEM 4 —	Submission of Matters to a Vote of Security Holders		15
ITEM 5 —	Other Information		15
ITEM 6 —	Exhibits and Reports on Form 8-K		16
SIGNATURES			17

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PART I — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

DELTEK SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

		June 30,			December 31,
		2001			2000
		(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents	$	11,797		$	8,939
	Marketable securities		7,702			5,217
	Accounts receivable, net of allowance for doubtful accounts of $2,025 and $1,652, respectively		16,204			15,159
	Prepaid expenses, deferred income taxes and other current assets		5,048			5,581
Total current assets			40,751			34,896
Furniture, equipment, and leasehold improvements, net of accumulated depreciation and amortization of $11,592 and $10,528 respectively			6,969			7,358
Computer software development costs, net of accumulated amortization of $4,904 and $4,210, respectively			6,317			6,319
Purchased intangibles, net of accumulated amortization of $6,247 and $4,291 respectively			13,210			15,238
Other assets			362			350
Total assets		$	67,609		$	64,161
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Accounts payable and accrued expenses	$	8,406		$	8,962
	Deferred revenue		12,525			9,968
Total current liabilities			20,931			18,930
Commitments and contingencies
Shareholders’ equity:
Preferred stock, $0.001 par value per share, 2,000,000 shares authorized, none issued or outstanding			—			—
Common stock, $0.001 par value per share, 45,000,000 shares authorized, 15,210,849 and 15,125,058 shares issued and outstanding at June 30, 2001 and December 31, 2000, respectively			15			15
Paid-in capital			714			424
Retained earnings			46,024			44,901
Accumulated other comprehensive income			(75	)		(109	)
Total shareholders’ equity			46,678			45,231
Total liabilities and shareholders’ equity		$	67,609		$	64,161

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

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DELTEK SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(unaudited)

			Three Months Ended				Six Months Ended
			June 30				June 30
			2001		2000		2001		2000
Revenues:
	Software license fees		$	6,439	$	5,038	$	12,204	$	12,087
	Services			15,373		16,292		34,054		33,981
	Third-party equipment and software			1,282		779		1,972		1,334
		Total revenues		23,094		22,109		48,230		47,402
Operating expenses:
	Cost of software license fees			952		826		1,996		1,646
	Cost of services			8,314		9,320		18,318		18,122
	Cost of third-party equipment and software			1,145		673		1,763		1,204
	Software development			4,878		4,532		9,789		8,686
	Sales and marketing			4,325		3,389		8,114		6,113
	General and administrative			1,963		1,938		4,012		3,394
	Amortization of goodwill and intangibles			978		353		1,956		601
		Total operating expenses		22,555		21,031		45,948		39,766
Income from operations				539		1,078		2,282		7,636
Other income, net				176		239		298		507
Income before income taxes				715		1,317		2,580		8,143
Provision for income taxes				496		499		1,457		3,142
Net income			$	219	$	818	$	1,123	$	5,001
Net income per share:
	Basic		$	0.01	$	0.05	$	0.07	$	0.30
	Diluted		$	0.01	$	0.05	$	0.07	$	0.30
Shares used to compute per share amounts:
	Basic			15,208		16,711		15,191		16,694
	Diluted			15,271		16,905		15,247		16,937

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

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DELTEK SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

			Six Months Ended
			June 30,
			2001			2000
Cash flows from operating activities:
	Net income		$	1,123		$	5,001
	Adjustments to reconcile net income to net cash provided by operating activities, net of effect of acquisitions:
		Depreciation and amortization		4,074			2,263
		Change in accounts receivable, net		(973	)		451
		Change in prepaid expenses and other assets		521			104
		Change in accounts payable and accrued expenses		(556	)		(297	)
		Change in deferred revenue		2,557			(183	)
		Other noncash credits		—			2
Net cash provided by operating activities				6,746			7,341
Cash flows from investing activities:
	Net (purchases) sales of marketable securities			(2,485	)		3,517
	Purchases of property and equipment			(1,035	)		(1,334	)
	Acquisition of A/E Management, Inc.			—			(3,549	)
	Capitalization of software development costs			(692	)		(1,425	)
Net cash used in investing activities				(4,212	)		(2,791	)
Cash flows from financing activities:
	Cash proceeds from issuance of stock for employee purchase plan and option plans			290			475
	Common stock purchased and retired			—			(437	)
Net cash provided by financing activities				290			38
Impact of changes in foreign exchange rates				34			(136	)
Net increase in cash and equivalents				2,858			4,452
Cash and cash equivalents, beginning of period				8,939			5,989
Cash and cash equivalents, end of period			$	11,797		$	10,441
Cash paid during the period for income taxes			$	910		$	3,089

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

5

DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.  DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

Deltek Systems, Inc. (“Deltek” or the “Company”) is a leading provider of business software, solutions and consulting to over 7,500 professional services firms and project-based companies worldwide. Deltek’s solutions encompass project and financial accounting, customer relationship management, time collection and employee expense, proposal automation, project and resource management, human resources and payroll, business intelligence and e-Business. The Company provides integrated services including customer support and software maintenance, implementation and practice management consulting and classroom training.

Basis of Presentation

The consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2000, included in the Company’s Annual Report on Form 10-K.

2.  NET INCOME PER COMMON SHARE

Net income per common share was calculated in accordance with Statement of Financial Accounting Standards No. 128, “Earnings per Share.” No reconciling items existed between the net income used for basic and diluted net income per share. The only reconciling item between the shares used for basic and diluted net income per share relates to outstanding stock options.

3.  COMMON STOCK PURCHASED AND RETIRED

During 2000, Deltek repurchased and retired 1,697,500 common shares at an average price of $6.73 per share. The repurchase plan was completed by December 2000. Purchases were made out of the Company’s general corporate funds.

4.  COMMITMENTS AND CONTINGENCIES

The Company’s continuing operations entail various claims incidental to its business. The Company is contesting these matters, and in the opinion of management, the ultimate resolution of any legal proceedings will not have a material adverse effect on the financial condition or the future operating results of the Company.

5.  REVENUE RECOGNITION

The Company recognizes software revenue in accordance with Statement of Position 97-2 “Software Revenue Recognition,” and Statement of Position 98-9 “Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions.”

The Company grants perpetual licenses under a standard license agreement. For certain of its software products (primarily Deltek Costpoint), the Company historically granted, at the customer’s discretion, a right of return for a full or partial refund of the license fee during a refund period, which generally spanned 60 to 90 days from the date of the initial software delivery. Deltek Costpoint license fees were therefore deferred until the expiration of the applicable refund period. Beginning in the quarter ended September 30, 2000, license agreements were amended to permit returns in the event of material defects only, as defined in the

6

DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

license agreement. Accordingly, the Company is no longer required to defer software license fee revenue as related to the refund period.

6.  ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. The Company adopted this statement on January 1, 2001, which did not materially impact its financial condition or results of operations.

In June 2001, the FASB approved SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 prospectively prohibits the pooling of interest method of accounting for business combinations initiated after June 30, 2001. SFAS No. 142 requires companies to cease amortizing goodwill that existed at June 30, 2001. The amortization of existing goodwill will cease on December 31, 2001. Any goodwill resulting from acquisitions completed after June 30, 2001 will not be amortized. SFAS No. 142 also establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below is carrying value. The adoption of SFAS No. 142 will result in the Company’s discontinuation of amortization of its goodwill; however, the Company will be required to test its goodwill for impairment under the new standard beginning in the first quarter of 2002, which could have an adverse effect on the Company’s future results of operations if an impairment occurs.

7.  COMPREHENSIVE INCOME (in thousands)

			Three Months					Six Months
			Ended					Ended
			June 30					June 30
			2001		2000			2001		2000
Net Income			$	219	$	818		$	1,123	$	5,001
	Unrealized gains and losses from investment activity			12		(3	)		28		(71	)
	Foreign currency translation adjustments activity			8		(45	)		6		(55	)
		Total Comprehensive Income	$	238	$	770		$	1,157	$	4,875

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND                     RESULTS OF OPERATIONS

      The following information should be read in conjunction with the unaudited Financial Statements and Notes included in Item 1 of this Quarterly Report. The following information should also be read in conjunction with the audited Financial Statements and Notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2000 as contained in the Company’s Annual Report on Form 10-K.

      In addition to historical information, this Quarterly Report includes certain “forward-looking statements.” The words “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends” and other similar expressions are intended to identify these forward-looking statements, but are not the exclusive means of identifying them. Readers are cautioned not to place undue reliance on these forward-looking statements as these forward-looking statements reflect the current view of the Company or its management and are subject to certain risks, uncertainties and contingencies which could cause the Company’s actual results, performance or achievements to differ materially from those expressed in or implied by these statements. These risks, uncertainties and contingencies include, but are not limited to, the factors discussed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors that May Affect Future Results” and elsewhere in this Quarterly Report. Deltek undertakes no obligation and does not intend to update, revise or otherwise publicly release the result of any revisions to these forward-looking statements that may be made to reflect future events or circumstances.

Results of Operations

      The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of total revenues:

Statement of Operations Data (Unaudited)

			Three months						Six months
			ended						ended
			6/30/01			6/30/00			6/30/01			6/30/00
Revenues:
	Software license fees			27.9	%		22.8	%		25.3	%		25.5	%
	Services			66.6			73.7			70.6			71.7
	Third-party equipment and software			5.5			3.5			4.1			2.8
		Total revenues		100.0			100.0			100.0			100.0
Operating expenses:
	Cost of software license fees			4.1			3.7			4.1			3.5
	Cost of services			36.0			42.2			38.0			38.2
	Cost of third-party equipment and software			5.0			3.0			3.7			2.5
	Software development			21.1			20.5			20.3			18.3
	Sales and marketing			18.7			15.3			16.8			12.9
	General and administrative			8.5			8.8			8.3			7.2
	Amortization of goodwill and intangibles			4.3			1.6			4.1			1.3
		Total operating expenses		97.7			95.1			95.3			83.9
Income from operations				2.3			4.9			4.7			16.1
Other income, net				0.8			1.1			0.6			1.1
Income before income taxes				3.1			6.0			5.3			17.2
Provision for income taxes				2.1			2.3			3.0			6.6
Net income				1.0	%		3.7	%		2.3	%		10.6	%

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000

     Summary. Net income for the three months ended June 30, 2001 amounted to $219 thousand, or $0.01 per diluted share, compared with $818 thousand, or $0.05 per diluted share for the second quarter of 2000. Excluding amortization of goodwill and intangibles, net income, as adjusted, amounted to $1.0 million, or $0.07 per diluted share for the current quarter compared with $1.0 million and $0.06 per diluted share for the corresponding period in 2000. Total revenue for the quarter ended June 30, 2001 increased by 4.5% from the second quarter of 2000 attributed principally to an increase in software, maintenance and third party hardware revenue, as consulting services revenue was 25.7% short of the corresponding 2000 total. The amortization of goodwill and intangibles increased 177.1% due to the Semaphore, Inc. acquisition, over the corresponding 2000 levels and accounted for much of the contraction in the operating margin, which was 2.3% for the current quarter compared with 4.9% for the second quarter of 2000.

     Software License Fees. License fees for the quarter ended June 30, 2001 increased by 28.0% to $6.4 million from $5.0 million for the same period in 2000, and represented 27.9% of total revenue in the current quarter compared with 22.8% for the year earlier quarter. The most significant changes in software revenue were related to: an increase in Deltek CRM & Deltek Proposals sales to $841 thousand for the current quarter compared with $177 thousand for the corresponding period last year; an increase in Deltek GCS Premier sales to $655 thousand for the current period compared with $333 thousand for the prior period; and new product sales for the current quarter were $555 thousand and $284 thousand for Deltek Sema4 and Deltek Corporate and Project Planner, respectively. In addition, Deltek Advantage sales increased to $1.1 million for the current quarter compared with $1.0 million for the prior period. Deltek Costpoint sales decreased by 18.1% to $1.8 million for the current quarter, from $2.2 million for the corresponding quarter last year.

     Services. Service revenues for the quarter ended June 30, 2001 decreased by 5.5% to $15.4 million from $16.3 million for the same period in 2000. The decrease was principally attributed to consulting service revenues. Maintenance and support service revenues for the quarter ended June 30, 2001 increased to $8.9 million from $7.6 million in the comparable period last year, a 17.1% increase. Consulting service revenues decreased by 25.7% to $5.5 million for the quarter ended June 30, 2001 from $7.4 million for the same period in 2000. Other service revenues, which includes training, travel reimbursements and custom programming, decreased by 27.8% to $939 thousand for the quarter ended June 30, 2001 from $1.3 million for the same period in the prior year. Service revenues comprised 66.6% of the Company’s total revenues for the quarter ended June 30, 2001, compared to 73.7% for the same period in 2000.

     Third-Party Equipment and Software. Revenue from third-party equipment and software for the quarter ended June 30, 2001 increased by 66.9% to $1.3 million from $779 thousand for the year-earlier quarter and comprised 5.5% and 3.5% of total revenues for each of the comparable periods. The third-party equipment and software gross margin decreased by 21.3% to 10.7% at June 30, 2001 from 13.6% for the corresponding period in 2000.

     Cost of Software License Fees. Cost of software license fees is composed primarily of royalties, maintenance payments to third parties, amortization of software development costs, the cost of production and distribution of software and related user manuals. Cost of software for the current and corresponding quarters was $952 thousand and $826 thousand, respectively. The increase was due to additional royalty expenses. Royalties associated with certain software products currently under development by joint business arrangements and charges associated with software products and technologies acquired from various third party vendors may cause the cost of software license fees, as a percentage of software license fees revenue, to increase in future periods.

     Cost of Services. Cost of services is composed primarily of personnel costs for consulting, customer training, and support. Cost of services for the quarter ended June 30, 2001 decreased by 10.8% to $8.3 million compared with $9.3 million for the same period in 2000. The cost of services gross margin increased to 45.9%

9

DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for the second quarter of 2001 from 42.8% a year earlier as a result of improved consultant utilization rates, lower personnel costs and decreased indirect travel costs. Cost of services as a percentage of services revenue decreased to 54.1% for the most recent quarter compared with 57.2% for the second quarter of 2000.

     Cost of Third-Party Equipment and Software.Cost of third-party equipment and software consists of computer and peripheral equipment, license fees and royalties for third-party software and increased to $1.1 million for the recent quarter from $673 thousand in the second quarter of 2000. The increase was due to a significant increase in the quantity of third-party equipment and software sales.

     Software Development. Software development costs are composed of personnel expenses for analysts and programmers who research, develop, maintain and enhance the Company’s existing software products and who develop new products. Amounting to $4.9 million for the current quarter compared with $4.5 million last year, the increase was due primarily to increased web development efforts, increased labor costs for subcontractors and a lower amount of capitalized costs for software development. Software development costs represented 21.1% and 20.5% of total revenue for the quarters ended June 30, 2001 and 2000, respectively.

     Sales and Marketing. Sales and marketing expenses are composed of personnel costs, advertising, direct mail and other sales and marketing activities. Sales and marketing expenses for the quarter ended June 30, 2001 increased to $4.3 million from $3.4 million for the corresponding period in 2000 and was related to increased staff with improved compensation and commission packages. Sales and marketing expenses represented 18.7% and 15.3% of the Company’s total revenue for the comparable quarters of 2001 and 2000, respectively.

     General and Administrative. General and administrative expenses consist primarily of the costs for management and administrative personnel, and include insurance expense, bad debt provisions, professional fees, and other operating costs. General and administrative expenses for the quarter ended June 30, 2001 increased by 5.3% to $2.0 million, from $1.9 million for the same period in 2000, and represented 8.5% of total revenue for the quarter ended June 30, 2001, compared with 8.8% for the same period in 2000.

     Amortization of Goodwill and Intangibles. Amortization expense of $978 thousand and $353 thousand for the quarters ended June 30, 2001 and June 30, 2000, respectively, were related to SalesKit Software Corporation, A/E Management, Inc. and Semaphore, Inc., acquired in April 1998, April 2001 and August 2001, respectively.

     Other Income. Other income is comprised of interest income, other expenses and realized gains or losses on currency exchange. Interest income is earned principally on short-term investments in tax-exempt securities and amounted to $116 thousand for the quarter ended June 30, 2001, a decrease of 57.2% from $271 thousand for the same period in 2000 attributed to a decline in average invested funds used for acquisitions and share repurchases.

     Income Tax Provision. The Company’s effective tax rate for the quarter ended June 30, 2001 was 69.4% compared with 37.9% for the quarter ended June 30, 2000. The increase in the effective tax rate is primarily due to the increase in non-deductible goodwill related to the acquisition of Semaphore, Inc.

Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000

     Summary. Net income for the six months ended June 30, 2001 amounted to $1.1 million, or $0.07 per diluted share, compared with $5.0 million, or $0.30 per diluted share for the six months of 2000. Excluding amortization of goodwill and intangibles, net income, as adjusted, amounted to $2.7 million, or $0.18 per diluted share for the current period compared with $5.4 million, or $0.32 per diluted share for the corresponding period in 2000. Total revenue for the two quarters ended June 30, 2001 increased by 1.7% from the first six months of 2000 attributed principally to a 25.3% and 23.1% increase in maintenance and training revenue, respectively, as consulting services revenue was 23.8% short of the corresponding 2000 total. Operating expenses increased 15.6% due to the 225.5% increase of goodwill and intangible amortization from

10

DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the Semaphore, Inc. acquisition, from the corresponding 2000 levels, and accounted for much of the contraction in the operating margin. The operating margin was 4.7% for the current six-month period compared with 16.1% for the corresponding period in 2000.

     Software License Fees. License fees for the six months ended June 30, 2001 increased by 1.0% to $12.2 million from $12.1 million for the same period in 2000. License fees from sales of Deltek CRM & Deltek Proposals increased 153.2% to $1.4 million for the six months ended June 30, 2001 compared with $553 thousand for the comparable 2000 period. Sales of new products, Sema4, Deltek Project Planner and Deltek Corporate Planner, produced $927 thousand and $446 thousand, respectively, in software revenue for the six months ended June 30, 2001, with no comparable revenue for 2000. Sales of Deltek Time Collection produced $2.1 million in fees for the six months ended June 30, 2001 compared with $1.6 million for the corresponding period last year, an increase of 31.3%. Deltek Costpoint license fees were $3.8 million for the six months ended June 30, 2001, a decrease of 9.5% for the same period in 2000. Factors discussed in the preceding three-month analysis are applicable to the six-month periods as well.

     Services. Services revenue for the current six-month period increased slightly to $34.1 million from $34.0 million for the same period in 2000 attributed principally to offsetting increases in maintenance and support plan services revenue for all product lines and decreases in consulting service revenue for mainly large scale Deltek Costpoint implementations. Maintenance and support plan services revenue increased by 25.3% to $18.8 million for the six months ended June 30, 2001 compared with $15.0 million for the same period last year. Other service revenues, which includes training, travel reimbursements, user conference and custom programming increased by 3.3% to $3.1 million for the current period from $3.0 million for the six months of 2000. The registration fees for the international user conference held the week of March 25, 2001, amounted to $1.0 million whereas a user conference did not occur during fiscal year 2000. Consultant services revenue decreased by 23.8% to $12.2 million for the six months ended June 30, 2001 compared with $16.0 million for the same period last year. Services revenue comprised 70.6% of the Company’s total revenue for the six months ended June 30, 2001, compared to 71.7% for the same period in 2000. Factors discussed in the preceding three-month analysis are applicable to the six-month periods as well.

     Third-Party Equipment and Software. Revenue from third-party equipment and software for the six months ended June 30, 2001 increased by 53.8% to $2.0 million from $1.3 million for the six months ended June 30, 2000. These revenues comprised 4.1% and 2.8% of total revenues for the six months ended June 30, 2001 and 2000, respectively.

     Cost of Software License Fees. Cost of software license fees for the comparable six-month periods ended June 30 were $2.0 million, or 16.4% of related software revenue, and $1.6 million, or 13.6% of related revenue, respectively. The increase was due to royalty expenses associated with new products. In addition, amortization expense related to new products released late in the first quarter of 2000 increased for this period since a full 6 months of amortization expense was recognized in 2001. Royalties associated with certain software products currently under development by joint business arrangements and charges associated with software products and technologies acquired from various third party vendors may cause the cost of software license fees as a percentage of software license fees revenue to increase in future periods.

     Cost of Services. Cost of services for the current six-month period increased by 1.1% to $18.3 million, from $18.1 million for the same period in 2000. The cost of services gross margin of 46.2% for the current period declined from 46.7% for the prior six-month period due to a decrease in consultant utilization rates related to the decline in demand for Deltek Costpoint implementations.

     Cost of Third-Party Equipment and Software. Costs for third-party equipment and software increased by 50.0% to $1.8 million from $1.2 million for each of the comparable six-month periods ended June 30, 2001 and 2000. Costs decreased as a percentage of related revenue to 89.4% and 90.3% for the six months ended June 30, 2001 and 2000, respectively.

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Software Development. Software development costs for the six months ended June 30, 2001 were $9.8 million, an increase of 12.6% from the same period in 2000 due primarily to a reduction in capitalized costs for software development and increased wages. Software development costs represented 20.3% and 18.3% of total revenues for the six months ended June 30, 2001 and 2000, respectively.

     Sales and Marketing. Sales and marketing expenses for the six months ended June 30, increased to $8.1 million compared with $6.1 million for the same period in 2000. Sales and marketing expenses represented 16.8% and 12.9% of the Company’s total revenues for the comparable six months of 2001 and 2000, respectively. Factors discussed in the preceding three-month analysis are applicable to the six-month periods as well.

     General and Administrative. General and administrative expenses for the six months ended June 30, 2001 increased by 17.6% to $4.0 million from $3.4 million for the same period in 2000. This increase was due to additional professional fees and labor costs. General and administrative expenses represented 8.3% of the Company’s total revenue for the six months ended June 30, 2001, compared to 7.2% for the same period in 2000.

     Amortization of Goodwill and Intangibles. Amortization expense of $2.0 million and $601 thousand for the comparable six-month periods, respectively, were related to SalesKit Software Corporation, A/E Management, Inc. and Semaphore, Inc., acquired in April 1998, April 2001 and August 2001, respectively.

     Other Income. Interest income declined to $266 thousand for the six months ended June 30, 2001, a decrease of 51.0% from $543 thousand for the same period in 2000 attributed to a decline in average invested funds used for acquisitions and share repurchases.

     Income Tax Provision. The Company’s effective tax rate for the six months ended June 30, 2001 was 56.5% compared with 38.7% for the six months ended June 30, 2000. The increase in the effective tax rate is primarily due to the increase in non-deductible goodwill related to the acquisition of Semaphore, Inc.

Liquidity and Capital Resources

      The Company’s principal source of funding is cash flow from operating activities. At June 30, 2001, the Company had cash and cash equivalents of $11.8 million, marketable securities of $7.7 million, and total working capital of $19.8 million.

      For the six months ended June 30, 2001, the Company’s net cash provided by operating activities was $6.7 million compared with $7.3 million for the comparable 2000 period. Accounts receivable, net of the allowance for doubtful accounts, were $16.2 million at June 30, 2001, compared to $15.2 million at December 31, 2000. Accounts receivable days sales outstanding (DSO) was 61 at June 30, 2001 compared with 56 at December 31, 2000. While the Company believes that its allowance for doubtful accounts at June 30, 2001, was adequate, there can be no assurance that such allowance will be sufficient to cover receivables that are later determined to be uncollectible.

      Net cash used in investing activities amounted to $4.2 million for the six months ended June 30, 2001 compared with $2.8 million for the comparable 2000 period. Cash used to purchase marketable securities amounted to $2.5 million, while $1.0 million was used to purchase property and equipment, and $692 thousand was used for capitalized software production costs.

      Cash received from financing activities for the six months ended June 30, 2001 consisted of $290 thousand in proceeds from the exercise of stock options and the issuance of stock under the Company’s employee stock purchase plan compared with $475 thousand for the six months of 2000.

      In mid July, the Company reduced its labor force by approximately 50 positions or 8.0% in order to improve margins throughout the organization. The company will incur severance expense of approximately $550,000, which will be recognized in the third quarter. Since the severance packages were 8–12 weeks of pay

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

on average, the reduction in labor expense and resulting operating margin impact will not benefit the financial statements until midway through the fourth quarter of 2001.

      Deltek believes that its current liquidity, together with anticipated cash flow from operations, will satisfy the Company’s anticipated working capital and capital expenditure requirements through the foreseeable future. However, depending on its rate of growth, profitability and other factors, some of which are not in the Company’s control, the Company believes additional financing may be required to meet its working capital requirements or capital expenditure needs, including acquisitions, in the future. Deltek may consider additional appropriate acquisitions should such opportunities present themselves. There can be no assurance that additional financing will be available when required or, if available, that any such financing will be on terms satisfactory to the Company.

Factors That May Affect Future Results

      Several factors may require the Company to defer recognition of license revenue for a significant period of time after entering into a license agreement. These factors include:

•  Whether the license agreement relates partially or entirely to then unavailable software products;

•  Whether enterprise transactions include both currently deliverable software products and software products that are under development or other undeliverable elements;

•  Whether customer demands services that include significant modifications, customizations of complex interfaces that could delay product delivery or acceptance;

•  Whether the transaction involves acceptance criteria that may preclude revenue recognition or if there are identified product-related issues, such as known defects; and

•  Whether the transaction involves payment terms or fees that depend on contingencies.

      Because of the factors listed above and other specific requirements under GAAP for software revenue recognition, the Company must have very precise terms in its license agreements in order to recognize revenue when it initially delivers software or performs services. Although the Company has a standard form of license agreement that meets the criteria under GAAP for current revenue recognition on delivered elements, it negotiates and revises these terms and conditions in some transactions. Negotiation of mutual acceptance terms and conditions can extend the sales cycle, and sometimes we do not obtain terms and conditions that permit revenue recognition at the time of delivery or event as work on the project is completed.

     Recent accounting pronouncements could adversely impact our profitability by delaying some revenue recognition into future periods.Over the past several years,the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position of SOP 97-2, “Software Revenue Recognition,” and SOP 98-4, “Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition,” and SOP 98-9, “Modification of SOP 97-2 Software Revenue Recognition with Respect to Certain Transactions.” These standards address software revenue recognition matters primarily from a conceptual level and do not include specific implementation guidance. The Company believes that it is currently in compliance with SOPs 97-2, 98-4, and SOP 98-9. The Company adopted SOP 98-9 on January 1, 2000 and changed certain business policies to meet the requirements of this SOP.

      In December 1999, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”) which explains how the SEC staff believes existing revenue recognition rules should be applied or analogized to for transactions not addressed by existing rules. In addition, in October 2000, the SEC staff issued a Frequently Asked Questions and Answers (“FAQ”) document, which further elaborates on the SEC staff’s views regarding issues addressed in SAB 101. SAB 101 was effective in the fourth quarter of 2000 and did not have a material impact on the Company’s financial position of results of operations.

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The accounting profession continues to discuss certain provisions of SOP No. 97-2 and SAB 101 with the objective of providing additional guidance on potential interpretations. These discussions and the issuance of implementation guidelines and interpretations, once finalized, could lead to unanticipated changes in our current revenue accounting practices, which could cause us to recognize lower revenue. As a result, we may change our business practices significantly in order to continue to recognize a substantial portion of our license revenues. These changes may reduce demand, extend sales cycles, increase administrative costs and otherwise adversely affect the Company.

     We may experience fluctuations in quarterly operating results that may adversely impact the price of our stock.Our results for any quarter are subject to significant variation depending upon a number of factors including the following:

•  the discretionary nature of our customers’ purchase and budget cycles;

•  demand for our products;

•  the size and timing of specific sales;

•  the delay or deferral of customer implementations or revenue recognition;

•  the level of product and price competition that we encounter;

•  the length of our sales cycles;

•  our ability to attract and retain personnel;

•  the timing of new hires;

•  the timing of our new product introductions and product enhancements and of our competitors;

•  the mix of products and services we sell;

•  the activities of and acquisitions by our competitors;

•  the timing of our international user conference;

•  general economic conditions;

•  our ability to develop and market new software products and enhancements;

•  our ability to control costs; and

•  our ability to collect receivables.

      Our future quarterly operating results from time to time may not meet the expectations of market analysts or investors. In that event, the price of our common stock would likely be materially adversely affected.

     Our operating results, particularly our quarterly results, could be significantly affected by the loss or delay of individual orders as well as changes in revenue recognition rules.Our revenues from license fees are difficult to predict because of the length and variability of our sales cycles (typically three to 18 months). Our operating expenses, on the other hand, are based on anticipated revenue trends. A high percentage of our operating expenses are relatively fixed. To the extent we incur expenses before realizing anticipated revenues, our operating results could be materially adversely affected.

     We may be unable to accurately forecast timing of sales, which may adversely affect our business.We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of all proposals, such as the date when they estimate that a customer will make a purchase decision and the potential dollar amount of the sale. Management aggregates these estimates periodically in order to generate a sales pipeline. Management compares the pipeline at various points in time to look for trends in our business. While this pipeline analysis may provide some guidance to management in business planning and budgeting, these pipeline estimates are necessarily speculative and may not correlate to revenues in a particular quarter or over a longer period of time. A variation in the conversion of the pipeline into contracts or in the pipeline itself could cause us to improperly plan of budget and thereby adversely affect our business or results of operations.

     Internet-enabled products present unique risks. The increased commercial use of the Internet could require substantial modification and customization of our products and the introduction of new products. We

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

may not be able to effectively compete in the Internet-related products and services market. In addition, critical issues concerning the commercial use of the Internet, including security, demand, reliability, cost, ease of use, accessibility, quality of service and potential tax or other government regulation, remain unresolved and may affect the use of the Internet as a medium to support the functionality of our products and distribution of our software. If these critical issues are not favorably resolved, our business, operating results and financial condition could be materially and adversely affected.

     Other Factors. For a discussion of additional factors that may affect future results, see “Factors That May Affect Future Results and Market Price of Stock” in the Company’s Annual Report on Form 10-K which discussion is incorporated herein by reference.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      No material changes since year-end.

PART II — OTHER INFORMATION

ITEM 1 — LEGAL PROCEEDINGS

      The Company is not a party to any legal proceeding that would have a material impact on the Company, its operations or financial results.

ITEM 2 — CHANGES IN SECURITIES AND USE OF PROCEEDS

      (a)-(b)-(c)-(d)  Not applicable.

ITEM 3 — DEFAULTS UPON SENIOR SECURITIES

      None

ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

      On May 18, 2001 the Company held its Annual Meeting of Shareholders. At the meeting, the following actions were taken:

a)  Two Class I Directors, James F. Petersen and Charles W. Stein, were elected to serve for three years or until their successors have been duly elected and shall qualify. The votes cast and withheld for each director were was follows:

	For		Withheld
James F. Petersen		14,405,452		184,034
Charles W. Stein		14,381,424		208,062

b)  The appointment of Arthur Andersen LLP as the Company’s independent auditors for its current fiscal year was ratified with the following vote:

For	Against		Abstain
14,497,924		85,677		5,885

ITEM 5 — OTHER INFORMATION

      None

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DELTEK SYSTEMS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K

      None

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