UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended September 30, 2005
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-18603
INTEGRAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
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| Maryland | | 52-1267968 |
(State or other jurisdiction of incorporation of organization) | | (I.R.S. Employer Identification No.) |
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| 5000 Philadelphia Way, Lanham, MD | | 20706 |
| (Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code: (301) 731-4233
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class
| | | | Name of each exchange on which registered
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of the Common Stock of the Registrant (based upon the average bid and asked prices of the Common Stock as reported by the market makers) held by non-affiliates of the Registrant was $224,832,776.
As of November 4, 2005, 10,675,764 shares of the Common Stock of the Registrant were outstanding.
INDEX
PART 1
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INDEX (CONTINUED)
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PART 1
Company Overview
Integral Systems, Inc. (the “Company”) builds satellite ground systems and equipment for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 205 different satellite missions for communications, science, meteorology, and earth resource applications. The Company has an established domestic and international customer base that includes government and commercial satellite operators, spacecraft and payload manufacturers and aerospace systems integrators.
The Company has developed innovative software products that reduce the cost and minimize the development risk associated with traditional, custom-built systems. The Company believes that it was the first to offer a comprehensive commercial-off-the-shelf (“COTS”) software product line for command and control. As a systems integrator, the Company leverages these products to provide turnkey satellite control facilities that can operate multiple satellites from any manufacturer. These systems offer significant cost savings for customers that have traditionally purchased a separate custom control center for each of their satellites.
Through its wholly owned subsidiaries SAT Corporation (“SAT”) and Newpoint Technologies Inc. (“Newpoint”), the Company offers complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring and control and satellite data processing. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information regarding the acquisition of Newpoint.
In March 2001, the Company formed a wholly owned subsidiary, Integral Systems Europe S.A.S. (“ISI Europe”), with headquarters in Toulouse, France. ISI Europe serves as the focal point for the support of all of Integral’s European business.
Through its wholly owned subsidiary Real Time Logic, Inc. (“RT Logic”), the Company designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range facilities. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information regarding the acquisition of RT Logic.
On October 3, 2005, Lumistar, Inc., a newly-formed subsidiary of RT Logic, acquired substantially all of the assets of Lumistar, LLC. Through this indirect wholly owned subsidiary, the Company provides system level and board level telemetry products. See Note 19 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information regarding the acquisition of the assets of Lumistar, LLC.
In July 2003, the Company acquired the intellectual property rights, inventory, and certain other assets of the former Jackson & Tull Satellite Ground Systems division. The acquisition was an extension of the satellite ground systems business segment and enabled the Company to be a “turnkey” provider of full motion antennas and radio frequency (“RF”) systems used for tracking low earth orbiting satellites and launch vehicles as well as aeronautical telemetry range operations. Effective November 1, 2004, the Company disposed of the intellectual property rights, inventory and certain other assets of its Antenna Systems Division. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information.
Integral Systems, Inc. is a Maryland corporation, ISO 9000 certified, and was incorporated in 1982.
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Industry Background
The space industry can be broken down into the following industry sectors: space infrastructure, surveillance/data collection, communications, emerging applications and support services. Both government and commercial investments fund each of these sectors. Space infrastructure encompasses the development, manufacture, and procurement of hardware and related systems for both space assets (i.e., satellites and payloads) and ground assets (i.e., satellite ground systems). The Company’s business is focused in the ground system component of the infrastructure sector. The U.S. Government makes up the majority of the surveillance/data collection sector of the space industry, making extensive use of satellites to support military operations. The communications sector of the space industry includes revenue generated by satellite systems for commercial telecommunications services and government and military communications. Satellite technology has become critical to supporting many aspects of telecommunications infrastructure, including long-distance telephone, personal communications systems, and private networks. The emerging applications sector of the space industry includes space technologies utilized for new applications such as global positioning systems and remote sensing. Support services for the space industry include technical support, engineering, finance and consulting, which facilitate growth in space-related markets.
The Company estimates that the current worldwide command and control market represents approximately $5 billion in annual revenues. However, the Company also believes that the increasing acceptance of COTS products will eventually lead to substantial price reductions and a subsequent decrease in the size of this market. The Company believes that its COTS software products leave it well positioned to capitalize on this market trend, resulting in an increase in both its revenues and market share.
The Company Solution
The Company offers satellite ground systems products, systems, and services that provide low-cost, efficient and flexible satellite operations systems. The principal characteristics of the Company’s approach are as follows:
Advanced Architecture.Unlike the traditional host-based approach, the Company’s ground systems are fully distributed, consisting of a set of workstations and front-end equipment all communicating via a local area network (“LAN”) backbone. Any software function can be performed on any workstation, eliminating the host computer bottleneck and allowing the processing and network loading to be fine-tuned by reallocation of logical processes to physical hardware. This approach also provides more reliable operations by eliminating single points of failure. The Company’s ground systems equipment is designed to be programmable, allowing a core set of hardware devices to be easily tailored to specific customer functions.
Depth of Functionality.The Company’s core product line, EPOCH IPS (Integrated Product Suite), supports satellite operations through a suite of integrated software products. This includes products for real-time satellite control and monitoring, off-line data trending, orbit analysis and database configuration. The Company’s real-time products perform daily and routine satellite operations, including commanding, telemetry processing and fault detection and correction. The trending package supports sustaining engineering functions, including trending and statistical analysis of data archived by the real-time system. The orbit analysis package performs orbit determination and prediction functions to monitor and control the position of a satellite in space. The database package tailors the performance of the other three packages, which are general in scope, to the specific requirements of each satellite mission. The database package defines the telemetry and command characteristics and the desired orbital elements and tolerances for each satellite.
Mixed Fleet Operations.The Company’s products are compatible with most of the world’s major manufacturers satellite models. This enables the Company to provide a single product solution to operators who own fleets of mixed satellite models. Where previously, these operators would have several different types of ground systems for their fleet, a single, expandable system from the Company will operate the entire fleet. This reduces the end user’s costs for procurement, training, support and spare parts. It also reduces the end user’s incremental costs to add a new satellite to the fleet and provides a safer operations environment due to reduced complexity associated with a single solution.
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Flexibility/Adaptability.A critical element to achieving initial operator acceptance of a new system and facilitating rapid implementation is the ability of the Company’s software to serve the needs of particular satellite systems. All of the Company’s software is database driven, allowing it to support satellite design changes or different series of satellites, without modifying the underlying software. Similarly, the software also supports a wide range of COTS antenna, RF and baseband equipment (including the Company’s own products), allowing the total system to be delivered in the most efficient configuration for each mission. The Company’s ground systems equipment products consolidate a number of functions and are both scalable and programmable to support a wide range of requirements. Finally, the software is supported on the most widely used computer platforms, including Sun Solaris, IBM AIX, and Windows 2000/XP.
Superior Price/Performance.The Company seeks to achieve superior price/performance by providing comprehensive solutions within the budgetary needs of its customers. The Company believes that its COTS software products provide advanced yet cost-effective solutions for satellite ground systems and operators. These COTS software products eliminate the need for expensive development services, thereby substantially reducing the overall cost of a ground system. The Company’s database-driven software allows satellites to be added over time, which permits the initial system acquisition costs to be amortized over years of operations. The Company believes its products exceed industry expectations in functionality, technical sophistication and ease of use.
Company Strategy
The Company is currently a leading provider of satellite command and control systems, providing systems for a wide variety of satellites. The Company intends to extend its leadership and to expand its market share in world command and control solutions for users of all satellite types. Primary elements of the Company’s strategy include:
Technological Leadership.The Company intends to continue to commit substantial resources to further develop the next generation of its off-the-shelf software and programmable hardware products upon which all its delivered systems are built. In addition, because the satellite infrastructure industry is increasingly requiring compliance standards, the Company intends to adhere to existing and future industry standards and participate in the further development of such standards.
Strategic Alliances and Partnerships.In addition to its own development and marketing organization, the Company has and will continue to establish partnerships with select third parties, primarily satellite and hardware manufacturers, to assist the Company in successfully integrating its software products, implementing total solution command and control systems and developing customer relationships.
Integration with Complementary Products.The Company believes that its ability to offer command and control software products that can integrate seamlessly with all satellite types and ground system components is a key competitive advantage. The Company also intends to integrate its software products with complementary products, including visualization tools, scheduling engines and decision support aids in order to maintain its competitive advantage and provide maximum flexibility for its customers.
Sales, Support, Service and Marketing Organizations.The Company currently sells and supports its software and systems through direct sales to satellite operators and systems integrators in North America, Europe and Asia. From its headquarters in Lanham, MD, the company performs worldwide marketing, sales and services, including its direct marketing efforts with U.S. Government organizations to capitalize on the growing acceptance of COTS solutions in the government sphere. The Company’s Colorado Springs office serves as the focal point for the Company’s support of its services, products and operations provided to the U.S. Air Force. Through its wholly owned European subsidiary, ISI Europe headquartered in Toulouse, France, the Company provides sales, marketing, support and engineering services to the European market.
Professional Services Capabilities.The Company believes that providing comprehensive services and a high level of customer support is critical to its ability to maintain its leading position in command and control systems and to expand into new markets. Therefore, the Company intends to expand its professional services offerings in
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areas such as hardware testing, pre- and post-sale software support, quality assurance, project installation management, satellite procedure development, mission unique software development, and training. The Company is ISO 9000 certified to ensure the consistent delivery of high quality products and services.
Products
Most of the Company’s sales involve a combination of COTS software and hardware products together with development services for mission-specific requirements and system integration as summarized below. The Company believes that it is uniquely positioned in the industry to offer full-function ground systems, utilizing products from its RT Logic, Newpoint, SAT, and Lumistar subsidiaries.
Command and Control Software.
EPOCH IPS,the Company’s COTS software products solution for satellite command and control is designed to operate a variety of satellites with a minimum of personnel. EPOCH IPS’s success has placed the Company at the forefront of replacing antiquated satellite control centers with smaller systems that can operate multiple satellites produced by any manufacturer. EPOCH IPS’s open architecture, in combination with a graphical user interface and automated monitoring and control features, allows operators to monitor and control both their satellites and ground systems.
EPOCH IPS features a modern, distributed architecture consisting of a series of servers and user workstations interconnected via an Ethernet LAN. This approach provides better performance than traditional mini-computer based ground systems at a lower cost. The EPOCH Integrated Product Suite includes the following products:
| | • | | EPOCH T&C Server andEPOCH Client, the Company’s real-time satellite data processing and control software products, provide satellite command and control capabilities, including telemetry processing and display, commanding and command verification (“CV”), ground station control, alarm/event processing and data archive. These functions are driven by theEPOCH Database product, allowing the system to support multiple satellites solely through database updates, without modifying the run-time software. This results in lower maintenance and operations costs throughout the lifecycle of the ground system. |
| | • | | OASYS, the Company’s mission-planning software provides full spectrum support for spacecraft orbit determination and control, including measurement set reductions, orbit determination, ephemeris propagation, maneuver planning, and orbit events/reports. OASYS allows the user to manage a single spacecraft or a fleet in any Earth orbit, including low Earth, geosynchronous and Molniya-type orbits. |
| | • | | ABE, the Company’s offline analysis product provides trending and statistical analysis of the information recorded in the real-time EPOCH IPS archives. ABE supports automatic data extraction of key data along with summary-level statistics (i.e., daily and seasonal minimums and maximums), advanced statistical processing techniques (i.e., covariance, convolution, and regression) and graphical data visualization. |
| | • | | Archive Manager, the Company’s archive manager product performs archive data product generation, storage, storage management and retrieval. The Archive Manager is capable of managing on-line storage and retrieval of terabytes of satellite data on RAID and NAS storage units, providing an efficient low cost storage capability. Data compression is utilized to provide additional value to the product. |
Signal Monitoring.
The Company’s wholly owned subsidiary SAT offers a range of software products and turnkey systems for communications signal monitoring, includingMONICS, a family of scalable products from single site to fully networked multi site systems for satellite transponder monitoring and interference detection,SAT-DSA, a stand
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alone interference detection and analysis tool for satellite transponder monitoring andSIGMON, a turnkey system for detecting terrestrial communications interference.
Equipment Monitoring and Control.
The Company’s wholly owned subsidiary Newpoint offers an integrated suite of products targeted at commercial users, including communication satellite operators, communication satellite users, and general-purpose telecommunications companies. Newpoint has two flagship products: (1) COMPASS, which provides distributed monitoring and control of networked communications systems, and (2) MERCURY, a rack-mountable smart box that provides monitoring and control of local network nodes and their associated ground equipment. Newpoint also offers a number of add-ons to their core products, including Stratus, which provides carrier management for satellite transponder operations, and Eclipse, a tool for setting up and reconfiguring the communications traffic on satellite transponders.
Telemetry, Command and Range Processing.
The Company’s wholly owned subsidiary RT Logic offers a comprehensive set of products for satellite ground systems. The product line incorporates programmable hardware modules and common software architecture. The suite ofTELEMETRIX products support telemetry processing, commanding, ranging, and remote site interfaces for a variety of applications, including tracking stations, control centers, spacecraft and payload integration, and launch range operations. The TELEMETRIX 501, 508, and 500GT products are used in satellite control centers to process the satellite telemetry and command links. The TELEMETRIX Frequency Conversion System and TELEMETRIX 70/70 perform the RF, intermediate frequency (“IF”), and baseband processing at ground antenna sites.
The Company’s indirect wholly owned subsidiary Lumistar offers a wide selection of products that process telemetry down-links for the flight, test, airborne and satellite ground station markets. These include board-level and system-level products for frequency conversion, receiving, diversity combination, modulation/demodulation, bit/frame synchronization, simulation and test transmitters. Lumistar also has an extensive software selection from board-level drivers to system-level control of device parameters allowing for the efficient integration of the Company’s products into larger applications.
Development Services and Systems Integration
The Company provides services to support mission-specific requirements for both government and commercial customers. Most of the Company’s ground system contracts have a service component. Depending on the application, the services may include development of software applications to interface to and augment the COTS software products, integration of third-party hardware and software, and/or custom software development. The Company also provides post-delivery warranty and maintenance service for most of its turnkey systems. The Company believes that its expertise and experience in satellite systems and operations, computer software and hardware, engineering/mathematical analysis and end-user applications allow it to provide ground systems that exceed traditional expectations on system performance, cost, and implementation schedule. The Company’s experience, together with its innovative COTS software products and software tools, reduce the risks and lead time associated with ground systems development.
Customers
In general, there are four major applications for satellites: communications, military applications, remote sensing and scientific research. The Company has customers in each of these areas. The Company believes that the combination of its proven COTS software products and its strength as a systems integrator has positioned it to serve as an end-to-end provider of total solutions for all of these applications.
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Commercial Communications Satellites.
The Company provides satellite command and control products for a variety of communications satellites. One of the principal advantages that the Company’s products offer in the commercial sector is the ability to operate fleets of satellites from multiple vendors. This capability allows operators to reduce costs by consolidating their control centers and use a single software package to operate their satellite fleet. The Company also provides its payload monitoring systems and software to satellite operators for monitoring quality of service and identification of interfering signals. The Company’s ground equipment monitor and control software is also used by satellite operators to control the ground equipment in the control center and remote equipment sites.
The Company’s products are currently flying communications satellites from most of the major satellite manufacturers, including Boeing, Lockheed Martin, Space Systems Loral, Orbital Sciences, EADS, and Alcatel. The Company’s customers include NewSkies, Echostar, GE Americom, Loral Skynet, Shin Satellite, Binariang Satellite Systems, Asiasat, SatMex, Orbital Sciences, PanAmSat, Cable & Wireless Optus, and ChinaSat. All of these operators have purchased the Company’s products to operate their fleets of geosynchronous Earth orbit (“GEO”) communications satellites.
The Company is also the leading provider of command and control products for U.S. military communications satellites.
Military Applications.
The Company provides ground systems software and equipment for multiple U.S. Department of Defense (“DoD”) programs. The Company’s products are used in a majority of the Air Force and Navy satellite control systems. The Company’s customers include multiple aerospace prime contractors such as Lockheed-Martin, Boeing, Honeywell, Northrop Grumman and Raytheon. The Company also sells directly to the DoD. The U.S. Air Force is the company’s largest single customer, providing 57% of the Company’s 2005consolidated revenues. The Company is the prime contractor for the CCS-C (Command and Control Center – Consolidated) Contract to upgrade the Air Force’s satellite command and control system for the DSCS and Milstar satellites. In addition, the Company is the prime contractor on a contract with Space and Missiles System Center (SMC), on behalf of U.S. Air Force, Air Force Space Command, for the first developmental step (Spiral 1) of the RAIDRS (Rapid Attack Identification Detection Reporting System) program. The Company is also replacing the signal processing and antenna control systems at all of the Air Force Satellite Control Network (AFSCN) sites.
The Company’s products support the processing of telemetry, commanding, and ranging data, performing generation and reception of the RF links to and from the on-orbit satellites. In addition, the Company’s products are used to receive telemetry data from the space lift ranges during launch of military satellites and to test satellites at the place of manufacture.
Remote Sensing and Meteorology.
The Company builds command and control systems as well as payload and image data processing systems for meteorological satellites. Since its inception, the Company has provided ground systems for the U.S. National Oceanic and Atmospheric Administration (“NOAA”), including both their Geostationary Operational Environmental Satellite (“GOES”) Program and the Television Infrared Observational Satellite (“TIROS”) programs. The Company’s systems support mission operations, instrument data processing, simulation and flight software validation. The Company also built the complete command and control system for the U.S. Air Force Defense Meteorological Satellite Program (“DMSP”), whose operations were transitioned to civilian control under NOAA’s aegis. Since 1982, the Company has also been under contract to provide the DMSP program with satellite simulators used for training, ground system checkout and flight software analysis.
High-performance ground systems are required to support Earth resource satellites that provide military and civilian customers with accurate image data. The Company has provided such command and control subsystems to Space Imaging/EOSAT and other operators.
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Scientific Research.
The Company has supported a variety of diverse and complex scientific missions. The Company has supported more than a dozen missions for the National Aeronautics and Space Administration (“NASA”), including the Small Explorer (“SMEX”) missions, International Solar-Terrestrial Physics (“ISTP”) missions, X-ray Timing Explorer (“XTE”) and Tropical Rainfall Measuring Mission (“TRMM”). Projects range from the development of distributed command and control systems to validation of complex embedded flight software.
The Company was selected by the Johns Hopkins University Applied Physics Laboratory (“APL”) to support the first NASA Discovery Mission, the Near Earth Asteroid Rendezvous Program (“NEAR”). NEAR was the first in a series of low-cost, small-planet exploratory missions designed to gather data about asteroids in the solar system. APL subsequently chose the Company to provide its command and control products for the Timed, Contour, Stereo and Messenger and Horizon science satellites. The Company’s EPOCH IPS products form the core of the mission’s command and control ground system and also support the spacecraft integration and test (“I&T”).
The National Space Program Office (“NSPO”) for the Republic of China selected the Company to provide the complete multi-mission command and control system for their ROCSAT series of satellites. The Company also supports small satellite missions in the United States such as Orbital Sciences Corporation’s SeaStar and Microlab programs.
Marketing
The Company relies upon senior corporate management, project managers and senior technical staff for its marketing program, including the development and execution of marketing plans, proposal presentations, and the performance of related tasks. These individuals collect information concerning requirements of current and potential customers in the course of contract performance and formal and informal briefings, from published literature and through participation in professional and industry organizations. Senior management evaluates this information, identifies potential business opportunities and coordinates proposal efforts. The primary source of business in the Company’s existing markets is by referral from existing customers. Additionally, the Company advertises periodically inSpace News and other industry publications as well as delivering papers and exhibiting at industry conferences.
The Company seeks business believed to be of long-term benefit based on considerations such as technical sophistication, favorable market positioning and potential product spin-offs. One of the Company’s primary marketing strategies is to anticipate and understand the changing needs of its customers and then to be prepared to meet those needs as they arise in new programs or in new program functions. This approach to marketing is mirrored in the Company’s products which are highly adaptable to growth and change in the requirements of each user.
U.S. Government Contracts
Revenues from U.S. Government contracts are derived from a combination of contracts with the U.S. Government and subcontracts with other companies that have prime contracts with the U.S. Government. For fiscal years 2005, 2004 and 2003 approximately 77%, 76% and 76%, respectively, of the Company’s revenues were derived from contracts or subcontracts funded by the U.S. Government.
The U.S. Air Force represented 57%, 55% and 50% of revenues, respectively, for fiscal years 2005, 2004 and 2003. The Company expects that at least 50% of its revenue for fiscal year 2006 will be derived from Air Force contracts and subcontracts. The loss of any one of these Air Force contracts could significantly affect the Company’s performance. Similarly, the expiration, or termination for convenience, of any major contract could significantly affect the Company’s performance if not renewed or replaced by contracts of similar value. It is estimated that the single largest Air Force contract will represent approximately 20% of the Company’s fiscal year 2006 revenue. Under this contract, the Company is leading a team of subcontractors to produce a modern, consolidated command
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and control infrastructure for the military’s fleet of communication satellites, including Milstar, DSCS III, Advanced EHF and Wideband Gapfiller. It is also estimated that a contract with Space and Missiles System Center (SMC), on behalf of U.S. Air Force, Air Force Space Command, will represent approximately 13% of the Company’s fiscal year 2006 revenue. The Company is again leading a team of subcontractors on this program. This program is intended for global satellite communications interference detection, characterization, event reporting, and mission impact assessment for U.S. owned, operated, or used space systems through delivery of a suite of RF interference sensors, geolocation equipment, and centralized control.
NOAA, another U.S. Government agency, represented 8%, 15% and 19% of revenues, respectively, for fiscal years 2005, 2004 and 2003. The Company expects that approximately 5% of its revenue for fiscal year 2006 will be derived from NOAA contracts. See Note 3 of the notes to the Consolidated Financial Statements included elsewhere herein for information pertaining to the NOAA contracts.
U.S. Government contracts are awarded by formal advertising or procurement by negotiation. Negotiated procurements may, but do not necessarily, involve the solicitation of competitive proposals. If competitive proposals are solicited, the U.S. Government selects the proposal most advantageous to it and then conducts negotiations with the selected bidder.
Many of the U.S. Government programs in which the Company participates as a contractor or subcontractor extend for several years but are funded only on an annual basis. Accordingly, the Company’s contracts and subcontracts are subject to termination, reduction, or modification in the event of changes in the government’s requirements or budgetary constraints. Additionally, when the Company participates in a project as a subcontractor, it is subject to the risk that the prime contractor may fail or be unable to perform the prime contract.
All of the Company’s U.S. Government contracts and subcontracts are also subject to termination for “convenience,” which means termination without cause. Should a contract be so terminated, the Company would be reimbursed for allowable costs to the date of termination and would be paid a proportionate amount of the stipulated profits or fees attributable to the work actually performed.
The Company’s books and records are subject to audit by the Defense Contract Audit Agency (“DCAA”). Such audits can result in adjustments to contract costs and fees. Although the Company thus far has not been required to make any material audit adjustments, the possibility that such adjustments will be required always exists. Management is of the opinion that any such audit adjustments would not have a material adverse effect on the financial position or results of operations of the Company. The Company has been audited by the DCAA through its fiscal year ended September 30, 2002, and RT Logic has been audited by the DCAA through March 31, 2000. Newpoint, SAT, ISI Europe and Lumistar are not currently subject to audits by the DCAA.
The Company’s contracts and subcontracts with U.S. Government agencies are subject to competition and awarded on the basis of technical merit, personnel qualifications, experience and price. The Company’s business, financial condition, and results of operations could be materially affected by changes in procurement policies, a reduction in funds available for the services provided by it and other risks generally associated with federal government contracts. New government contract awards also are subject to protest by competitors at the time of award that can result in the re-opening of the competition or evaluation process, or the award of a contract to a competitor. The Company considers such bid protests to be a customary element in the process of procuring government contracts.
In addition to the right to terminate, U.S. Government contracts are conditioned upon the continuing availability of Congressional appropriations and are typically subject to modification or termination in the event of changes in funding. Congress usually appropriates funds on a fiscal year basis even though contract performance may take several years. Consequently, at the outset of a major program, the contract is usually incrementally funded, and additional funds are normally committed to the contract by the procuring agency as Congress makes appropriations for future fiscal years. In addition, contractors often experience revenue uncertainties during the first quarter of the U.S. Government’s fiscal year, which begins October 1, until differences between budget requests and appropriations are resolved. Historically, Congress has funded all current years of the multi-year major program
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contracts for which the Company has served as prime contractor or a subcontractor, although there can be no assurance that this will be the case in the future.
Non-U.S. Government Contracts
The Company also has contracts with commercial and international organizations. For fiscal years 2005, 2004 and 2003 approximately 23%, 24% and 24%, respectively, of the Company’s revenues were derived from non-U.S. Government contracts. These contracts are typically with commercial satellite operators, satellite manufacturers, aerospace systems integrators and foreign governments.
Some of the Company’s non-U.S. Government contracts are with international organizations. For fiscal years 2005, 2004 and 2003 approximately 11 %, 13% and 13%, respectively, of the Company’s revenues were derived from international organizations. Revenues from foreign sources are discussed in Note 1 of the Notes to the Financial Statements included elsewhere herein. Operations in numerous countries outside the United States carry substantial managerial, operational, legal, and political uncertainties. These operations are subject to changes in government regulations and telecommunications standards, tariffs or taxes, and other trade barriers. In addition, the Company’s agreements relating to foreign operations may be enforceable only in foreign jurisdictions so that it may be difficult for the Company to enforce its rights.
The Company currently has three contracts that are subject to currency fluctuations in foreign markets. The value of these contracts is not material. However, to mitigate currency fluctuation, the Company periodically uses foreign currency exchange contracts. (See Note 15 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information.) There can be no assurance that the Company will enter into foreign currency exchange contracts to mitigate currency fluctuation in the future.
In addition, various agencies and departments of the U.S. Government regulate the Company’s ability to pursue business opportunities outside the United States. Exports of space-related products, services, and technical information require licenses granted by the U.S. Government. For the Company’s products, services or technical information requiring such a license, the Company does not currently have blanket authorization for their export and cannot assure that it will be able to obtain the necessary licenses or approvals on a per transaction basis.
Most of the Company’s non-U.S. Government contracts are awarded competitively and are performed on a fixed price basis. Typically, these contracts are for turnkey systems that are delivered by the Company in six to eighteen months. Payment is most often based on delivery milestones established in the Company’s contract. In addition, the contracts may include a system warranty period that lasts one to two years. The Company also offers extended support for the system on a fixed-price or time and material (“T&M”) basis.
For certain of the Company’s non-U.S. Government contracts, the Company often has terms in its contracts under which the customer can enforce performance of the Company or seek damages in case the Company does not perform as agreed to in the contract. Contracts may require the Company to post a performance bond, establish an irrevocable letter of credit, or agree to pay liquidated damages in the event of late delivery. In addition, although a significant portion of the Company’s revenues are generated from the sale of its services and products in commercial markets, the Company cannot assure that it will continue to compete successfully in these markets. Many of the Company’s commercial contracts are for a fixed price. This subjects the Company to substantial risks relating to unexpected cost increases and other factors outside of its control. In addition, the Company may fail to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract.
Competition
Commercial Contracts:The Company believes it is one of four companies in the United States that comprise serious competition for the development of commercial satellite ground systems. The Company considers itself to be the leader in this field, since unlike its competitors its systems currently are installed and operational in almost every commercial satellite operator’s facility in the world. The Company expects its leadership position to
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continue since the Company’s installed base of systems and software will be compatible with any new satellites that these operators procurel. None of the Company’s competitors can offer this range of compatibility. The Company’s satellite command and control products are compatible with all of the world’s production satellite types providing a competitive edge to the Company.
Military Contracts:For military programs, the Company competes with numerous companies for satellite command and control contracts, including Lockheed Martin Corporation, Raytheon Company, L3 and Northrop Grumman. Many of these competitors are significantly larger and have greater financial resources than the Company. In addition, some of these competitors are divisions or subsidiaries of large, diversified companies that have access to the financial resources of their parent companies. Some of our competitors are also current or potential customers, teammates, or subcontractors. In addition, several smaller companies have specialized capabilities in command and control image processing. There are also a number of smaller companies which compete with our subsidiaries in the areas of signal monitoring, network monitoring, and telemetry processing.
The Company’s products also face competition from certain government off-the-shelf, or “GOTS,” products for satellite command and control. In its other business areas, ground equipment and systems integration, the Company competes against systems integrators and product manufacturers.
The Company believes that the principal competitive factors in the businesses in which it operates are technical understanding, management capability, past contract performance, personnel qualifications and price.
The Company principally obtains contracts and subcontracts through competitive procurements offered by the U.S. Government or commercial enterprises. Because of its size, the Company often joins with a larger company in pursuing major procurements. It is not unusual for the Company to compete with a company for a contract while simultaneously joining with the same company in pursuit of another contract.
It is not possible to predict how the Company’s competitive position may be affected by changing economic or competitive conditions, customer requirements, or technological developments.
Proprietary Rights
The Company regards its products as proprietary trade secrets and confidential information. The Company has made the strategic decision after discussion with intellectual property counsel not to seek patent protection for its software, hardware, or systems. None of the Company’s software, hardware or systems are patented. The Company relies on a combination of common law copyright and trade secret laws, third-party nondisclosure agreements and other industry standard methods for protecting ownership of its proprietary software, hardware, and systems. The Company generally registers its trademarks with respect to new products and new versions of its software as they are developed. There can be no assurance, however, that in spite of these precautions, an unauthorized third party will not obtain and use information that the Company considers proprietary. In addition, the laws of some foreign countries do not protect the Company’s proprietary rights to the same extent as the laws of the United States. Moreover, the Company does not have confidentiality agreements with any of its employees hired before mid-December 2000. There can be no assurance that the mechanisms used by the Company to protect its software will be adequate or that the Company’s competitors will not independently develop software products that are substantially equivalent or superior to the Company’s products. The Company believes that it has all necessary rights to market its products, although there can be no assurance third parties will not assert infringement claims in the future.
The Company believes that, due to the nature of its products, the skill of personnel, knowledge and experience of management and familiarity with the operation of the Company’s products are more important in maintaining a leadership position in the industry than the protection of intellectual property rights.
10
Employees
The Company believes that its employees and their knowledge and capabilities are a major asset. The Company has been successful in attracting and retaining employees skilled in its core business competencies. The Company intends to continue to employ highly skilled personnel, as well as personnel knowledgeable concerning the needs and operations of its major customers.
As of September 30, 2005, the Company had approximately 400 employees, including employees of ISI Europe in Toulouse, France, SAT Corporation in Sunnyvale, California, Newpoint Technologies in Salem, New Hampshire and RT Logic in Colorado Springs and Denver, Colorado. Approximately 67% of the Company’s employees are full-time professionals in engineering related disciplines.
The Company believes that its relations with its employees are good. None of the Company’s employees are covered by collective bargaining agreements.
Industry Segments
Effective October 1, 2004, the Company reorganized its operations into four reportable segments. The primary purpose of the reorganization was to place the Company’s commercially oriented operations under common marketing and management leadership and to more efficiently sell and promote its products to common customers. The four segments are:
| | • | | Ground Systems - Government |
| | • | | Ground Systems - Commercial |
| | • | | Space Communications Systems |
The Ground Systems – Government segment provides ground systems products and services to the U.S. Government. It is currently the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force and NOAA.
The Ground Systems – Commercial segment provides ground systems products and services to commercial enterprises and international governments and organizations. It consists of the Company’s core command and control business for commercial applications and three of the Company’s wholly owned subsidiaries as follows:
| | • | | SAT and Newpoint, acquired by the Company in August 2000 and January 2002, respectively, offer complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring and control and satellite data processing. |
| | • | | ISI Europe, the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business. |
The Space Communications Systems segment, consisting of the Company’s wholly owned subsidiary RT Logic, designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range operations.
The Corporate segment is the Company’s “all other” segment. It includes the Company’s Product Division, which is responsible for the Company’s core command and control product line (EPOCH IPS); business areas in the development stage and businesses being disbanded (the Company’s Antenna Division, the Company’s Skylight product, and the Company’s Integration and Test (I&T) Division). The Product Division licenses the Company’s EPOCH IPS product line to other operating segments and to third party customers. It is also the segment responsible for EPOCH IPS maintenance and support revenue and expenses.
11
In connection with the change by the Company of its reportable segments effective as of October 1, 2004, the Company has restated the corresponding items of segment information for the earlier periods addressed herein and in the Consolidated Financial Statements included elsewhere herein.
See Note 17 of the notes to the Consolidated Financial Statements included elsewhere herein for financial information regarding these segments.
Available Information
The Company’s web site address is www.integ.com.
The Company makes available free of charge on or through its internet web site its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such material, or furnishes it to, the Commission.
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Operations of the Company and its subsidiaries are currently conducted in leased properties. On August 25, 2005, RT Logic Tract TT2, LLC, a newly-formed and wholly owned subsidiary of RT Logic, closed on the purchase of 9.99 acres of real property in Colorado Springs, Colorado for a purchase price of approximately $2.3 million, pursuant to a Purchase Agreement with Northgate Properties, LLC. RT Logic is constructing its new headquarters on this property. The Company believes that it has adequate insurance coverage to protect its properties and assets. The following table describes the location, square footage and lease expiration of the Company’s existing facilities:
| | | | | | |
LOCATION
| | SIZE
(Square Footage)
| | EXPIRATION DATE
| | RELATED BUSINESS SEGMENT
|
Integral Systems, Inc. 5000/5200 Philadelphia Way Lanham, MD 20706 | | 83,974 | | October 31, 2015 | | Ground Systems – Government segment, Ground Systems Commercial segment, and Corporate segment |
| | | |
Integral Systems, Inc. 980 Technology Court Colorado Springs, CO 80915 | | 33,190 | | May 31, 2010 | | Ground Systems – Government segment |
| | | |
Integral Systems, Europe S.A.S. Buroparc III Voie 2 31675 Labege Cedex Toulouse France | | 4,532 | | November 30, 2013 | | Ground Systems – Commercial segment |
| | | |
Integral Systems Europe S.A.S. High Tech Buro C Voie 2 31677 Labege Cedex Toulouse, France | | 1,698 | | September 14, 2006 | | Ground Systems – Commercial segment |
| | | |
SAT Corporation 931 Benecia Avenue Sunnyvale, CA 94085 | | 10,000 | | November 30, 2009 | | Ground Systems – Commercial segment |
| | | |
Newpoint Technologies, Inc. 8B Industrial Way Salem, NH 03079 | | 4,290 | | September 30, 2006 | | Ground Systems – Commercial segment |
| | | |
RT Logic, Inc. 1042 Elkton Drive Colorado Springs, CO 80907 | | 24,058 | | December 31, 2006 | | Space Communications Systems segment |
| | | |
RT Logic, Inc. 975 Elkton Drive Colorado Springs, CO 80907 | | 4,605 | | December 31, 2006 | | Space Communications Systems segment |
| | | |
RT Logic, Inc. 8591 Prairie Trail Drive Englewood, CO 80112 | | 11,750 | | April 30, 2009 | | Space Communications Systems segment |
| | | |
TOTAL LEASED SPACE | | 178,097 | | | | |
The Company is from time to time involved in litigation incidental to the conduct of its business. The Company is not currently a party to any lawsuit or proceeding which, in the opinion of management, would be likely to have a material adverse effect on the Company’s business, financial condition or results of operations.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
No matters were submitted to our stockholders during the fourth quarter of the fiscal year ended September 30, 2005.
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PART II
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Company’s common stock is traded on the NASDAQ National Market under the symbol “ISYS.” The following table sets forth for the quarters indicated the high and low sales price of the Company’s common stock and the cash dividends paid per share of common stock.
| | | | | | | | | |
| | | High
| | Low
| | Dividend
Per Share
|
2005 Fiscal Year | | | | | | | | | |
Fourth Quarter | | $ | 24.09 | | $ | 19.25 | | $ | 0.04 |
Third Quarter | | $ | 23.73 | | $ | 20.01 | | $ | 0.04 |
Second Quarter | | $ | 24.70 | | $ | 17.25 | | $ | 0.04 |
First Quarter | | $ | 20.73 | | $ | 18.01 | | $ | 0.04 |
| | | |
2004 Fiscal Year | | | | | | | | | |
Fourth Quarter | | $ | 19.65 | | $ | 15.35 | | $ | 0.03 |
Third Quarter | | $ | 19.25 | | $ | 15.29 | | $ | 0.03 |
Second Quarter | | $ | 22.12 | | $ | 17.15 | | $ | 0.03 |
First Quarter | | $ | 22.00 | | $ | 17.69 | | $ | 0.03 |
As of November 4, 2005, there were approximately 2,000 holders of record or beneficiaries of the Company’s common stock.
Prior to fiscal year 2004, the Company had not paid any cash dividends. On November 30, 2005 the Company’s Board of Directors declared a quarterly cash dividend of five cents per share. The dividend will be paid on or about January 4, 2006 to shareholders of record as of December 19, 2005 The payment of future dividends, if any, will be determined in light of any applicable contractual restrictions limiting the Company’s ability to pay dividends, the Company’s earnings, financial condition, capital requirements and other factors deemed relevant by the Board of Directors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”
During the fourth quarter of fiscal year 2005, the Company did not reacquire any shares of its stock.
The information required by this item regarding equity compensation plans is set forth in Item 12 of this Annual Report on Form 10-K.
| ITEM 6. | SELECTED FINANCIAL DATA |
The following table presents selected consolidated financial data of the Company for the fiscal years ended September 30, 2005, 2004, 2003, 2002 and 2001. The financial data for the fiscal year ended September 30, 2001 has been derived from the financial statements of the Company, which have been audited, by Rubino & McGeehin, Chartered, independent registered public accounting firm. The financial data for the fiscal years ended September 30, 2003 and 2002 has been derived from the financial statements of the Company, which have been audited by Ernst & Young LLP, independent registered public accounting firm. The financial data for the fiscal year ended September 30, 2005 and 2004 has been derived from the financial statements of the Company, which have been audited by Grant Thornton LLP, independent registered public accounting firm, as set forth in the financial statements and notes thereto presented elsewhere herein. The following information should be read in conjunction with the Company’s financial statements and notes thereto presented elsewhere herein. See “Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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| | | | | | | | | | | | | | | |
| | | Years Ended September 30,
|
| | | 2005
| | 2004
| | 20032
| | 2002
| | 2001
|
| | | (in thousands, except for per share data) |
Statement of Operations Data: | | | | | | | | | | | | | | | |
Revenue | | $ | 97,725 | | $ | 90,311 | | $ | 82,585 | | $ | 50,923 | | $ | 40,532 |
Gross margin | | | 29,713 | | | 30,526 | | | 27,210 | | | 13,291 | | | 11,826 |
Income from operations | | | 9,824 | | | 10,351 | | | 8,802 | | | 1,817 | | | 3,457 |
Income from continuing operations | | | 6,301 | | | 6,761 | | | 5,019 | | | 2,623 | | | 4,011 |
Net income | | $ | 6,301 | | $ | 6,761 | | $ | 5,019 | | $ | 2,623 | | $ | 4,011 |
Cash dividends declared per common share | | $ | 0.16 | | $ | 0.12 | | | — | | | — | | | — |
Income from continuing operations per common and equivalent share—basic | | $ | 0.61 | | $ | 0.68 | | $ | 0.52 | | $ | 0.29 | | $ | 0.42 |
Income from continuing operations per common and equivalent share—diluted | | $ | 0.60 | | $ | 0.67 | | $ | 0.51 | | $ | 0.28 | | $ | 0.41 |
Net income per common and equivalent share—basic | | $ | 0.61 | | $ | 0.68 | | $ | 0.52 | | $ | 0.29 | | $ | 0.42 |
Net income per common and equivalent share—diluted | | $ | 0.60 | | $ | 0.67 | | $ | 0.51 | | $ | 0.28 | | $ | 0.41 |
Weighted average common and equivalent shares outstanding—basic1 | | | 10,282 | | | 9,895 | | | 9,713 | | | 9,175 | | | 9,462 |
Weighted average common and equivalent shares outstanding—diluted1 | | | 10,534 | | | 10,150 | | | 9,860 | | | 9,233 | | | 9,673 |
Balance Sheet Data: | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 24,775 | | $ | 18,199 | | $ | 22,527 | | $ | 16,064 | | $ | 2,380 |
Working capital | | | 70,339 | | | 64,278 | | | 60,715 | | | 71,164 | | | 71,427 |
Total assets | | | 149,196 | | | 132,466 | | | 122,793 | | | 96,617 | | | 90,413 |
Long-term obligations, net of current | | | 126 | | | 1,453 | | | 2,468 | | | 2,540 | | | 2,005 |
Stockholders’ equity | | | 120,686 | | | 105,339 | | | 95,629 | | | 82,256 | | | 78,177 |
| 1 | For all periods presented, the difference between income and net income per common share-basic and income and net income per common share-diluted relates to the effect of dilutive securities, namely employee stock options, and the shares relating to contingent consideration payable to former RT Logic shareholders in connection with the acquisition of RT Logic. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein. |
| 2 | During fiscal year 2003, the Company completed the acquisition of RT Logic as discussed further in Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein. |
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
The Company builds satellite ground systems for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 205 different satellite missions for communications, science, meteorology, and earth resource applications. The Company has an established domestic and international customer base that includes government and commercial satellite operators, spacecraft and payload manufacturers, and aerospace systems integrators.
The Company has developed innovative software products that reduce the cost and minimize the development risk associated with traditional custom-built systems. The Company believes that it was the first to offer a comprehensive COTS software product line for command and control. As a systems integrator, the Company leverages these products to provide turnkey satellite control facilities that can operate multiple satellites from most manufacturers. These systems offer significant cost savings for customers that have traditionally purchased a separate custom control center for each of their satellites.
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Through its wholly owned subsidiary SAT, acquired in August 2000, the Company also offers turnkey systems and software for satellite and terrestrial communications signal monitoring.
In March 2001, the Company formed a wholly owned subsidiary, ISI Europe, with headquarters in Toulouse, France. ISI Europe serves as the focal point for the support of all of Integral’s European business.
On January 30, 2002, the Company acquired Newpoint. Newpoint provides equipment monitoring and control software to satellite operators and the telecommunications industry.
In October 2002, the Company acquired RT Logic. RT Logic manufactures satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories, and range facilities.
In July 2003, the Company acquired the intellectual property rights, inventory and certain other assets of the former Jackson & Tull Satellite Ground Systems division. The acquisition was an extension of the satellite ground systems business segment and enabled the Company to be a “turnkey” provider of full motion antennas and RF systems used for tracking low earth orbiting satellites and launch vehicles as well as aeronautical telemetry range operations.
Effective November 1, 2004, the Company disposed of the intellectual property rights, inventory and certain other assets of Antenna Systems division to LJT & Associates, Inc. of Montgomery, Alabama (LJT). The disposition was effective November 1, 2004. As consideration, LJT agreed to pay the Company $215,000 and executed a promissory note requiring payment of that sum in eight equal installments of $26,875 due on July 1 and January 1 beginning on July 1, 2005. As additional consideration, LJT agreed to make future contingent payments to the Company, in certain circumstances, for the period beginning November 1, 2004 through December 31, 2006. The contingent payments are calculated every December 31 beginning December 31, 2005 based on pretax income as defined in the Asset Purchase Agreement. Under the Asset Purchase Agreement, the Company will continue to fulfill its obligations under existing customer contracts but will look to LJT as a subcontractor to perform the actual work. The Company did not record a material gain or a loss as a result of this transaction.
On October 3, 2005, Lumistar, Inc., a newly-formed subsidiary of RT Logic, acquired substantially all of the assets of Lumistar, LLC. Through this indirect wholly-owned subsidiary, the Company provides system level and board level telemetry products.
Contract Revenue
The Company generates revenue under three types of contracts: fixed price, cost-plus, and time and material (“T&M”) contracts. Under a fixed price contract, the Company is paid a stipulated price for services or products and bears the risk of increased or unexpected costs. Revenue under a fixed price contract is recognized using the percentage of completion method of accounting based on costs incurred in relation to total estimated costs. Under a cost-plus contract, the Company is reimbursed for allowable costs within the contractual terms and conditions and is paid a negotiated fee. The fee may be fixed or based on performance incentives. Revenue recognition under a cost-plus contract is based upon actual costs incurred and a pro rata amount of the negotiated fee. Under a T&M contract, the Company receives fixed hourly rates intended to cover salary costs attributable to work performed on the contract and related overhead expenses, reimbursement for other direct costs and a profit. Revenue is recognized under a T&M contract at the contractual rates as labor hours and direct expenses are incurred. To date, the vast majority of contracts for the purchase of the Company’s COTS software products have been fixed priced in nature, either firm fixed price contracts or T&M contracts with fixed labor rates.
The Company earns revenues from sales of its products and services through contracts that are funded by the U.S. Government as well as commercial and international organizations. The Company may be either a prime contractor directly to the end-user of its products and services or it may act as a subcontractor under a contract with another contractor.
16
The percentages of revenues received by the Company from prime contracts and subcontracts for fiscal years 2005, 2004 and 2003 are as follows:
| | | | | | | | | |
Contract Source
| | 2005
| | | Fiscal Year 2004
| | | 2003
| |
| | | |
Prime Contract | | 59 | % | | 61 | % | | 58 | % |
Subcontract | | 41 | % | | 39 | % | | 42 | % |
For a given contract, the revenue mix may include the Company’s COTS software products, pass-through of third-party hardware and software and services provided by the Company or its subcontractors.
The following table summarizes the percentage of revenues attributable to each contract type for the period indicated:
| | | | | | | | | |
Contract Type
| | 2005
| | | Fiscal Year 2004
| | | 2003
| |
| | | |
Cost-Plus | | 36 | % | | 30 | % | | 25 | % |
Fixed Price | | 57 | % | | 60 | % | | 65 | % |
Time and Materials | | 7 | % | | 10 | % | | 10 | % |
Sale of Software Products
Most of the Company’s contracts include the sale of proprietary software products. Sales of the Company’s software products take many forms. The Company sells (1) software only (a “Software-Only Sale”), (2) software and services together or (3) software, services and hardware together. In addition, depending on a customer’s requirements, the Company may or may not provide post-contract customer support (“PCS”).
The Company’s recognition of revenue for sales of software products depends on customer requirements and the nature of the contracts involved. In accordance with SOP 97-2,Software Revenue Recognition, for a Software-Only Sale, the Company recognizes revenue when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the vendor’s fee is fixed or determinable and collectibility is probable. In situations where software is sold together with services and/or hardware, the Company recognizes software license revenue on a percentage of completion basis.
The Company recognizes PCS revenue on a percentage of completion basis when PCS is part of a broader fixed price contract that includes software and services. Alternatively, when PCS services (i.e., software maintenance and support) are awarded to the Company under a separate maintenance contract, the Company recognizes PCS revenue on a straight-line basis pro rata over the term of the maintenance contract.
During fiscal year 2005, the Company incurred approximately $2.4 million in Research and Development (“R&D”) costs in connection with software and hardware products. The Company incurred approximately $3.7 million in related R&D costs in fiscal year 2004 and $2.7 million in fiscal year 2003.
Backlog
The Company’s estimated backlog is as follows (in thousands):
| | | | | | | | | |
| | | Sept. 30, 2005
| | Sept. 30, 20043
| | Sept. 30, 20033
|
Outstanding Commitments1 | | $ | 47,700 | | $ | 63,200 | | $ | 55,000 |
General Commitments2 | | $ | 196,000 | | | 83,100 | | | 92,200 |
| | |
|
| |
|
| |
|
|
Total | | $ | 243,700 | | $ | 146,300 | | $ | 147,200 |
| | |
|
| |
|
| |
|
|
| (1) | Represents orders that are firm and funded. |
| (2) | Represents principally unexercised options on existing contracts. |
| (3) | Fiscal years 2004 and 2003 have been restated to include certain unfunded contract options not previously counted. |
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The increase in backlog between fiscal 2005 and fiscal 2004 relates primarily to backlog in the Ground Systems-Government segment. The decrease in backlog between fiscal 2004 and fiscal 2003 relates to a decrease in the Ground Systems-Government segment which was partially offset by increased bookings at both Space Communications Systems and the Ground Systems-Commercial segments.
Under outstanding commitments, the Company agrees to provide specific services, frequently over an extended period of time, with continued performance of those services, contingent upon the customer’s decision to exercise options on an existing contract.
General commitments consist of contract options and sole source business that management believes likely to be exercised or awarded in connection with existing contracts. Contract options are the Company’s contractual agreement to perform specifically defined services only in the event the customer thereafter requests the Company to do so. Sole source business refers to contract work which the Company reasonably expects to be awarded based on its unique expertise in a specific area or because it has previously done all such work in that area for the customer or prime contractor who will award the contract. The Company estimates that 30% of backlog as of September 30, 2005 will be completed during fiscal year 2006. Estimated backlog includes contract options through September 30, 2011 including general commitments.
Many of the Company’s contracts are multi-year contracts and contracts with option years, and portions of these contracts are carried forward from one year to the next as part of the Company’s contract backlog. The Company’s total contract backlog represents management’s estimate of the aggregate unearned revenues expected to be earned by the Company over the life of all of its contracts, including option periods. Because many factors affect the scheduling of projects, there can be no assurance as to when revenues will be realized on projects included in the Company’s backlog. In addition, although contract backlog represents only business which is considered to be firm, there can be no assurance that cancellations or scope adjustments will not occur. The majority of backlog represents contracts under the terms of which cancellation by the customer would entitle the Company to all or a portion of its costs incurred and potential fees to the date of cancellation.
However, the Company also believes that backlog is not necessarily indicative of future revenues. The Company’s backlog typically is subject to large variations from quarter to quarter as existing contracts are renewed or new contracts are awarded. Additionally, all U.S. Government contracts included in backlog may be terminated at the convenience of the government.
Critical Accounting Policies
The Company believes the following accounting policies are critical to the understanding of the Company’s financial condition and results of operations.
Revenue Recognition
The Company provides services under fixed price contracts for which revenue is generally recognized using the percentage of completion method based on the relationship of actual costs incurred to total costs estimated over the duration of the contract. These estimates regarding costs underlie the Company’s determinations as to overall contract profitability and the timing of revenue recognition. If the Company does not accurately estimate the resources required or the scope of the work to be performed, or does not manage its projects properly within the planned periods of time or satisfy its obligations under the contracts, then actual results may differ from projected results and losses on contracts may need to be recognized. The Company accounts for cost reimbursable contracts by charging contract costs to operations as incurred and recognizing contract revenues and profits by applying the negotiated fee and or estimated award fee rate to actual costs on an individual contract basis. Management reviews contract performance, costs incurred, and estimated completion costs regularly and adjusts revenues and profits on contracts in the period in which changes become determinable.
Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause the Company’s operating results to vary significantly from quarter to quarter.
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Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. A considerable amount of judgment is required in assessing the ultimate realization of individual accounts receivable balances, including the credit worthiness of each customer and the period in which customers’ financial condition deteriorate and they are no longer able to pay the balances owed to the Company.
To the extent the Company does not recognize deterioration in its customers’ financial condition in the period it occurs, or to the extent the Company overestimates its customers’ ability to pay, the amount of bad debt expense recognized in a given reporting period will be impacted.
Goodwill and Other Intangible Assets
The Company’s acquisitions of other companies have resulted in the acquisition of certain intangible assets and goodwill. Goodwill is subject to impairment to the extent the Company’s operations experience significant negative results. These negative results can be the result of the Company’s individual operations or negative trends in the Company’s industry or in the general economy, which impact the Company. To the extent the Company’s goodwill is determined to be impaired, then these balances are written down to their estimated fair value on the date of the impairment. The Company conducts an annual review for impairment and determining when and if an impairment has occurred involves a significant amount of judgment. Management bases its judgment on a number of factors including viability of the businesses acquired, their integration into the Company’s operations, the market in which those businesses operate and their projected future results, cash flow projections, and numerous other factors. The results reported in any given period could be impacted by management’s determination as to when an impairment has occurred.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) 123 (Revised 2004),Shared-Based Payment. SFAS 123R addresses the requirements of an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which an employee is required to provide services in exchange for the award. The Company will be required to adopt this Statement during the first quarter of fiscal year 2006. As of September 30, 2005, the Company had 4,772 unvested share-based payments outstanding. In addition, the Company does not intend to issue stock option awards for the foreseeable future. Therefore, the Company believes that the adoption of SFAS 123R will not have a material impact on its future operations and financial reporting.
In May 2005, the FASB issued Statement 154,“Accounting Changes and Error Corrections – a replacement of AFB Opinion No. 20 and FASB Statement No. 3”(AC Section A07). Statement 154 requires that all voluntary changes in accounting principles and changes required by a new accounting pronouncement that do not include specific transition provisions be applied retrospectively to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. Statement 154 is effective prospectively for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for fiscal years beginning after the date the statement was issued (May 2005). The Company believes that the implementation of the guidance contained in Statement 154 will not have a material effect on its financial condition, results of operations, or liquidity.
In June 2005, the Emerging Issues Task Force reached consensus on EITF Issue 05-06,“Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination”(“EITF 05-6”). EITF 05-6 concluded that leasehold improvements acquired in a business combination should be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of acquisition. The Task Force also concluded that leasehold improvements
19
placed in service significantly after and not contemplated at or near the beginning of the lease term should be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date the leasehold improvements are purchased. EITF 05-6 is effective prospectively for leasehold improvements purchased or acquired in periods beginning after June 29, 2005. The Company’s implementation of the guidance contained in EITF 05-6 did not have an effect on its financial condition, results of operations, or liquidity in fiscal year 2005 and is not expected to have a material effect on its financial condition, results of operations, or liquidity in fiscal year 2006 and beyond.
Results of Operations
The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the fiscal years ended September 30, 2005, 2004 and 2003:
| | | | | | | | | | | | | | | | | | | | | |
| | | Fiscal Year
2005
| | | Fiscal Year
2005
| | | Fiscal Year
2004
| | | Fiscal Year
2004
| | | Fiscal Year
2003
| | | Fiscal Year
2003
| |
| | | (in thousands) | | | % of Revenue | | | (in thousands) | | | % of Revenue | | | (in thousands) | | | % of Revenue | |
Revenue | | $ | 97,725 | | | 100.0 | % | | $ | 90,311 | | | 100.0 | % | | $ | 82,585 | | | 100.0 | % |
Cost of Revenue | | | 68,012 | | | 69.6 | | | | 59,785 | | | 66.2 | | | | 55,375 | | | 67.1 | |
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Gross Margin | | | 29,713 | | | 30.4 | | | | 30,526 | | | 33.8 | | | | 27,210 | | | 32.9 | |
SG&A | | | 13,432 | | | 13.7 | | | | 12,657 | | | 14.0 | | | | 11,466 | | | 13.9 | |
Research & Development | | | 2,415 | | | 2.5 | | | | 3,691 | | | 4.1 | | | | 2,664 | | | 3.2 | |
Non recurring compensation | | | 1,185 | | | 1.2 | | | | — | | | — | | | | — | | | — | |
Product Amortization | | | 2,582 | | | 2.6 | | | | 3,045 | | | 3.3 | | | | 2,989 | | | 3.6 | |
Amortization-Intangible Assets | | | 275 | | | 0.3 | | | | 782 | | | 0.9 | | | | 1,289 | | | 1.6 | |
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Income from Operations | | | 9,824 | | | 10.1 | | | | 10,351 | | | 11.5 | | | | 8,802 | | | 10.6 | |
Other Income (Expense): | | | | | | | | | | | | | | | | | | | | | |
Interest Income | | | 1,151 | | | 1.2 | | | | 616 | | | 0.7 | | | | 595 | | | 0.7 | |
Gain on Sale of Marketable Securities | | | 50 | | | 0.0 | | | | 46 | | | 0.1 | | | | 140 | | | 0.2 | |
Impairment Loss on Marketable Securities | | | — | | | — | | | | — | | | — | | | | (1,364 | ) | | (1.7 | ) |
Miscellaneous Expense | | | (637 | ) | | (0.7 | ) | | | (408 | ) | | (0.6 | ) | | | (290 | ) | | (0.3 | ) |
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Income Before Income Taxes | | | 10,388 | | | 10.6 | | | | 10,605 | | | 11.7 | | | | 7,883 | | | 9.5 | |
Income Taxes | | | 4,087 | | | 4.2 | | | | 3,844 | | | 4.2 | | | | 2,864 | | | 3.4 | |
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Net Income | | $ | 6,301 | | | 6.4 | % | | $ | 6,761 | | | 7.5 | % | | $ | 5,019 | | | 6.1 | % |
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Revenue
The Company earns revenue, both as a prime contractor and a subcontractor, from sales of its products and services through contracts that are funded by the U.S. Government as well as commercial and international organizations.
20
For the fiscal years ended September 30, 2005, 2004, and 2003, the Company’s revenues were generated from the following sources:
| | | | | | | | | |
Revenue Type
| | Fiscal Year
2005
| | | Fiscal Year
2004
| | | Fiscal Year
2003
| |
Government | | | | | | | | | |
USAF | | 57 | | | 55 | | | 50 | |
NOAA | | 8 | | | 15 | | | 19 | |
Other U.S. Government Users | | 12 | | | 6 | | | 7 | |
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|
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|
|
Subtotal | | 77 | % | | 76 | % | | 76 | % |
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|
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|
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|
|
Commercial | | 23 | % | | 24 | % | | 24 | % |
Total | | 100 | % | | 100 | % | | 100 | % |
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21
FISCAL YEAR 2005 COMPARED TO FISCAL YEAR 2004
On a consolidated basis, revenue increased 8.2%, or $7.4 million, to $97.7 million for the fiscal year 2005, from $90.3 million for fiscal year 2004. Revenue for fiscal years 2005 and 2004 for each of the Company’s segments is shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | 2005
| | | 2004
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Revenue | | | | | | | | | | | | |
Ground Systems – Government | | $ | 47,609 | | | $ | 45,300 | | | $ | 2,309 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 11,006 | | | | 10,888 | | | | 118 | |
Newpoint | | | 3,711 | | | | 2,760 | | | | 951 | |
SAT | | | 3,768 | | | | 4,596 | | | | (828 | ) |
Intra-Segment Elimination | | | (560 | ) | | | (1,047 | ) | | | 487 | |
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|
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|
|
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|
|
|
Ground Systems – Commercial | | | 17,925 | | | | 17,197 | | | | 728 | |
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|
|
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|
|
|
Space Communications Systems | | | 32,483 | | | | 26,266 | | | | 6,217 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 3,608 | | | | 4,584 | | | | (976 | ) |
Antenna | | | 2,566 | | | | 2,021 | | | | 545 | |
I&T | | | — | | | | 1,821 | | | | (1,821 | ) |
Other | | | 1,281 | | | | 1,214 | | | | 67 | |
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|
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Corporate | | | 7,455 | | | | 9,640 | | | | (2,185 | ) |
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|
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|
|
|
Elimination | | | (7,747 | ) | | | (8,092 | ) | | | 345 | |
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|
|
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|
|
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|
|
|
Total Revenue | | $ | 97,725 | | | $ | 90,311 | | | $ | 7,414 | |
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|
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Revenue increases in the Company’s Ground Systems—Government segment between the fiscal years ended September 30, 2005 and 2004 primarily relate to increased sales of approximately $7.4 million from the Company’s contracts with the U.S. Air Force which were largely offset by revenue decreases from NOAA.
Revenue increases of approximately $730,000 for the Company’s Ground Systems – Commercial segment resulted from increased revenue in Newpoint and the Command & Control units resulting from increased order bookings and increased system shipments which were offset by revenue decreases at SAT.
Revenue increases for the Company’s Space Communications Systems segment resulted from increased bookings and increased product shipments for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004.
In the Company’s Corporate segment, revenues for the Product Group decreased approximately $980,000 for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004 principally due to decreased license revenue.
Although the Company disposed of the intellectual property right, inventory and certain other assets of the Antenna division on November 17, 2004, the Antenna Division revenues increased approximately $540,000 for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004 primarily because of
22
the Company’s on-going contract with the Malaysian military for the delivery of two antenna systems. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information regarding the disposition of the Antenna Systems division.
The Company disbanded its I&T Division during the fourth quarter of fiscal year 2004 and accordingly, no revenues or costs were recorded for this division during fiscal year 2005.
Cost of Revenue/Gross Margin
The Company computes gross margin by subtracting cost of revenue from revenue. Included in cost of revenue are direct labor expenses, overhead charges associated with the Company’s direct labor base and other costs that can be directly related to specific contract cost objectives, such as travel, consultants, equipment, subcontracts and other direct costs.
Gross margins on contract revenues vary depending on the type of product or service provided. Generally, license revenues related to the sale of the Company’s COTS products have the greatest gross margins because of the minimal associated marginal costs to produce. By contrast, gross margins for equipment and subcontract pass-throughs seldom exceed 15%. Engineering service gross margins typically range between 20% and 40%. These definitions and ratios generally apply across all segments, although margins on equipment costs for the Space Communications Systems segment are generally greater than the equipment margins in the other segments because that segment’s business is composed of internally developed hardware products.
23
During fiscal year 2005, cost of revenue increased by 13.8%, or $8.2 million, compared to fiscal year 2004, increasing from $59.8 million to $68.0 million. Gross margin decreased to $29.7 million from $30.5 million, a decrease of $800,000, or 2.7%, during the periods being compared. Cost of revenue and gross margin for fiscal years 2005 and 2004 for each of the Company’s segments are shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | | 2005
| | | 2004
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Cost of Revenue | | | | | | | | | | | | |
Ground Systems – Government | | $ | 38,356 | | | $ | 35,777 | | | $ | 2,579 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 8,382 | | | | 9,115 | | | | (733 | ) |
Newpoint | | | 1,919 | | | | 1,237 | | | | 682 | |
SAT | | | 2,338 | | | | 2,649 | | | | (311 | ) |
Intra-Segment Elimination | | | (538 | ) | | | (974 | ) | | | 436 | |
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|
Ground Systems – Commercial | | | 12,101 | | | | 12,027 | | | | 74 | |
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|
|
|
Space Communications Systems | | | 17,971 | | | | 12,150 | | | | 5,821 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 2,555 | | | | 1,953 | | | | 602 | |
Antenna | | | 3,442 | | | | 3,180 | | | | 262 | |
I&T | | | — | | | | 1,691 | | | | (1,691 | ) |
Other | | | 1,276 | | | | 1,037 | | | | 239 | |
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|
|
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|
Corporate | | | 7,273 | | | | 7,861 | | | | (588 | ) |
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|
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|
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|
Elimination | | | (7,689 | ) | | | (8,030 | ) | | | 341 | |
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|
|
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|
|
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|
|
|
Total Cost of Revenue | | $ | 68,012 | | | $ | 59,785 | | | $ | 8,227 | |
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|
|
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|
|
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|
|
|
Gross Margin | | | | | | | | | | | | |
Ground Systems – Government | | $ | 9,253 | | | $ | 9,523 | | | | ($270 | ) |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 2,624 | | | | 1,773 | | | | 851 | |
Newpoint | | | 1,792 | | | | 1,523 | | | | 269 | |
SAT | | | 1,430 | | | | 1,947 | | | | (517 | ) |
Intra-Segment Elimination | | | (22 | ) | | | (73 | ) | | | 51 | |
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|
Ground Systems – Commercial | | | 5,824 | | | | 5,170 | | | | 654 | |
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|
Space Communications Systems | | | 14,512 | | | | 14,116 | | | | 396 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 1,053 | | | | 2,631 | | | | (1,578 | ) |
Antenna | | | (876 | ) | | | (1,159 | ) | | | 283 | |
I&T | | | — | | | | 130 | | | | (130 | ) |
Other | | | 5 | | | | 177 | | | | (172 | ) |
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|
Corporate | | | 182 | | | | 1,779 | | | | (1,597 | ) |
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|
Elimination | | | (58 | ) | | | (62 | ) | | | 4 | |
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|
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|
|
|
Total Gross Margin | | $ | 29,713 | | | $ | 30,526 | | | ($ | 813 | ) |
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24
The decreased gross margin in the Company’s Ground Systems – Government segment (approximately $270,000) primarily relates to a lower percentage of fixed price revenue compared to cost reimbursable revenue in the segment’s revenue mix for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004. The Company generally earns higher margins on its fixed price contracts than its cost reimbursable type contracts because of the greater risk associated with fixed price efforts. Many of the Company’s new awards with the U.S. Air Force have been cost reimbursable type contract vehicles.
The higher gross margin (approximately $650,000) for the Company’s Ground Systems - Commercial segment is primarily attributable to increased revenue of approximately $730,000 for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004. Both Newpoint and the Command and Control unit in this segment posted increased gross margins due to increased revenue for the current year. SAT’s gross margin decreased by approximately $520,000 on a year to year basis due to revenue declines of approximately $830,000.
The Space Communications System segment experienced an increase in gross margin of approximately $400,000 on increased revenue of approximately $6.2 million for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004. The segment’s gross margin percentage declined from 53.7% for the fiscal year ended September 30, 2004 to 44.7% for the fiscal year ended September 30, 2005 due to a considerably greater mix of third-party equipment costs in the segment’s cost of revenue in the current fiscal year than in the fiscal year ended September 30, 2004. Similar to the Company’s other business segments, the Space Communications Systems segment typically earns less gross margin on third-party equipment purchases than on other cost elements. Further, the segment had a significantly higher percentage of production type revenue during fiscal year 2004 than in fiscal year 2005. Generally, production type contracts generate higher gross margins due to increased cost efficiencies as compared to non-production oriented jobs.
In the Corporate segment, the Product Group experienced a decrease in gross margin of approximately $1.6 million on a period-to-period basis principally because of decreased license revenue. Further, effective April 1, 2005, the Company determined that its EPOCH IPS product line was substantially complete and therefore costs associated with the product were no longer eligible for capitalization. The costs of software bug fixes and support were higher in the second half of the fiscal year than similar costs incurred during the second half of the fiscal year ended September 30, 2004, thereby further contributing to the lower gross margin.
Although the Antenna Division was able to reduce its gross margin deficit by approximately $280,000, the Antenna Division nonetheless recorded an approximate $880,000 gross margin deficit during the fiscal year ended September 30, 2005. Contract overruns for the Division have continued on three of the unit’s four remaining contracts. The Company believes that all four of these contracts will be completed by the first quarter of fiscal year 2006 (with the exception of warranty obligations; costs for such warranty obligations are reflected in the cost-to-complete estimates). The Company expects no further losses from Antenna contracts in fiscal year 2006.
The I&T Division posted no gross margins as it had no revenue or costs during the current year.
25
Operating Expenses
Operating expenses for fiscal years 2005 and 2004 for each of the Company’s segments are shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | | 2005
| | | 2004
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Operating Expenses | | | | | | | | | | | | |
Ground Systems – Government | | $ | 5,323 | | | $ | 4,564 | | | $ | 759 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 1,514 | | | | 1,369 | | | | 145 | |
Newpoint | | | 1,471 | | | | 1,517 | | | | (46 | ) |
SAT | | | 1,830 | | | | 2,568 | | | | (738 | ) |
Intra-Segment Elimination | | | (63 | ) | | | (50 | ) | | | (13 | ) |
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|
|
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|
|
| |
|
|
|
Ground Systems – Commercial | | | 4,752 | | | | 5,404 | | | | (652 | ) |
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|
|
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|
|
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|
|
|
Space Communications Systems | | | 5,062 | | | | 5,213 | | | | (151 | ) |
Corporate | | | | | | | | | | | | |
Product Group | | | 3,321 | | | | 3,853 | | | | (532 | ) |
Antenna | | | 118 | | | | 336 | | | | (218 | ) |
I&T | | | — | | | | 683 | | | | (683 | ) |
Other | | | 1,393 | | | | 214 | | | | 1,179 | |
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|
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|
|
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|
|
Corporate | | | 4,832 | | | | 5,086 | | | | (254 | ) |
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|
|
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|
|
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|
|
Elimination | | | (80 | ) | | | (92 | ) | | | 12 | |
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|
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|
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| |
|
|
|
Total Operating Expenses | | $ | 19,889 | | | $ | 20,175 | | | | ($286 | ) |
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|
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|
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|
Operating expenses in the Company’s Ground Systems – Government segment increased by approximately $760,000 for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004 due to increased bid and proposal costs coupled with increased costs incurred related to compliance with Sarbanes-Oxley regulations.
Operating expenses in the Company’s Ground Systems - Commercial segment decreased by approximately $650,000 for the fiscal year ended September 30, 2005 compared to the fiscal year ended September 30, 2004 due to decreased operating expenses at SAT. Operating expenses at SAT were down almost $740,000 principally due to reductions in research and development costs and product amortization expenses.
The Space Communications Systems segment’s operating expenses for the fiscal year ended September 30, 2005 decreased by approximately $150,000 compared to the fiscal year ended September 30, 2004. Although SG&A expenses increased some $820,000 period to period, R&D expense and amortization expense decreased approximately $460,000 and $510,000, respectively, accounting for the overall decrease.
Operating expenses in the Corporate segment for the fiscal year ended September 30, 2005 decreased by approximately $250,000 compared to the fiscal year ended September 30, 2004 principally due to the closure of the I&T Division, the sale of operating assets of the Antenna Division in November 2004 and reduced product related selling expenses. The year to year decrease in operating expenses for the Corporate segment would have been
26
greater by approximately $1.2 million were it not for the one time expense recorded during the fourth quarter of fiscal year 2005 related to the acceleration of the Company’s non-vested stock options.
Income from Operations
Income from operations for fiscal years 2005 and 2004 for each of the Company’s segments is shown in the following table:
| | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | | 2005
| | | 2004
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | |
Income from Operations | | | | | | | | | | | |
Ground Systems – Government | | $ | 3,930 | | | $ | 4,959 | | | ($1,029 | ) |
Ground Systems – Commercial | | | | | | | | | | | |
Command & Control | | | 1,110 | | | | 404 | | | 706 | |
Newpoint | | | 321 | | | | 6 | | | 315 | |
SAT | | | (400 | ) | | | (621 | ) | | 221 | |
Intra-Segment Elimination | | | 41 | | | | (23 | ) | | 64 | |
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|
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|
|
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|
|
Ground Systems – Commercial | | | 1,072 | | | | (234 | ) | | 1,306 | |
| | |
|
|
| |
|
|
| |
|
|
Space Communications Systems | | | 9,450 | | | | 8,903 | | | 547 | |
Corporate | | | | | | | | | | | |
Product Group | | | (2,268 | ) | | | (1,222 | ) | | (1,046 | ) |
Antenna | | | (994 | ) | | | (1,495 | ) | | 501 | |
I&T | | | — | | | | (553 | ) | | 553 | |
Other | | | (1,388 | ) | | | (37 | ) | | (1,351 | ) |
| | |
|
|
| |
|
|
| |
|
|
Corporate | | | (4,650 | ) | | | (3,307 | ) | | (1,343 | ) |
| | |
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|
| |
|
|
| |
|
|
Elimination | | | 22 | | | | 30 | | | (8 | ) |
| | |
|
|
| |
|
|
| |
|
|
Total Income from Operations | | $ | 9,824 | | | $ | 10,351 | | | ($527 | ) |
| | |
|
|
| |
|
|
| |
|
|
Income from operations during the periods compared decreased by approximately $1.0 million in the Company’s Ground Systems –Government segment as a result of decreased gross margins (related to a lower percentage of fixed price contracts) coupled with increased operating expenses.
Income from operations during the periods compared increased by approximately $1.3 million in the Company’s Ground Systems – Commercial segment as a result of increased revenue and gross margins at its Newpoint and Command and Control units coupled with decreased operating expenses at SAT as described above.
The Space Communications Systems segment recorded increased income from operations of approximately $550,000 principally due to increased gross margins coupled with reduced operating expenses.
In the Corporate segment, the Product Group posted an operating loss of almost $2.3 million primarily because of decreased gross margin (resulting in part from lower license revenue) partially offset by lower operating expenses. Although the Product Group recorded losses for the year, a large portion of the revenue generated in the Company’s ground systems business (both Government and Commercial) is a result of its EPOCH IPS product line, which the Company believes favorably distinguishes it from its competitors.
27
Operating losses in the Antenna Division have been reduced between the periods compared due to the sale of the unit’s assets, while operating losses at the I&T Division have been eliminated during the fiscal year ended September 30, 2005 due to the shutdown of that unit during 2004.
Operating income in the Corporate segment was adversely affected by approximately $1.2 million in fiscal year 2005 as a result of the one time expense recorded in the fourth quarter related to the acceleration of the Company’s non-vested stock options.
Other Income/Expense
Other income and expense increased by approximately $310,000 between fiscal year 2004 and fiscal year 2005, mostly as a result from increased interest income related to higher interest rates.
Income Before Income Taxes/Net Income
Income before income taxes decreased by approximately $220,000 in fiscal year 2005 when compared to fiscal year 2004 principally due to decreased operating income of approximately $530,000 as described above partially offset by increased interest income.
The Company’s effective tax rate increased from 36.2% for fiscal year 2004 to 39.3% for fiscal year 2005 principally due to the non-deductibility of certain expenses.
As a result of the above, net income decreased to approximately $6.30 million during fiscal year 2005 from $6.76 million during fiscal year 2004.
28
FISCAL YEAR 2004 COMPARED TO FISCAL YEAR 2003
On a consolidated basis, revenue increased 9.4%, or $7.7 million, to $90.3 million for the fiscal year 2004, from $82.6 million for fiscal year 2003. Revenue for fiscal years 2004 and 2003 for each of the Company’s segments is shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | | 2004
| | | 2003
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Revenue | | | | | | | | | | | | |
Ground Systems – Government | | $ | 45,300 | | | $ | 39,965 | | | $ | 5,335 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 10,888 | | | | 9,650 | | | | 1,238 | |
Newpoint | | | 2,760 | | | | 2,360 | | | | 400 | |
SAT | | | 4,596 | | | | 3,415 | | | | 1,181 | |
Intra-Segment Elimination | | | (1,047 | ) | | | (81 | ) | | | (966 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Ground Systems – Commercial | | | 17,197 | | | | 15,344 | | | | 1,853 | |
| | |
|
|
| |
|
|
| |
|
|
|
Space Communications Systems | | | 26,266 | | | | 23,169 | | | | 3,097 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 4,584 | | | | 4,194 | | | | 390 | |
Antenna | | | 2,021 | | | | 1,322 | | | | 699 | |
I&T | | | 1,821 | | | | 5,298 | | | | (3,477 | ) |
Other | | | 1,214 | | | | 2,728 | | | | (1,514 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Corporate | | | 9,640 | | | | 13,542 | | | | (3,902 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Elimination | | | (8,092 | ) | | | (9,435 | ) | | | 1,343 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total Revenue | | $ | 90,311 | | | $ | 82,585 | | | $ | 7,726 | |
| | |
|
|
| |
|
|
| |
|
|
|
Revenue increased on a year-to-year basis for all of the Company’s operating segments. The Company does not consider its Corporate segment to be an operating segment.
Revenue increases in the Company’s Ground Systems - Government segment pertain to increased sales volume as a result of the Company’s contract awards with the U.S. Air Force (specifically the CCS-C and SCNC programs) that were made in the spring of 2002. Revenue from this segment’s Air Force customer increased approximately $7.1 million, more than offsetting revenue decreases of approximately $1.7 million from NOAA.
All units in the Company’s Ground Systems – Commercial segment experienced increased revenues on a year-to-year basis. Revenue levels for the core business Command & Control unit, SAT and Newpoint were up 12.8%, 34.6% and 17.0% respectively in fiscal year 2004 compared to fiscal year 2003 and generally relate to increased bookings and increased shipments of new orders. The Ground Systems – Commercial segment sells primarily to commercial satellite operators and commercial satellite users where market conditions have been depressed during the past few years. The Company believes that these markets are beginning to economically improve, as evidenced by the revenue increases in fiscal year 2004, and if this improvement continues, the Company believes that the segment should be able to post continued revenue gains in future fiscal periods. The Company is also currently proposing both SAT and Newpoint products on several outstanding government bids.
29
The revenue generated by the Space Communications Systems segment (RT Logic) for fiscal year 2004 was the highest annual revenue in that subsidiary’s history and was 13.4% greater than the revenue posted in fiscal year 2003.
In the Corporate segment, revenue decreased approximately $3.5 million in the segment’s I&T (Integration & Test) division. During the fourth quarter of fiscal year 2004, the Company disbanded the I&T division and merged its operations with the other Company business units. The revenue increase from the segment’s Antenna Division (approximately $700,000) is primarily attributable to that division earning revenue for a full twelve-month period in fiscal year 2004 as compared to only five months in fiscal year 2003.
30
Cost of Revenue/Gross Margin
During fiscal year 2004, cost of revenue increased by 8.0%, or $4.4 million, compared to fiscal year 2003, increasing from $55.4 million to $59.8 million. Gross margin increased from $27.2 million to $30.5 million, an increase of $3.3 million, or 12.2%, during the periods being compared. Cost of revenue and gross margin for fiscal years 2004 and 2003 for each of the Company’s segments are shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | 2004
| | | 2003
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Cost of Revenue | | | | | | | | | | | | |
Ground Systems – Government | | $ | 35,777 | | | $ | 33,473 | | | $ | 2,304 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 9,115 | | | | 7,730 | | | | 1,385 | |
Newpoint | | | 1,237 | | | | 1,792 | | | | (555 | ) |
SAT | | | 2,649 | | | | 2,019 | | | | 630 | |
Intra-Segment Elimination | | | (974 | ) | | | (81 | ) | | | (893 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Ground Systems – Commercial | | | 12,027 | | | | 11,460 | | | | 567 | |
| | |
|
|
| |
|
|
| |
|
|
|
Space Communications Systems | | | 12,150 | | | | 10,751 | | | | 1,399 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 1,953 | | | | 1,153 | | | | 800 | |
Antenna | | | 3,180 | | | | 1,193 | | | | 1,987 | |
I&T | | | 1,691 | | | | 4,173 | | | | (2,482 | ) |
Other | | | 1,037 | | | | 2,531 | | | | (1,494 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Corporate | | | 7,861 | | | | 9,050 | | | | (1,189 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Elimination | | | (8,030 | ) | | | (9,359 | ) | | | 1,329 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total Cost of Revenue | | $ | 59,785 | | | $ | 55,375 | | | $ | 4,410 | |
| | |
|
|
| |
|
|
| |
|
|
|
Gross Margin | | | | | | | | | | | | |
Ground Systems – Government | | $ | 9,523 | | | $ | 6,492 | | | $ | 3,031 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 1,773 | | | | 1,920 | | | | (147 | ) |
Newpoint | | | 1,523 | | | | 568 | | | | 955 | |
SAT | | | 1,947 | | | | 1,396 | | | | 551 | |
Intra-Segment Elimination | | | (73 | ) | | | — | | | | (73 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Ground Systems – Commercial | | | 5,170 | | | | 3,884 | | | | 1,286 | |
| | |
|
|
| |
|
|
| |
|
|
|
Space Communications Systems | | | 14,116 | | | | 12,418 | | | | 1,698 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 2,631 | | | | 3,041 | | | | (410 | ) |
Antenna | | | (1,159 | ) | | | 129 | | | | (1,288 | ) |
I&T | | | 130 | | | | 1,125 | | | | (995 | ) |
Other | | | 177 | | | | 197 | | | | (20 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Corporate | | | 1,779 | | | | 4,492 | | | | (2,713 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Elimination | | | (62 | ) | | | (76 | ) | | | 14 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total Gross Margin | | $ | 30,526 | | | $ | 27,210 | | | $ | 3,316 | |
| | |
|
|
| |
|
|
| |
|
|
|
Gross margin increased for all operating segments on a year-to-year basis.
31
Gross margin increased by approximately $3.0 million in the Company’s Ground Systems – Government segment in fiscal year 2004 compared to fiscal year 2003 due to increased revenue of approximately $5.3 million coupled with a higher percentage of more profitable fixed price contracts in the segment’s fiscal year 2004 revenue mix.
Gross margin increased by approximately $1.3 million in the Company’s Ground Systems – Commercial segment in fiscal year 2004 compared to fiscal year 2003 due to gross margin increases at SAT and Newpoint. Gross margin decreased in the Command & Control unit of this segment due to competitive (i.e. lower) pricing of new awards received during fiscal year 2004. The gross margin increases at SAT and Newpoint were due to increased revenues at both subsidiaries coupled with cost cutting measures implemented during the prior fiscal year. Gross margin as a percentage of revenue at SAT increased to 42.4% from 40.9% while gross margin as a percentage of revenue at Newpoint increased to 55.2% from 24.1% on a year-to-year basis.
During fiscal year 2004, the Space Communication Systems (RT Logic) segment’s gross margin percentage against revenue was flat at 53.7% compared to 53.6% for the prior fiscal year. However, gross margin increased by approximately $1.7 million as a result of increased revenue. The segment’s gross margin dollar performance during fiscal year 2004 was the highest in its history and contributed to a record year for operating income for that segment.
This Product division of the Company’s Corporate segment experienced a decline in gross margin of approximately $410,000 between fiscal year 2003 and fiscal year 2004 as a result of decreased license revenues and increased product expenses. The segment’s I&T division posted an approximate $1.0 million decrease in gross margin during the periods being compared as result of decreased revenues. This division was disbanded during the fourth quarter of fiscal year 2004. The Antenna division of the Corporate segment posted a gross margin deficit of approximately $1.2 million in fiscal year 2004 compared to a gross profit of approximately $100,000 during fiscal year 2003. The fiscal year 2004 deficit was principally caused by contracts that were under-priced and under-bid, primarily with respect to direct material and equipment costs. During fiscal year 2004, this division recorded approximately $1.8 million of direct material and equipment costs compared to revenue of approximately $2.0 million leaving virtually no funding to cover direct labor and associated indirect costs.
32
Operating Expenses
Operating Expenses for fiscal year 2004 and 2003 for each of the Company’s segments are shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | 2004
| | | 2003
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Operating Expenses | | | | | | | | | | | | |
Ground Systems – Government | | $ | 4,564 | | | $ | 3,677 | | | $ | 887 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 1,369 | | | | 986 | | | | 383 | |
Newpoint | | | 1,517 | | | | 1,482 | | | | 35 | |
SAT | | | 2,568 | | | | 2,835 | | | | (267 | ) |
Intra-Segment Elimination | | | (50 | ) | | | — | | | | (50 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Ground Systems – Commercial | | | 5,404 | | | | 5,303 | | | | 101 | |
| | |
|
|
| |
|
|
| |
|
|
|
Space Communications Systems | | | 5,213 | | | | 4,921 | | | | 292 | |
Corporate | | | | | | | | | | | | |
Product Group | | | 3,853 | | | | 3,426 | | | | 427 | |
Antenna | | | 336 | | | | 85 | | | | 251 | |
I&T | | | 683 | | | | 991 | | | | (308 | ) |
Other | | | 214 | | | | 63 | | | | 151 | |
| | |
|
|
| |
|
|
| |
|
|
|
Corporate | | | 5,086 | | | | 4,565 | | | | 521 | |
| | |
|
|
| |
|
|
| |
|
|
|
Elimination | | | (92 | ) | | | (58 | ) | | | (34 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total Operating Expenses | | $ | 20,175 | | | $ | 18,408 | | | $ | 1,767 | |
| | |
|
|
| |
|
|
| |
|
|
|
In the Company’s Ground Systems – Government segment, Selling, General & Administrative (“SG&A”) expenses increased by approximately $890,000 during the periods being compared. The increase principally relates to increased marketing and proposal costs related to new Air Force opportunities coupled with increased management and administrative costs needed to operate a considerably larger business base. As a percentage of revenue, SG&A for this segment represented 10.1% of revenue in fiscal year 2004 compared to 9.2% of revenue during fiscal year 2003.
Operating expenses in the Company’s Ground Systems – Commercial segment were approximately flat on a year –to-year basis. At the Command & Control unit of the segment, operating expenses were approximately $380,000 higher in fiscal year 2004 than in fiscal year 2003 primarily due to allocated bid and proposal cost. At SAT, period-to-period SG&A costs were down approximately $270,000 due to a decrease in R&D expenses from almost $1.1 million to approximately $850,000 in the periods compared. The decrease in fiscal year 2004 R&D expenses resulted from the more effective utilization of the segment’s engineering staff on direct contracts as opposed to R&D efforts. SAT also recovered approximately $56,000 of bad debts provided for in prior years during fiscal year 2004, further contributing to the improvement in year-to-year SG&A costs. Newpoint’s fiscal year 2004 SG&A expenses increased approximately $35,000 compared to fiscal year 2003, resulting from R&D spending related to new product undertakings at this segment.
33
Operating expenses increased by approximately $290,000 in the Company’s Space Communications segment on a year-to-year basis. R&D expenses in the segment increased from almost $1.4 million in fiscal year 2003 to approximately $2.2 million in fiscal year 2004 as a result of new product undertakings, consistent with RT Logic’s fiscal year 2004 plan. This increase was partially offset by decreases in SG&A spending in fiscal year 2004 compared to fiscal year 2003.
Operating expenses in the Company’s Corporate segment increased by approximately $520,000 in fiscal year 2004 compared to fiscal year 2003. Increases in the Product division of approximately $430,000 primarily relate to increased marketing and selling costs coupled with increased product amortization of approximately $60,000 during fiscal year 2004 as compared to fiscal year 2003. The $250,000 increase in operating expenses from the segment’s Antenna Division is primarily attributable to that division incurring costs for a full twelve-month period in fiscal year 2004 as compared to only five months in fiscal year 2003. Operating expenses in the segment’s I&T division decreased approximately $150,000 as a result of decreased business activity in fiscal year 2004 compared to fiscal year 2003.
Income from Operations
Income from operations for fiscal years 2004 and 2003 for each of the Company’s segments is shown in the following table:
| | | | | | | | | | | | |
| | | Fiscal Year Ended
September 30,
| | | Increase/ (Decrease)
| |
| | 2004
| | | 2003
| | |
| | | (in thousands) | | | (in thousands) | | | (in thousands) | |
| Segment | | | | | | | | | | | | |
Income from Operations | | | | | | | | | | | | |
Ground Systems – Government | | $ | 4,959 | | | $ | 2,815 | | | $ | 2,144 | |
Ground Systems – Commercial | | | | | | | | | | | | |
Command & Control | | | 404 | | | | 934 | | | | (530 | ) |
Newpoint | | | 6 | | | | (914 | ) | | | 920 | |
SAT | | | (621 | ) | | | (1,439 | ) | | | 818 | |
Intra-Segment Elimination | | | (23 | ) | | | — | | | | (23 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Ground Systems – Commercial | | | (234 | ) | | | (1,419 | ) | | | 1,185 | |
| | |
|
|
| |
|
|
| |
|
|
|
Space Communications Systems | | | 8,903 | | | | 7,497 | | | | 1,406 | |
Corporate | | | | | | | | | | | | |
Product Group | | | (1,222 | ) | | | (385 | ) | | | (837 | ) |
Antenna | | | (1,495 | ) | | | 44 | | | | (1,539 | ) |
I&T | | | (553 | ) | | | 134 | | | | (687 | ) |
Other | | | (37 | ) | | | 134 | | | | (171 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Corporate | | | (3,307 | ) | | | (73 | ) | | | (3,234 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Elimination | | | 30 | | | | (18 | ) | | | 48 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total Income from Operations | | $ | 10,351 | | | $ | 8,802 | | | $ | 1,549 | |
| | |
|
|
| |
|
|
| |
|
|
|
Income from operations during the periods compared increased by approximately $2.1 million in the Company’s Ground Systems – Government segment principally as a result of increased gross margin partially offset by increased operating expenses as described above.
34
Income from operations during the periods compared increased by approximately $1.2 million in the Company’s Ground Systems – Commercial segment principally as a result of the elimination of operating losses at Newpoint and the reduction of operating losses at SAT. Income from operations in the segment’s Command & Control unit decreased by approximately $530,000 as a result of a lower gross margin coupled with increased operating expenses.
Operating income for the Space Communications Systems segment (RT Logic) increased approximately $1.4 million or 18.8% in fiscal year 2004 over the prior fiscal year’s results. RT Logic operating income is the highest in that subsidiary’s history and was achieved despite additional R&D spending of approximately $840,000 in fiscal year 2004 over fiscal year 2003 and primarily relates to $1.7 million of gross margin increases coupled with amortization decreases of approximately $510,000.
Operating income for the Corporate segment decreased by approximately $3.2 million during the periods compared as a result of operating losses posted by the segment’s Antenna division, the decline and ultimate closure of the I&T division, and decreased license revenue coupled with increased operating expenses in the segment’s Product Division.
Other Income/Expense
During fiscal year 2003, the Company recorded other expense of approximately $1.4 million related to its investment in the common stock of Loral Space and Communications Ltd (“LOR”). LOR filed a voluntary petition for bankruptcy under Chapter 11 of the Federal Bankruptcy Code on July 15, 2003. As a result of this filing, the Company believed that its investment in this entity had been permanently impaired and accordingly wrote down its carrying value to approximately $50,000 as of September 30, 2003. No such impairment occurred in fiscal year 2004.
The Company recorded approximately $46,000 of gains on the sale of marketable equity securities during fiscal year 2004 compared to almost $140,000 of such gains during the prior fiscal year.
During fiscal year 2004, the Company also recorded approximately $615,000 of interest income compared to approximately $590,000 of interest income recorded for fiscal year 2003.
The changes in miscellaneous expense between the periods being compared are considered immaterial.
Income Before Income Taxes/Net Income
Income before income taxes increased by approximately $2.7 million to $10.6 million from $7.9 million during the periods compared, principally due to operating income improvements from the Company’s on-going operating segments (Ground Systems – Government; Ground Systems – Commercial; and the Space Communications segments) combined with the elimination of an impairment charge in fiscal year 2004. These gains were partially offset by decreases in operating income posted in the Company’s Corporate segment as described above.
The Company’s effective tax rate was 36.2% and 36.3% for fiscal years 2004 and 2003, respectively.
As a result of the above, net income increased to approximately $6.76 million during fiscal year 2004 from approximately $5.02 million during fiscal year 2003.
Fiscal year 2004 revenue, operating income, net income and earnings per share were Company historic annual records, exceeding prior records posted in fiscal year 2003 by 9%, 18%, 35% and 31%, respectively.
35
OUTLOOK
This outlook section contains forward-looking statements, all of which are based on current expectations. There is no assurance that the Company’s projections will in fact be achieved and these projections do not reflect any acquisitions or divestitures which may occur in the future. Reference should be made to the various important factors listed under the heading “Forward-Looking Statements” that could cause actual future results to differ materially.
At this time, the Company has a backlog of work to be performed and it may receive additional contract awards based on proposals in the pipeline. Management believes that operating results for future periods will improve based on the following assumptions:
| | • | | Demand for satellite technology and related products and services will continue to expand; and |
| | • | | Sales of its software products and engineering services will continue to increase. |
For fiscal year 2005 in its entirety, the Company anticipated that operating results would be comparable to results posted in fiscal year 2004 for revenue, operating income, net income and fully diluted earnings per common share. In fiscal year 2005 excluding the effects of the non-recurring compensation expense related to stock option acceleration (approx. $1.2 million), the Company exceeded fiscal year 2004 results for revenue, operating income, net income and fully diluted earnings per common share by 8%, 6%, 8% and 3% respectively.
Looking forward to fiscal year 2006 in its entirety, the Company believes that results for revenue, operating income, net income and fully diluted earnings per common share will exceed results for fiscal year 2005 by approximately 15%, 45%, 55% and 53% respectively. Excluding the effect of the non-recurring compensation expense related to stock option acceleration (approx. $1.2 million) in fiscal year 2005, the Company believes that results for revenue, operating income, net income and fully diluted earnings per common share in fiscal year 2006 will exceed results for fiscal year 2005 by approximately 15%, 30%, 35% and 33% respectively.
Although the Company cannot provide any assurances as to the fiscal year 2006 forecasted results described above, the Company currently believes these results are achievable because:
| | • | | The Company’s existing backlog in its Ground Systems – Government segment indicates growth in revenue and operating income. |
| | • | | The Company does not anticipate a fiscal year 2006 charge for non-recurring compensation related to stock options. |
| | • | | The Company does not anticipate fiscal year 2006 losses associated with its Antenna Division. |
| | • | | The Company believes that its acquisition of Lumistar LLC will be immediately accretive to operating results. |
LIQUIDITY AND CAPITAL RESOURCES
Since the Company’s inception in 1982, it has been profitable on an annual basis and has generally financed its working capital needs through internally generated funds, supplemented by borrowings under the Company’s general line of credit facility with a commercial bank and the proceeds from the Company’s initial public offering in 1988. In June 1999, the Company supplemented its working capital position by raising approximately $19.7 million (net) through the private placement of approximately 1.2 million shares of its common stock. In February 2000, the Company raised an additional $40.9 million (net) for use in connection with potential acquisitions and other general corporate purposes through the private placement of 1.4 million additional shares of its common stock. With respect to the capital raised in the private placements, at September 30, 2005, $15,506,000 was invested in variable rate State of Maryland debt securities, and $17,210,000 was invested in Banc of America Securities LLC Auction Rate Securities. See Notes 1 and 4 of the Notes to the Financial Statements included elsewhere herein.
36
For fiscal year 2005, the Company provided approximately $11.3 million of cash in operating activities and used $8.1 million in investing activities, while financing activities provided $3.4 million. Included in the Company’s investing activities were approximately $600,000 for newly capitalized software development costs, $2.3 million for the purchase of land, and approximately $1.8 million for the purchase of fixed assets (principally new computers and equipment).
During fiscal year 2005, the Company had access to a line of credit facility through which it could borrow up to $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5 to 2.4% based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable and has certain financial covenants, including minimum net worth and liquidity ratios. The line expires on February 28, 2007. At September 30, 2005, 2004 and 2003, the Company had no amounts outstanding under the lines of credit.
On November 30, 2005, the Company’s Board of Directors declared a dividend of five cents per share for shareholders on record as of December 19, 2005. The Company’s general line of credit facility prohibits the declaration or payment of dividends by the Company until all of its obligations under the facility are paid in full or performed. As of September 30, 2005, all of the Company’s obligations under the facility have been met.
The Company also has access to a $2.0 million equipment lease line of credit under which it had $25,119 outstanding as of September 30, 2005. The outstanding balance is payable over a 8-month period from lease inception and bears interest at a rate of 8.8% per annum.
Looking forward to fiscal year 2006, the Company anticipates that it will require liquidity for the following major expenditures:
| | • | | Up to an additional $10.0 million for the construction of RT Logic’s new corporate headquarters in Colorado Springs |
| | • | | Approximately $3.8 million for the cash component related to the third and final contingent payment period to the former shareholders of RT Logic |
| | • | | Approximately $5.0 million for the cash component related to the purchase of assets of Lumistar, LLC |
The Company currently anticipates that its current cash balances, amounts available under its lines of credit and net cash provided by operating activities will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months including the expenditures identified above. The Company believes that inflation did not have a material impact on the Company’s revenues or income from operations in fiscal years 2005, 2004 and 2003.
37
CONTRACTUAL COMMITMENTS
The following tables reflect the Company’s contractual obligations and other commitments as of September 30, 2005 (amounts in thousands):
| | | | | | | | | | | | | | | |
| | | Payments Due by Period
|
Contractual Obligations
| | Total
| | Due in less
than 1 year
| | Due in 1-3
years
| | Due in 4-5
years
| | Due after
5 years
|
Operating leases | | $ | 6,624,063 | | $ | 1,799,127 | | $ | 4,307,760 | | $ | 373,870 | | $ | 143,306 |
Capital lease obligations | | | 25,918 | | | 25,918 | | | — | | | — | | | — |
Total contractual obligations | | $ | 6,649,981 | | $ | 1,825,045 | | $ | 4,307,760 | | $ | 373,870 | | $ | 143,306 |
| |
| | | Amount of Commitment Expiration Per Period
|
Other Commitments(1)
| | Total
| | Due in less
than 1 year
| | Due in 1-3
years
| | Due in 4-5
years
| | Due after
5 years
|
Letters of credit | | $ | 1,965,489 | | $ | 995,879 | | $ | 969,610 | | $ | — | | $ | — |
Former shareholders of RT Logic(2) | | $ | 7,611,023 | | $ | 7,611,023 | | $ | — | | $ | — | | $ | — |
Former shareholders of Newpoint(3) | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — |
| (1) | Does not include contingent consideration that may be payable in connection with the Company’s acquisition of a division of Jackson & Tull because such payments are based on the future performance of this business and cannot be determined at this time. However, the Company does not expect there to be contingent consideration since it has sold the intellectual property rights and certain assets of this business and since the business has been operating at a significant loss. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information. |
| (2) | Represents consideration payable in connection with the Company’s acquisition of RT Logic which was fully accrued at September 30, 2005. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information regarding the acquisition of RT Logic. |
| (3) | Represents contingent consideration payable in connection with the Company’s acquisition of Newpoint. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information regarding the acquisition of Newpoint. |
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no “off-balance sheet arrangements” as such term is defined in Item 303(a)(4)(ii) of Regulation S-K.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained in the Business section, in other parts of this 10-K, and in this section, including those under the headings “Outlook” and “Liquidity and Capital Resources,” are forward looking. In addition, from time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. Forward-looking statements can be identified by the use of forward-looking terminology such as “may”, “will”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, or other similar words, including statements as to the intent, belief, or current expectations of the Company and its directors, officers, and management with respect to the Company’s future operations, performance, or positions or which contain other forward-looking information. These forward-looking statements are predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. The Company’s actual results may differ significantly from the results discussed in the forward-looking statements. While the Company believes that these statements are and will be accurate, a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations
38
expressed in the Company’s statements. The Company’s business is dependent upon general economic conditions and upon various conditions specific to its industry, and future trends cannot be predicted with certainty. Particular risks and uncertainties that may affect the Company’s business, other than those described elsewhere herein, include the following:
| | • | | A significant portion of the Company’s revenue is derived from contracts or subcontracts funded by the U.S. Government, which are subject to termination without cause, government regulations and audits, competitive bidding, and the budget and funding process of the U.S. Government. |
| | • | | The presence of competitors with greater financial resources and their strategic response to the Company’s new services. |
| | • | | The potential obsolescence of the Company’s services due to the introduction of new technologies. |
| | • | | The response of customers to the Company’s marketing strategies and services. |
| | • | | The Company’s commercial contracts are subject to strict performance and other requirements. |
| | • | | The intense competition in the satellite ground system industry could harm the Company’s financial performance. |
| | • | | With respect to the Company’s acquisition strategy, integration of the companies and assets the Company has acquired or, if the Company is able to identify and acquire one or more businesses, may acquire, may be costly and may result in a decrease in the value of the Company’s common stock. |
| | • | | The Company may not have adequately assessed the risks inherent in the companies or assets it has acquired or correctly assessed the potential contribution of those companies or assets to its financial performance, and in the future the Company may not adequately assess the risks inherent in a particular acquisition candidate or correctly assess the candidate’s potential contribution to the Company’s financial performance. |
| | • | | The Company may need to divert more management resources to integration of an acquired business or assets than it planned, which may adversely affect its ability to pursue other more profitable activities. |
| | • | | The difficulties of integrating an acquired business or assets may be increased by the necessity of coordinating geographically separated organizations, integrating personnel with disparate backgrounds and combining different corporate cultures. |
| | • | | The Company may not eliminate as many redundant costs as it anticipated in selecting the companies or assets it has acquired or may acquire. |
| | • | | The companies or assets the Company has acquired or may acquire may have liabilities or adverse operating issues that the Company failed to discover through its diligence prior to the acquisition. |
| | • | | Changes in activity levels in the Company’s core markets. |
| | • | | The Company may not be able to effectively manage any continued growth. |
| | • | | The business is subject to risks associated with international transactions. |
| | • | | The Company depends upon intellectual property rights and risk having its rights infringed. |
| | • | | The estimated backlog is not necessarily indicative of revenues that will actually be realized under the contracts. |
| | • | | The Company’s quarterly operating results may vary significantly from quarter to quarter. |
| | • | | The market price of the Company’s common stock may be volatile. |
These forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which may not be realized. Because of the number and range of the assumptions underlying the Company’s forward-looking statements, many of which are subject to significant uncertainties and contingencies beyond the
39
reasonable control of the Company, some of the assumptions inevitably will not materialize and unanticipated events and circumstances may occur subsequent to the date of this document. These forward-looking statements are based on current information and expectation, and the Company assumes no obligation to update. Therefore, the actual experience of the Company and the results achieved during the period covered by any particular forward-looking statement should not be regarded as a representation by the Company or any other person that these estimates will be realized, and actual results may vary materially. There can be no assurance that any of these expectations will be realized or that any of the forward-looking statements contained herein will prove to be accurate.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
While the Company currently does not have significant European operations, its customer base is expanding outside the U.S. and therefore certain contracts now and in the future will likely be denominated in currencies other than the U.S. dollar. As a result, the Company’s financial results could be affected by factors such as foreign currency exchange rates for contracts denominated in currencies other than the U.S. dollar. To mitigate the effect of changes in foreign currency exchange rates, the Company may periodically hedge this risk by entering into forward foreign currency contracts. As of September 30, 2005, virtually all of the Company’s contracts were denominated in U.S. dollars, and the Company did not have any outstanding hedge agreements. As the Company enters into new foreign currency based contracts in the future, it may employ similar hedging contracts.
40
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
TABLE OF CONTENTS
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Integral Systems, Inc.
We have audited the accompanying consolidated balance sheets of Integral Systems, Inc. (the Company), as of September 30, 2005 and 2004, and the related statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended September 30, 2005. We have also audited management’s assessment, included in the accompanying management’s report on internal control over financial reporting, that the Company maintained effective internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used, and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our audit of internal control included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
F-2
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2005 and 2004, and the results of its operations and its cash flows for each of the two years in the period ended September 30, 2005, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of September 30, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by COSO. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control–Integrated Framework issued by COSO.
/s/ Grant Thornton LLP
Vienna, Virginia
November 30, 2005
F-3
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Integral Systems, Inc.
We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows of Integral Systems, Inc. and subsidiaries for the year ended September 30, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2003 financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Integral Systems, Inc. and subsidiaries for the year ended September 30, 2003, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
McLean, Virginia
November 21, 2003
F-4
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2005 and 2004
| | | | | | |
| | | 2005
| | 2004
|
| ASSETS | | | | | | |
| Current assets | | | | | | |
Cash and cash equivalents | | $ | 24,775,460 | | $ | 18,198,832 |
Marketable securities, net | | | 32,716,000 | | | 29,060,396 |
Accounts receivable, net | | | 37,078,857 | | | 39,434,793 |
Inventories | | | 2,223,373 | | | 1,312,161 |
Prepaid expenses | | | 585,740 | | | 632,595 |
Notes receivable | | | 378,055 | | | 263,913 |
Employee and other receivables | | | 87,655 | | | 193,722 |
Deferred income taxes | | | 878,066 | | | 855,700 |
| | |
|
| |
|
|
Total current assets | | | 98,723,206 | | | 89,952,112 |
Property and equipment, net | | | 5,903,603 | | | 3,557,133 |
Notes receivable – long term portion | | | 267,708 | | | 300,338 |
Goodwill | | | 41,011,844 | | | 33,256,186 |
Intangible assets, net | | | 362,493 | | | 637,493 |
Software development costs, net of accumulated amortization | | | 2,601,693 | | | 4,591,904 |
Deposits and deferred charges | | | 325,736 | | | 171,275 |
| | |
|
| |
|
|
Total assets | | $ | 149,196,283 | | $ | 132,466,441 |
| | |
|
| |
|
|
| | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | |
| Current liabilities | | | | | | |
Accounts payable – trade | | $ | 6,360,140 | | $ | 5,491,629 |
Accrued expenses | | | 14,722,834 | | | 13,893,662 |
Capital leases payable | | | 25,119 | | | 35,119 |
Billings in excess of revenue for contracts in progress | | | 7,088,015 | | | 5,581,124 |
Income Taxes Payable | | | 188,285 | | | 672,148 |
| | |
|
| |
|
|
Total current liabilities | | | 28,384,393 | | | 25,673,682 |
Capital leases payable – long-term portion | | | — | | | 25,119 |
Deferred income taxes – long-term portion | | | 125,644 | | | 1,428,344 |
| | |
|
| |
|
|
Total liabilities | | | 28,510,037 | | | 27,127,145 |
| | |
|
| |
|
|
| Stockholders’ Equity | | | | | | |
Common stock, $.01 par value, 40,000,000 shares authorized, and 10,447,623 and 9,944,494 shares issued and outstanding | | | 104,476 | | | 99,445 |
Additional paid-in capital | | | 91,963,338 | | | 81,201,927 |
Retained earnings | | | 28,575,843 | | | 24,010,558 |
Accumulated other comprehensive income | | | 42,589 | | | 27,366 |
| | |
|
| |
|
|
Total stockholders’ equity | | | 120,686,246 | | | 105,339,296 |
| | |
|
| |
|
|
Total liabilities and stockholders’ equity | | $ | 149,196,283 | | $ | 132,466,441 |
| | |
|
| |
|
|
The accompanying notes are an integral part of these consolidated financial statements.
F-5
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended September 30, 2005, 2004 and 2003
| | | | | | | | | | | | |
| | | 2005
| | | 2004
| | | 2003
| |
Revenue | | $ | 97,724,835 | | | $ | 90,311,277 | | | $ | 82,585,064 | |
Cost of Revenue | | | | | | | | | | | | |
Direct labor | | | 21,948,542 | | | | 19,341,669 | | | | 17,780,499 | |
Overhead costs | | | 17,590,203 | | | | 14,231,494 | | | | 12,959,576 | |
Travel and other direct costs | | | 2,344,573 | | | | 2,428,071 | | | | 2,397,185 | |
Direct equipment & subcontracts | | | 26,128,721 | | | | 23,783,487 | | | | 22,237,986 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total cost of revenue | | | 68,012,039 | | | | 59,784,721 | | | | 55,375,246 | |
| | |
|
|
| |
|
|
| |
|
|
|
Gross margin | | | 29,712,796 | | | | 30,526,556 | | | | 27,209,818 | |
Selling, general & administrative | | | 13,432,287 | | | | 12,657,227 | | | | 11,465,932 | |
Research & development | | | 2,415,147 | | | | 3,690,795 | | | | 2,664,159 | |
Non recurring compensation | | | 1,184,538 | | | | — | | | | — | |
Product amortization | | | 2,581,628 | | | | 3,045,524 | | | | 2,988,924 | |
Intangible asset amortization | | | 275,000 | | | | 782,029 | | | | 1,289,060 | |
| | |
|
|
| |
|
|
| |
|
|
|
Income from operations | | | 9,824,196 | | | | 10,350,981 | | | | 8,801,743 | |
Other income (expense) | | | | | | | | | | | | |
Interest income | | | 1,150,879 | | | | 616,382 | | | | 594,551 | |
Interest expense | | | (7,393 | ) | | | (7,145 | ) | | | (9,345 | ) |
Gain on sale of marketable securities | | | 49,997 | | | | 45,604 | | | | 139,797 | |
Impairment loss on marketable securities | | | — | | | | — | | | | (1,364,180 | ) |
Miscellaneous, net | | | (629,948 | ) | | | (400,881 | ) | | | (279,939 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total other income | | | 563,535 | | | | 253,960 | | | | (919,116 | ) |
Income before income taxes | | | 10,387,731 | | | | 10,604,941 | | | | 7,882,627 | |
Provision for income taxes | | | 4,086,811 | | | | 3,843,943 | | | | 2,864,027 | |
| | |
|
|
| |
|
|
| |
|
|
|
Net income | | $ | 6,300,920 | | | $ | 6,760,998 | | | $ | 5,018,600 | |
| | |
|
|
| |
|
|
| |
|
|
|
Weighted avg. number of common shares: | | | | | | | | | | | | |
Basic | | | 10,282,420 | | | | 9,895,357 | | | | 9,713,321 | |
Diluted | | | 10,533,987 | | | | 10,150,348 | | | | 9,859,557 | |
Earnings per share (basic) | | $ | 0.61 | | | $ | 0.68 | | | $ | 0.52 | |
| | |
|
|
| |
|
|
| |
|
|
|
Earnings per share (diluted) | | $ | 0.60 | | | $ | 0.67 | | | $ | 0.51 | |
| | |
|
|
| |
|
|
| |
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
F-6
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended September 30, 2005, 2004 and 2003
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Number of
Shares
| | | Common
Stock at
Par Value
| | | Additional
Paid-in
Capital
| | | Retained
Earnings
| | | Accumulated
Other
Comprehensive
Income (Loss)
| | | Total
| |
Balance September 30, 2002 | | 9,322,783 | | | $ | 93,228 | | | $ | 65,070,787 | | | $ | 17,599,042 | | | $ | (506,877 | ) | | $ | 82,256,180 | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | — | | | | — | | | | — | | | | 5,018,600 | | | | — | | | | 5,018,600 | |
Unrealized gain on marketable securities (net of deferred tax of $59,844) | | — | | | | — | | | | — | | | | — | | | | 23,269 | | | | 23,269 | |
Reclassification adjustment on marketable securities | | — | | | | — | | | | — | | | | — | | | | 483,344 | | | | 483,344 | |
Unrealized loss on foreign currency exchange contracts | | — | | | | — | | | | — | | | | — | | | | (105,379 | ) | | | (105,379 | ) |
Cumulative currency translation adjustment | | — | | | | — | | | | — | | | | — | | | | 28,849 | | | | 28,849 | |
| | | | | | | | | | | | | | | | | | | | | |
|
|
|
Total comprehensive income | | — | | | | — | | | | — | | | | — | | | | — | | | | 5,448,683 | |
Repurchased shares | | (331,721 | ) | | | (3,318 | ) | | | (2,265,145 | ) | | | (4,029,457 | ) | | | — | | | | (6,297,920 | ) |
Shares issued to acquire RT Logic | | 709,676 | | | | 7,097 | | | | 13,742,903 | | | | — | | | | — | | | | 13,750,000 | |
Stock options exercised | | 23,064 | | | | 231 | | | | 330,126 | | | | — | | | | — | | | | 330,357 | |
Tax benefit of stock options exercised | | — | | | | — | | | | 141,286 | | | | — | | | | — | | | | 141,286 | |
| | |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Balance September 30, 2003 | | 9,723,802 | | | $ | 97,238 | | | $ | 77,019,957 | | | $ | 18,588,185 | | | | ($76,794 | ) | | $ | 95,628,586 | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | — | | | | — | | | | — | | | | 6,760,998 | | | | — | | | | 6,760,998 | |
Unrealized gain on marketable securities (net of deferred tax of $9,297) | | — | | | | — | | | | — | | | | — | | | | 14,545 | | | | 14,545 | |
Unrealized gain on foreign currency exchange contracts | | — | | | | — | | | | — | | | | — | | | | 84,536 | | | | 84,536 | |
Cumulative currency translation adjustment | | — | | | | — | | | | — | | | | — | | | | 5,079 | | | | 5,079 | |
| | | | | | | | | | | | | | | | | | | | | |
|
|
|
Total comprehensive income | | — | | | | — | | | | — | | | | — | | | | — | | | | 6,865,158 | |
Repurchased shares | | (16,750 | ) | | | (167 | ) | | | (126,876 | ) | | | (150,344 | ) | | | — | | | | (277,387 | ) |
Shares issued for fiscal 2003 RT Logic earnout | | 209,926 | | | | 2,099 | | | | 3,817,924 | | | | — | | | | — | | | | 3,820,023 | |
Stock options exercised | | 27,516 | | | | 275 | | | | 459,113 | | | | — | | | | — | | | | 459,388 | |
Tax benefit of stock options exercised | | — | | | | — | | | | 31,809 | | | | — | | | | — | | | | 31,809 | |
Cash dividends ($0.03 per share) | | — | | | | — | | | | — | | | | (1,188,281 | ) | | | — | | | | (1,188,281 | ) |
| | |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Balance September 30, 2004 | | 9,944,494 | | | $ | 99,445 | | | $ | 81,201,927 | | | $ | 24,010,558 | | | $ | 27,366 | | | $ | 105,339,296 | |
| | |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | — | | | | — | | | | — | | | | 6,300,920 | | | | — | | | | 6,300,920 | |
Unrealized gain (loss) on marketable securities (net of deferred tax of $9,129) | | — | | | | — | | | | — | | | | — | | | | (14,281 | ) | | | (14,281 | ) |
Unrealized gain on foreign currency exchange contracts | | — | | | | — | | | | — | | | | — | | | | 20,843 | | | | 20,843 | |
Cumulative currency translation adjustment | | — | | | | — | | | | — | | | | — | | | | 8,661 | | | | 8,661 | |
| | | | | | | | | | | | | | | | | | | | | |
|
|
|
Total comprehensive income | | — | | | | — | | | | — | | | | — | | | | — | | | | 6,316,143 | |
Repurchased shares | | (8,100 | ) | | | (81 | ) | | | (62,663 | ) | | | (82,726 | ) | | | — | | | | (145,470 | ) |
Shares issued for fiscal 2004 RT Logic earnout | | 230,349 | | | | 2,303 | | | | 4,184,059 | | | | — | | | | — | | | | 4,186,362 | |
Stock options exercised | | 280,880 | | | | 2,809 | | | | 5,182,931 | | | | — | | | | — | | | | 5,185,740 | |
Tax benefit of stock options exercised | | — | | | | — | | | | 272,546 | | | | — | | | | — | | | | 272,546 | |
Non recurring stock option compensation | | — | | | | — | | | | 1,184,538 | | | | — | | | | — | | | | 1,184,538 | |
Cash dividends ($0.04 per share) | | — | | | | — | | | | — | | | | (1,652,909 | ) | | | — | | | | (1,652,909 | ) |
| | |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Balance September 30, 2005 | | 10,447,623 | | | $ | 104,476 | | | $ | 91,963,338 | | | $ | 28,575,843 | | | $ | 42,589 | | | $ | 120,686,246 | |
| | |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
F-7
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 2005, 2004 and 2003
| | | | | | | | | | | | |
| | | 2005
| | | 2004
| | | 2003
| |
Cash flows from operating activities: | | | | | | | | | | | | |
Net income | | $ | 6,300,920 | | | $ | 6,760,998 | | | $ | 5,018,600 | |
Adjustments to reconcile net income to Net cash provided by operating activities: | | | | | | | | | | | | |
Depreciation and amortization | | | 4,487,333 | | | | 5,591,684 | | | | 5,873,013 | |
Bad debt expense | | | 22,390 | | | | 66,132 | | | | (240,000 | ) |
Gain on sale of marketable securities | | | (49,997 | ) | | | (45,604 | ) | | | (139,797 | ) |
Impairment of marketable securities | | | — | | | | — | | | | 1,364,180 | |
Loss on disposal of fixed assets | | | 40,395 | | | | 43,518 | | | | 27,237 | |
Gain on write off of goodwill associated with sale of the Antenna Division | | | (172,057 | ) | | | — | | | | — | |
Non recurring stock compensation expense | | | 1,184,538 | | | | — | | | | — | |
(Benefit) Provision for deferred income taxes | | | (1,204,448 | ) | | | (742,771 | ) | | | (724,474 | ) |
Changes in operating assets and liabilities, net of effects from acquisitions: | | | | | | | | | | | | |
Accounts receivable and other receivables | | | 2,433,103 | | | | (7,468,330 | ) | | | (9,457,626 | ) |
Prepaid expenses and deposits | | | (94,478 | ) | | | (306,300 | ) | | | 326,045 | |
Inventories | | | (1,256,080 | ) | | | (478,890 | ) | | | 700,328 | |
Accounts payable | | | 843,465 | | | | 946,952 | | | | (2,444,541 | ) |
Accrued expenses | | | (2,612,685 | ) | | | (3,074,396 | ) | | | 93,125 | |
Billings in excess of revenue | | | 1,506,891 | | | | (1,428,505 | ) | | | 2,437,931 | |
Income taxes payable | | | (82,176 | ) | | | 840,986 | | | | 4,388,552 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total adjustments | | | 5,046,194 | | | | (6,055,524 | ) | | | 2,203,973 | |
| | |
|
|
| |
|
|
| |
|
|
|
Net cash provided by operating activities | | | 11,347,114 | | | | 705,474 | | | | 7,222,573 | |
| | |
|
|
| |
|
|
| |
|
|
|
Cash flows from investing activities: | | | | | | | | | | | | |
Purchases of marketable securities | | | (24,610,000 | ) | | | (18,550,000 | ) | | | — | |
Sale of marketable securities | | | 20,980,983 | | | | 17,747,986 | | | | 18,302,778 | |
Issuance of Notes Receivable | | | (108,391 | ) | | | — | | | | (400,000 | ) |
Proceeds from payments on notes receivable | | | 293,483 | | | | 124,249 | | | | 5,242,806 | |
Acquisition of fixed assets | | | (4,096,047 | ) | | | (1,439,669 | ) | | | (1,398,029 | ) |
Software development costs | | | (591,417 | ) | | | (1,882,455 | ) | | | (2,253,255 | ) |
Acquisition of RT Logic, net of cash received | | | — | | | | — | | | | (13,414,315 | ) |
Acquisition of J&T antenna assets | | | — | | | | — | | | | (35,629 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Net cash (used in) provided by investing activities | | | (8,131,389 | ) | | | (3,999,889 | ) | | | 6,044,356 | |
| | |
|
|
| |
|
|
| |
|
|
|
Cash flows from financing activities: | | | | | | | | | | | | |
Proceeds from issuance of common stock | | | 5,185,740 | | | | 459,388 | | | | 330,357 | |
Stock repurchase | | | (145,470 | ) | | | (277,387 | ) | | | (6,297,920 | ) |
Dividend payments | | | (1,652,909 | ) | | | (1,188,281 | ) | | | — | |
Notes payable | | | — | | | | — | | | | (802,190 | ) |
Payments on capital lease obligations | | | (35,119 | ) | | | (32,270 | ) | | | (29,653 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Net cash provided by (used in) financing activities | | | 3,352,242 | | | | (1,038,550 | ) | | | (6,799,406 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Effect of currency translation | | | 8,661 | | | | 5,079 | | | | (5,168 | ) |
Net increase (decrease) in cash and cash equivalents | | | 6,567,967 | | | | (4,332,965 | ) | | | 6,467,523 | |
Cash and cash equivalents - beginning of year | | | 18,198,832 | | | | 22,526,718 | | | | 16,064,363 | |
| | |
|
|
| |
|
|
| |
|
|
|
Cash and cash equivalents - end of year | | $ | 24,775,460 | | | $ | 18,198,832 | | | $ | 22,526,718 | |
| | |
|
|
| |
|
|
| |
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
F-8
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies |
Nature of Business
Integral Systems, Inc. (the “Company”), headquartered in Lanham, Maryland, builds satellite ground systems for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 205 different satellite missions for communications, science, meteorology, and earth resource applications. The Company has an established domestic and international customer base that includes government and commercial satellite operators, spacecraft and payload manufacturers, and aerospace systems integrators. The Company’s wholly owned subsidiary, ISI Europe, with headquarters in Toulouse, France, serves as the focal point for the support of all of Integral’s European business.
Through its wholly owned subsidiaries SAT Corporation (“SAT”) and Newpoint Technologies Inc. (“Newpoint”), the Company offers complementary ground system components and systems. This includes “turnkey” systems, hardware, and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring and control, and satellite data processing.
Through its wholly owned subsidiary Real Time Logic, Inc. (“RT Logic”), which was acquired in October 2002, the Company manufactures satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories, and range facilities.
In July 2003, the Company acquired the intellectual property rights, inventory and certain other assets of the former Jackson & Tull Satellite Ground Systems division. The acquisition was an extension of the satellite ground systems business segment and enabled the Company to be a “turnkey” provider of full motion antennas and RF systems used for tracking low earth orbiting satellites and launch vehicles as well as aeronautical telemetry range operations. In November 2004, the Company disposed of the intellectual property rights, inventory and certain other assets relating to this division. See Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein for more information.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, SAT, Newpoint, RT Logic (see Note 2), and ISI Europe. All significant intercompany transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities, and changes therein, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
F-9
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Marketable Securities
The Company classifies its investments in marketable equity and debt securities as available for sale in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The investments are carried at fair market value, with temporary unrealized gains and losses reported in stockholders’ equity as a component of accumulated other comprehensive income (loss), net of any related tax effect. Other than temporary declines in fair market value are recorded as an impairment loss in the statement of operations.
Contract Revenue
Revenue from fixed-price contracts is recognized on the percentage-of-completion method, measured by the cost-to-cost method for each contract. Revenue under cost-plus-fixed-fee contracts is recorded on the basis of direct costs plus indirect costs incurred and an allocable portion of the fixed fee. Revenue from time and materials contracts is recognized based on fixed hourly rates for direct labor expended. The fixed rate includes direct labor, indirect expenses and profits. Reimbursements for material or other specified direct costs are recorded at actual cost.
Contract costs include all direct material and labor costs and those indirect costs related to contract performance. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on contracts in progress are made in the period in which they become determinable. Changes in job performance, job conditions, and estimated profitability, including final contract settlements, may result in revisions to costs and income and are recognized in the period in which the need for such revisions are determined. The Company’s contracts vary in length from one to six years after September 30, 2005.
The fees under certain government contracts may be increased or decreased in accordance with cost or performance incentive provisions that measure actual performance against established targets or other criteria. Such incentive fee awards or penalties are included in revenue at the time the amounts can be reasonably determined.
Unbilled accounts receivable represents revenue recognized in excess of amounts billed. Billings in excess of revenue for contracts in progress are recorded as deferred revenue until the revenue recognition criteria are met.
The allowance for doubtful accounts receivable is determined based upon management’s best estimate of potentially uncollectible accounts receivable.
F-10
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Sale of Software Products
Most of the Company’s contracts include the license of proprietary software products. Sales of the Company’s software products take many forms. The Company sells (1) software only (a “Software-Only Sale”), (2) software and services together, or (3) software, services and hardware together. In addition, depending on a customer’s requirements, the Company may or may not provide post-contract customer support (“PCS”).
The Company’s recognition of revenue for sales of Company software products depends on customer requirements and the nature of the contracts involved. In accordance with SOP 97-2, “Software Revenue Recognition”, for a Software-Only Sale, the Company recognizes revenue when all of the following criteria are met: persuasive evidence of an arrangements exists, delivery has occurred, the vendor’s fee is fixed or determinable and collectibility is probable. In situations where software is sold together with services and/or hardware, the Company recognizes software license revenue on a percentage of completion basis.
With respect to PCS, the Company recognizes PCS revenue on a percentage of completion basis when PCS is part of a broader fixed price contract that includes software and services. Alternatively, when PCS services (i.e. software maintenance and support) are awarded to the Company under a separate maintenance contract, the Company recognizes PCS revenue on a straight-line basis pro rata over the term of the maintenance contract.
Impairment of Long-Lived Assets
Pursuant to Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company periodically evaluates the recoverability of its long-lived assets. This evaluation consists of a comparison of the carrying value of the assets with the assets’ expected future cash flows, undiscounted and without interest costs. Estimates of expected future cash flows represent management’s best estimate based on reasonable and supportable assumptions and projections. If the expected future cash flow, undiscounted and without interest charges, exceeds the carrying value of the asset, no impairment is recognized. Impairment losses are measured as the difference between the carrying value of long-lived assets and their fair market value, based on discounted future cash flows of the related assets.
F-11
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Goodwill
The Company’s acquisition of other companies has resulted in the acquisition of certain intangible assets and goodwill. Goodwill is subject to impairment to the extent the Company’s operations experience significant negative results. These negative results can be the result of the Company’s individual operations or negative trends in the Company’s industry or in the general economy, which impact the Company. To the extent the Company’s goodwill is determined to be impaired then these balances are written down to their estimated fair value on the date of the impairment. The Company conducts an annual, or sooner if the situation warrants, review for impairment. Determining when an impairment has occurred involves a significant amount of judgment. Management bases its judgment on a number of factors including viability of the businesses acquired, their integration into the Company’s operations, the market in which those businesses operate and their projected future results, cash flow projections, and numerous other factors. In September 2005, the Company performed its annual review for impairment and determined that goodwill was not impaired.
Depreciation and Amortization
Property and equipment are stated at cost. The Company provides for depreciation and amortization by charges, using the straight-line method, to operating expenses at rates based on estimated useful lives as follows:
| | |
Classification
| | Estimated Useful Lives
|
Electronic equipment | | 3 Years |
Furniture and fixtures | | 5 Years |
Leasehold improvements | | Life of lease |
Software | | 3 Years |
Maintenance and repair costs are charged to expense as incurred. Replacements and betterments are capitalized. At the time properties are retired or otherwise disposed of, the property and related accumulated depreciation or amortization accounts are relieved of the applicable amounts and any resulting gain or loss is credited or charged to income.
F-12
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Inventories
Inventories are priced at the lower of cost or market using the first in, first-out (FIFO) method of accounting. Obsolete inventory is written off and its value is removed from inventory at the time its obsolescence is determined. Inventories consist of the following as of September 30:
| | | | | | |
| | | 2005
| | 2004
|
Finished Goods | | $ | 2,004,158 | | $ | 849,682 |
Work in process | | | — | | | 36,039 |
Raw Materials | | | 219,215 | | | 426,440 |
| | |
|
| |
|
|
Total | | $ | 2,223,373 | | $ | 1,312,161 |
| | |
|
| |
|
|
Software Development Costs
The Company has capitalized costs related to the development of certain software products. In accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed”, capitalization of costs begins when technological feasibility has been established and ends when the product is available for general release to customers. Amortization is computed on an individual product basis and has been recognized for those products available for market based on the products’ estimated economic lives of three to five years. Due to inherent technological changes in software development, however, the period over which such capitalized costs are being amortized may be modified.
Earnings Per Share
Basic earnings per share is computed using the weighted average number of shares outstanding during the period. In accordance with Statement of Financial Accounting Standards No. 128 “Earnings Per Share,” the diluted earnings per share calculation includes 171,396 and 230,349 shares relating to the September 30, 2005 and September 30, 2004, respectively, contingent consideration payable to the former RT Logic shareholders in connection with the RT Logic acquisition agreement (see Note 2). The only other reconciling item between the shares used for basic and diluted earnings per share relate to outstanding stock options. No reconciling items existed between the net income used for basic and diluted earnings per share.
F-13
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Cash and Concentrations of Risk
The Company considers all highly liquid debt instruments purchased with a maturity of 45 days or less to be cash equivalents. Cash accounts are maintained primarily with one federally insured financial institution. Balances usually exceed insured limits, but management does not consider this to be a significant concentration of credit risk.
Major customer information and revenue by customer category is discussed in Note 3. Revenue from foreign sources, primarily with corporations located in Malaysia, France, Greece, Taiwan, and Japan, totaled $10.9 million, $11.3 million, and $10.4 million for the years ended September 30, 2005, 2004, and 2003. The Company has no significant long-lived assets located in foreign countries.
Fair Value of Financial Instruments
The balance sheet includes various financial instruments (primarily cash and cash equivalents, marketable securities, accounts receivable, accounts payable, accrued expenses and billings in excess of revenue for contracts in progress). The fair values of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and billings in excess of revenue for contracts in progress approximate the carrying values due to the short maturity of these instruments. Marketable securities are recorded at fair market value.
Stock Based Compensation
The Company recognizes expense for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Accordingly, compensation cost is recognized for the excess of the estimated fair value of the stock at the grant date over the exercise price, if any.
F-14
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Stock Based Compensation (continued)
The Financial Accounting Standards Board recently published Statement of Financial Accounting Standards No. 123 (R), Share-Based Payment (“SFAS 123 (R)”), which is effective with the first fiscal year beginning after June 15, 2005. This statement will require compensation costs related to share-based payments, including stock options, to be recognized in the Consolidated Statement of Operations based on their fair values. On August 19, 2005, the Board of Directors approved resolutions to accelerate the vesting of all outstanding unvested options previously awarded to employees and officers of the Company effective August 31, 2005. However, holders of incentive stock options had the option to decline the acceleration of their options to prevent changing the status of the incentive stock options to a non-qualified stock option for federal income tax purposes. Holders of options to purchase 4,772 shares elected to decline the accelerated vesting. Options to purchase 453,268 shares of stock with exercise prices ranging from $16.13 to $22.96 were accelerated.
The primary purpose of the accelerated vesting was to eliminate future compensation expense the Company would otherwise recognize in its statement of operations with respect to these options upon the adoption of SFAS No. 123R. The acceleration of the vesting of these options resulted in the Company recording a non-cash stock compensation expense of approximately $1.2 million during the Company’s fourth quarter using the intrinsic value method. However, the related future compensation expense to be recorded upon adoption of SFAS 123R that was eliminated as a result of the acceleration of the vesting of these options is approximately $4.1 million. .
The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock- based employee compensation for the years ended September 30, 2005, 2004 and 2003 is as follows:
| | | | | | | | | |
| | | 2005
| | 2004
| | 2003
|
Net income, as reported | | $ | 6,300,920 | | $ | 6,760,998 | | $ | 5,018,600 |
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related taxes | | | 4,933,925 | | | 1,724,166 | | | 1,779,798 |
Add: Stock-based employee compensation included in net income, net of related taxes | | | 975,534 | | | — | | | — |
| | |
|
| |
|
| |
|
|
Pro forma net income (loss) | | $ | 2,342,529 | | $ | 5,036,832 | | $ | 3,238,802 |
| | |
|
| |
|
| |
|
|
Earnings per share: | | | | | | | | | |
As reported - basic | | $ | 0.61 | | $ | 0.68 | | $ | 0.52 |
- diluted | | $ | 0.60 | | $ | 0.67 | | $ | 0.51 |
Pro forma - basic | | $ | 0.23 | | $ | 0.51 | | $ | 0.33 |
- diluted | | $ | 0.22 | | $ | 0.50 | | $ | 0.33 |
These pro forma amounts are not necessarily indicative of future effects of applying the fair value-based method due to, among other things, the vesting period of the stock options and the fair value of additional stock options which may be issued in future years. The Company currently does not plan to grant any additional stock options to employees, officers or directors in future years.
F-15
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 1. | Summary of Significant Accounting Policies (continued) |
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) 123 (Revised 2004),Shared-Based Payment. SFAS 123R addresses the requirements of an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which an employee is required to provide services in exchange for the award. The Company will be required to adopt this Statement during the first quarter of fiscal year 2006. As of September 30, 2005, the Company had 4,772 unvested share-based payments outstanding. In addition, the Company does not intend to issue stock option awards for the foreseeable future. Therefore, the Company believes that the adoption of SFAS 123R will not have a material impact on its future operations and financial reporting.
In May 2005, the FASB issued Statement 154,“Accounting Changes and Error Corrections – a replacement of AFB Opinion No. 20 and FASB Statement No. 3”(AC Section A07). Statement 154 requires that all voluntary changes in accounting principles and changes required by a new accounting pronouncement that do not include specific transition provisions be applied retrospectively to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. Statement 154 is effective prospectively for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for fiscal years beginning after the date the statement was issued (May 2005). The Company believes that the implementation of the guidance contained in Statement 154 will not have a material effect on its financial condition, results of operations, or liquidity.
In June 2005, the Emerging Issues Task Force reached consensus on EITF Issue 05-06,“Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination”(“EITF 05-6”). EITF 05-6 concluded that leasehold improvements acquired in a business combination should be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonable assured at the date of acquisition. The Task Force also concluded that leasehold improvements placed in service significantly after and not contemplated at or near the beginning of the lease term should be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date the leasehold improvements are purchased. EITF 05-6 is effective prospectively for leasehold improvements purchased or acquired in periods beginning after June 29, 2005. The Company’s implementation of the guidance contained in EITF 05-6 did not have an effect on its financial condition, results of operations, or liquidity in fiscal year 2005 and is not expected to have a material effect on its financial condition, results of operations, or liquidity in fiscal year 2006 and beyond.
Reclassifications
Certain reclassifications have been made to prior year amounts in order to conform to the current year presentation.
F-16
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 2. | Acquisitions and Dispositions |
Newpoint Technologies
On January 30, 2002, the Company completed its acquisition of Newpoint Technologies, Inc. (“Newpoint”). As consideration for all of the issued and outstanding shares of Newpoint, the Company agreed to make future contingent payments to the shareholders of Newpoint for the period beginning February 1, 2002 through September 30, 2005. Pursuant to the agreement, the contingent payments are calculated every September 30 in the period from February 1, 2002 through September 30, 2005 based on a formula of net income and excess revenues as defined in the acquisition agreement. Through September 30, 2005, no contingent payments were accrued.
RT Logic
On October 1, 2002, the Company acquired all of the issued and outstanding stock of RT Logic pursuant to an Agreement and Plan of Reorganization dated October 1, 2002 (the “Reorganization Agreement”). The primary reason for acquiring RT Logic was to expand the Company’s existing products into RT Logic’s government client base. The initial purchase price payable to the shareholders of RT Logic was $13.25 million in cash and 683,870 shares of the Company’s common stock. Pursuant to the Reorganization Agreement, in November 2002 the former shareholders of RT Logic received additional consideration of $500,000 in cash and 25,806 shares of the Company’s common stock. The Reorganization Agreement further provides that the former RT Logic shareholders will be entitled to receive contingent consideration, which is payable in the event that RT Logic’s business meets certain earnings performance targets during a period of up to four years following the acquisition. One-half of any contingent consideration will be payable in cash and the remainder will be payable in shares of the Company’s common stock. Any shares of the Company’s common stock issued in connection with the contingent consideration will be valued based on a 30-trading-day average leading up to the end of each applicable earn-out period. The contingent consideration is subject to claims by the Company under the indemnification provisions of the Reorganization Agreement. For the year ended September 30, 2003 and pursuant to the Reorganization Agreement, in January 2004 the former shareholders of RT Logic received additional consideration of $3.8 million in cash and 209,926 shares of the Company’s common stock. For the year ended September 30, 2004 and pursuant to the Reorganization Agreement, in February 2005, the former shareholders of RT Logic received additional consideration of $4.2 million in cash and 230,349 shares of the Company’s common stock. For the year ended September 30, 2005, and pursuant to the Reorganization Agreement, in January 2006, the former shareholders of RT Logic will receive additional consideration of $3.8 million in cash and 171,396 shares of the Company’s common stock. This will be the final payment relating to the contingent purchase price in accordance with the Reorganization Agreement. The contingent purchase price payable in January 2006 is included in Other Accrued Expenses on the balance sheet. Additionally, the 171,396 share that are issuable and the 230,349 and 104,856 shares that were issued are included in the Company’s diluted earnings per share computation for the years ended September 30, 2005, 2004 and 2003, respectively.
F-17
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 2. | Acquisitions and Dispositions (continued) |
Antenna Systems Division
On July 23, 2003, the Company completed its acquisition of the intellectual property rights, inventory and certain other assets of the former Jackson & Tull Satellite Ground Systems division. As consideration, the Company agreed to make future contingent payments to Jackson & Tull for the period from July 23, 2003 to September 30, 2006. The contingent payments are calculated every September 30 beginning September 30, 2004 based on pretax income as defined in the Asset Purchase Agreement. As of September 30, 2005, no contingent payments have been accrued. Additionally, the Company loaned Jackson & Tull $400,000 to pay off certain vendor obligations that had been incurred prior to the purchase in exchange for a $400,000 promissory note. The promissory note accrues interest at a rate of 6% per annum and is payable in three equal installments of $133,333 plus accrued interest due on December 31 of each of 2004, 2005 and 2006.
Under the terms of the promissory note, Jackson & Tull has elected to make equal monthly payments in the amount of $15,114 beginning January 1, 2005 making the required lump sum payment that would have been due at December 31,2004.
On November 17, 2004, the Company disposed of the intellectual property rights, inventory and certain other assets of Antenna Systems division to LJT & Associates, Inc. of Montgomery, Alabama (LJT). The disposition was effective November 1, 2004. As consideration, LJT agreed to pay the Company $215,000 and executed a promissory note requiring payment of that sum in eight equal installments of $26,875 due on July 1 and January 1 beginning on July 1, 2005. As additional consideration, LJT agreed to make future contingent payments to the Company, in certain circumstances, for the period beginning November 1, 2004 through December 31, 2006. The contingent payments are calculated every December 31 beginning December 31, 2005 based on pretax income as defined in the Asset Purchase Agreement. Under the Asset Purchase Agreement, the Company will continue to fulfill its obligations under existing customer contracts but will engage LJT as a subcontractor to perform the actual work. The Company did not record a material gain or a loss as a result of this transaction.
F-18
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 3. | Accounts Receivable and Revenue |
Accounts receivable at September 30, 2005 and 2004 consist of the following:
| | | | | | | | |
| | | 2005
| | | 2004
| |
| Billed | | | | | | | | |
Government services | | | | | | | | |
Prime contracts | | $ | 5,987,298 | | | $ | 5,989,131 | |
Subcontracts | | | 8,254,749 | | | | 5,949,097 | |
Commercial products and services | | | 5,060,871 | | | | 3,179,379 | |
Allowance for doubtful accounts | | | (140,000 | ) | | | (150,000 | ) |
| | |
|
|
| |
|
|
|
Total billed | | | 19,162,918 | | | | 14,967,607 | |
| | |
|
|
| |
|
|
|
| Unbilled | | | | | | | | |
Government services | | | | | | | | |
Prime contracts | | | 9,725,503 | | | | 12,265,031 | |
Subcontracts | | | 3,673,967 | | | | 5,278,047 | |
Commercial products and services | | | 4,516,469 | | | | 6,924,108 | |
| | |
|
|
| |
|
|
|
Total unbilled | | | 17,915,939 | | | | 24,467,186 | |
| | |
|
|
| |
|
|
|
Total accounts receivable, net | | $ | 37,078,857 | | | $ | 39,434,793 | |
| | |
|
|
| |
|
|
|
Unbilled accounts receivable include amounts arising primarily from the use of the percentage-of-completion or other methods of recognizing revenue that differ from contractual billing terms. Substantially all unbilled receivables are expected to be billed and collected in one year.
The Company earns revenue, both as a prime contractor and a subcontractor, from sales of its products and services through contracts funded by the U.S. Government, as well as commercial and international organizations. During the years ended September 30, 2005, 2004 and 2003, approximately 77%, 76%, and 76%, respectively, of the Company’s revenue was from government services, primarily the United States Air Force (USAF) and the National Oceanic and Atmospheric Administration (NOAA). The remaining revenue is from commercial products and services.
In June 2004 and May 2005, Integral Systems filed claims in the amount of $1.8 million and $319,000, respectively, against NOAA. The claims arose under a contract from NOAA to provide the Data Collection System Automated Processing System II (DAPS-II System). Integral Systems has submitted appeals to the General Services Board of Contract Appeals related to these claims. A hearing date has not been set for the appeal. In August 2005, the Company filed another claim against NOAA in the amount of $135,000. This claim arose under a contract from NOAA to perform software and hardware upgrades on NOAA’s Polar Acquisition and Control Subsystem. NOAA intends to issue a final decision on this claim on or before January 23, 2006. As of September 30, 2005, accounts receivable includes approximately $1.1 million associated with these claims. This amount is based on management’s best estimate at September 30th. At this time, the Company believes it is recoverable,
F-19
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
The following summarizes the Company’s investments in debt and equity securities at September 30, 2005 and 2004:
| | | | | | | | | |
2005
| | Cost
| | Gross
Unrealized
Gain/(Loss)
| | Fair Market
Value
|
State Debt Securities | | $ | 15,506,000 | | $ | — | | $ | 15,506,000 |
Auction Rate Securities | | | 17,210,000 | | | — | | | 17,210,000 |
| | |
|
| |
|
| |
|
|
Total | | $ | 32,716,000 | | $ | — | | $ | 32,716,000 |
| | |
|
| |
|
| |
|
|
| | | |
2004
| | Cost
| | Gross
Unrealized
Gain/(Loss)
| | Fair Market
Value
|
State Debt Securities | | $ | 10,911,000 | | $ | — | | $ | 10,911,000 |
Preferred Stock | | | 18,000,000 | | | — | | | 18,000,000 |
Common Stock | | | 125,554 | | | 23,842 | | | 149,396 |
| | |
|
| |
|
| |
|
|
Total | | $ | 29,036,554 | | $ | 23,842 | | $ | 29,060,396 |
| | |
|
| |
|
| |
|
|
The investments in variable rate State of Maryland debt securities and Maryland “Auction Rate Securities” are carried at cost, which approximates fair market value. Banc of America Preferred Funding Corporation “Dividends Received Eligible Auction Market” preferred stock (“DREAMS”) was carried at cost, which approximated fair market value. The Company divested itself from these securities in June 2005. The investment in common stock is based on quoted market price. At September 30, 2004, an unrealized gain of $23,842 from the investment in common stock is reported in stockholders’ equity as other comprehensive income (loss), net of deferred tax expense of $9,297.
During fiscal year 2005 and 2004, the Company sold common stock that resulted in net gains of $49,997 and $45,604, respectively. The gains were determined using the specific identification method. The Company divested itself from these securities in fiscal year 2005.
Property and equipment as of September 30, 2005 and 2004 are as follows:
| | | | | | | | |
| | | 2005
| | | 2004
| |
Land | | $ | 2,327,329 | | | $ | — | |
Machinery and electronic equipment | | | 4,642,158 | | | | 4,884,764 | |
Furniture and fixtures | | | 659,612 | | | | 876,255 | |
Leasehold improvements | | | 1,706,393 | | | | 1,345,634 | |
Software | | | 808,520 | | | | 846,413 | |
| | |
|
|
| |
|
|
|
Total property and equipment | | | 10,144,012 | | | | 7,953,066 | |
Less: accumulated depreciation and amortization | | | (4,240,409 | ) | | | (4,395,933 | ) |
| | |
|
|
| |
|
|
|
Property and equipment, net | | $ | 5,903,603 | | | $ | 3,557,133 | |
| | |
|
|
| |
|
|
|
F-20
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 5. | Property and Equipment (continued) |
On August 25, 2005, RT Logic Tract TT2, LLC, a newly-formed and wholly owned subsidiary of RT Logic, closed on the purchase of 9.99 acres of real property in Colorado Springs, Colorado for a purchase price of approximately $2.3 million, pursuant to a Purchase Agreement with Northgate Properties, LLC. RT Logic intends to construct its new headquarters on this property.
Depreciation expense for the years ended September 30, 2005, 2004, and 2003 was $1,630,705, $1,764,133, and $1,595,029, respectively.
| 6. | Goodwill and Intangibles |
The following summarizes the Company’s goodwill and intangibles at September 30, 2005 and 2004:
| | | | | | |
| | | 2005
| | 2004
|
Goodwill | | $ | 41,011,844 | | $ | 33,256,186 |
| | |
|
| |
|
|
Intangibles | | | | | | |
Technology | | | 1,150,000 | | | 1,150,000 |
Customer Base | | | 1,621,082 | | | 1,621,082 |
| | |
|
| |
|
|
Less: Accumulated Amortization | | | 2,408,589 | | | 2,133,589 |
| | |
|
| |
|
|
Intangibles, net | | $ | 362,493 | | $ | 637,493 |
| | |
|
| |
|
|
The identified intangible assets have an estimated useful life ranging from 18 months to five years. Amortization expense for the years ended September 30, 2005, 2004 and 2003 was $275,000, $782,029 and $1,289,060, respectively. Future amortization expense is as follows:
| | | |
2006: | | | 212,500 |
2007: | | | 149,993 |
| | |
|
|
Total | | $ | 362,493 |
| | |
|
|
The increase in goodwill relates primarily to contingent consideration paid to the former shareholders of RT Logic in the amount of $7.6 million pursuant to an Agreement and Plan of Reorganization dated October 1, 2002.
F-21
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
Software development costs as of September 30, 2005 and 2004 consist of the following:
| | | | | | | | |
| | | 2005
| | | 2004
| |
Costs incurred | | $ | 18,828,018 | | | $ | 18,236,601 | |
Less: accumulated amortization | | | (16,226,325 | ) | | | (13,644,697 | ) |
| | |
|
|
| |
|
|
|
Software development costs, net | | $ | 2,601,693 | | | $ | 4,591,904 | |
| | |
|
|
| |
|
|
|
Amortization expense for the years ended September 30, 2005, 2004 and 2003, was $2,581,628, $3,045,522 and $2,988,924, respectively.
The Company has a line of credit agreement with a local bank for $10,000,000 for general corporate purposes. Borrowings under the line of credit are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5 to 2.4%, based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable, inventory, equipment, and insurance proceeds and has certain financial covenants, including minimum net worth and liquidity ratios. The line of credit expires on February 28, 2007. The Company did not use and had no balance outstanding at September 30, 2005 and 2004.
The Company had letters of credit amounting to $450,000, $490,000, and $230,000 as of September 30, 2005, 2004 and 2003, respectively, with certain banks relating to leased facilities. In addition, the Company had letters of credit amounting to $1.5 million, $3.7 million, and $2.6 million as of September 30, 2005, 2004 and 2003, respectively, with a bank relating to obligations on certain contracts.
Accrued expenses at September 30, 2005 and 2004, consist of the following:
| | | | | | |
| | | 2005
| | 2004
|
Accrued payroll and withholdings | | $ | 3,443,336 | | $ | 2,546,606 |
Accrued vacation | | | 1,928,325 | | | 1,859,501 |
Accrued profit sharing | | | 1,719,526 | | | 927,505 |
Accrued earnout (RT Logic) | | | 7,611,023 | | | 8,372,738 |
Other accrued expenses | | | 20,624 | | | 187,312 |
| | |
|
| |
|
|
Total accrued expenses | | $ | 14,722,834 | | $ | 13,893,662 |
| | |
|
| |
|
|
F-22
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 10. | Commitments and Contingencies |
Capital Leases
The Company has a $2,000,000 equipment lease line of credit under which the Company can sell equipment and lease it back for a period of three years. The line expires in May 2006. The Company incurred capital lease obligations when it entered into new leases for equipment. There were no capital lease additions for the years ended September 30, 2005, 2004 and 2003, respectively. Future payments under the capital lease obligations at September 30, 2005, are as follows:
| | | | |
Year ending September 30, 2006 | | $ | 25,918 | |
| | |
|
|
|
Total payments | | | 25,918 | |
Less amount representing interest at 8.8% per annum | | | (799 | ) |
| | |
|
|
|
Present value of future lease payments | | $ | 25,119 | |
| | |
|
|
|
Operating Leases
The Company leases office space in Colorado, Maryland, California, New Hampshire and Toulouse, France. The current leases for offices in the United States expire in 2010, 2009, 2009, and 2006. The current leases for offices in France expire in 2006 and 2013. Approximate future minimum lease payments under the office leases are as follows:
| | | |
Years ending September 30, 2006 | | $ | 1,799,000 |
2007 | | | 1,564,000 |
2008 | | | 1,535,000 |
2009 | | | 1,209,000 |
2010 | | | 311,000 |
Thereafter | | | 206,000 |
| | |
|
|
Total payments | | $ | 6,624,000 |
| | |
|
|
Lease payments do not include operating expenses or utilities, which are adjusted annually. Rent expense was $2,324,500, $2,199,696 and $2,250,047 for the years ended September 30, 2005, 2004 and 2003, respectively.
Government Contracts
A significant portion of the Company’s revenues represent payments made by the U.S. Government and by contractors that have prime contracts with the U.S. Government. Certain of these revenues are subject to adjustment upon audit by the Defense Contract Audit Agency (DCAA). Audits by the DCAA have been completed on the Company’s contracts and subcontracts through the year ended September 30, 2002. RT Logic, Inc. has been audited by DCAA through March 31, 2000. Management is of the opinion that any disallowances of costs for subsequent fiscal years by the government auditors will not materially affect the Company’s financial statements.
F-23
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
For the years ended September 30, 2005, 2004 and 2003, the provision for income taxes consists of the following:
| | | | | | | | | | | | |
| | | 2005
| | | 2004
| | | 2003
| |
Current tax expense | | | | | | | | | | | | |
Federal | | $ | 4,587,431 | | | $ | 3,732,659 | | | $ | 2,891,434 | |
State | | | 690,277 | | | | 854,056 | | | | 697,067 | |
| | |
|
|
| |
|
|
| |
|
|
|
| | | | 5,277,708 | | | | 4,586,715 | | | | 3,588,501 | |
Deferred tax benefit | | | (1,190,897 | ) | | | (742,771 | ) | | | (724,474 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total provision | | $ | 4,086,811 | | | $ | 3,843,944 | | | $ | 2,864,027 | |
| | |
|
|
| |
|
|
| |
|
|
|
At September 30, 2005 and 2004, the tax effect of significant temporary differences representing deferred tax assets and liabilities are as follows:
| | | | | | | | |
| | | Asset (Liability)
| |
| | | 2005
| | | 2004
| |
Deferred Tax Assets: | | | | | | | | |
Vacation accrual | | $ | 700,838 | | | $ | 657,745 | |
Allowance for doubtful accounts | | | 53,896 | | | | 58,500 | |
Impairment of marketable securities | | | — | | | | 309,817 | |
Accrued expenses and other | | | 99,632 | | | | — | |
NOL carry forwards | | | 509,112 | | | | 712,114 | |
Capital loss carryforward | | | 358,253 | | | | — | |
Stock option expense | | | 202,706 | | | | | |
Accrued commissions | | | 16,752 | | | | 25,813 | |
| | |
|
|
| |
|
|
|
Total Deferred Tax Assets | | | 1,941,189 | | | | 1,763,989 | |
| | |
|
|
| | | | |
Deferred Tax Liabilities: | | | | | | | | |
Purchase accounting | | | — | | | | (187,045 | ) |
Depreciation and amortization | | | (1,188,767 | ) | | | (2,140,458 | ) |
Unrealized loss on marketable securities | | | — | | | | (9,130 | ) |
| | |
|
|
| |
|
|
|
Total Deferred Tax Liabilities | | | (1,188,767 | ) | | | (2,336,633 | ) |
| | |
|
|
| |
|
|
|
Net Deferred Tax Asset/(Liability) | | $ | 752,422 | | | $ | (572,644 | ) |
| | |
|
|
| |
|
|
|
F-24
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 11. | Income Taxes (continued) |
As of September 30, 2005, the Company had approximately $8.1 million of state NOL’s which expire between 2010 and 2022. The Company also had capital loss carryforwards of approximately $930,000, which expire between 2009 and 2010. All federal NOLs have been realized.
In evaluating the Company’s ability to recover its deferred tax assets, we considered all available positive and negative evidence, including past operating results, the reversal of temporary differences, the forecasts of future taxable income from operations and investments and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with estimates being used to manage the business. Based on the weight of the positive and negative evidence and the information available, management believes that it is more likely than not that its deferred tax assets will be realized.
The temporary differences are presented in the balance sheet as follows:
| | | | | | | | |
| | | Asset (Liability)
| |
| | | 2005
| | | 2004
| |
Deferred income tax asset – current portion | | $ | 878,065 | | | $ | 855,700 | |
Deferred income tax asset/(liability) – long term portion | | | (125,643 | ) | | | (1,428,344 | ) |
| | |
|
|
| |
|
|
|
Net Deferred Tax Asset/(Liability) | | $ | 752,422 | | | $ | (572,644 | ) |
| | |
|
|
| |
|
|
|
The effective income tax rates differ from the statutory U.S. income tax rate due principally to the following:
| | | | | | | | | |
| | | 2005
| | | 2004
| | | 2003
| |
Federal statutory rate | | 35.0 | % | | 34.0 | % | | 34.0 | % |
State tax, net of federal income tax benefit | | 3.5 | | | 4.2 | | | 4.8 | |
Tax benefit of tax free investment income | | (2.2 | ) | | (.6 | ) | | (1.4 | ) |
Other | | 3.0 | | | (1.4 | ) | | (1.1 | ) |
| | |
|
| |
|
| |
|
|
Effective rate | | 39.3 | % | | 36.2 | % | | 36.3 | % |
| | |
|
| |
|
| |
|
|
F-25
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 12. | Profit Sharing and Employee Benefits Plans |
The Company has a profit sharing and 401(k) plan for the benefit of substantially all employees. The Company currently contributes a discretionary amount of 11% of eligible employee’s salary to the plan. Future contributions will be a discretionary amount determined by the company’s performance and profitability. The 401(k) feature allows employee’s to make elective deferrals not to exceed 25% of compensation. For the years ended September 30, 2005, 2004 and 2003, contributions to the plans totaled $3,428,676, $3,077,697, and $2,570,451, respectively.
Effective May 1, 2002, the Company established the 2002 Stock Option Plan, which was amended and restated effective May 1, 2005, to create additional incentives for the Company’s employees, consultants and directors to promote the financial success of the Company. The Stock Option Committee of the Board of Directors has sole authority to select full-time employees, directors or consultants to receive awards of options for the purchase of stock under this plan. The maximum number of shares of common stock that may be issued pursuant to the Amended and Restated 2002 Stock Option Plan is 1,150,000. The exercise price of each option is set at the stock’s closing price on the date the option is granted by the Stock Option Committee of the Board of Directors. Options expire no later than ten years from the date of grant (five years for greater-than-10% owners) or three months after employment ceases, whichever occurs first, and vest from one to five years.
Prior to adoption of the 2002 Stock Option Plan, which was effective May 25, 1988 and amended on January 1, 1994 and May 8, 1998, the Company established the 1988 Stock Option Plan. This plan was created to provide additional incentives for the Company’s employees, consultants and directors to promote the financial success of the Company. The Stock Option Committee of the Board of Directors has sole authority to select full-time employees, directors or consultants to receive awards of options for the purchase of stock under this plan. At September 30, 2005, the maximum number of shares of common stock which may be issued pursuant to the 1988 Stock Option Plan was 1,800,000. The exercise price of each option was set at the stock’s closing price on the date the option was granted by the Stock Option Committee of the Board of Directors. Options expire no later than ten years from the date of grant (five years for greater-than 10% owners) or three months after employment ceases, whichever comes first, and vest from one to five years. Pursuant to the approval by stockholders at the April 17, 2002 Annual Meeting of the Shareholders, no further options were granted after April 30, 2002 under the 1988 Stock Option Plan.
On August 19, 2005, the Board of Directors adopted resolutions to accelerate the time of vesting of all of the Company’s outstanding and unvested stock options as of August 31, 2005, subject to approval by the optionholder in certain circumstances. As a result options to purchase 453,268 shares of the Company’s common stock became fully exercisable as of August 31, 2005.
F-26
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 13. | Stock Option Plan (continued) |
The primary purpose of the accelerated vesting was to eliminate future compensation expense the Company would otherwise recognize in its statement of operations with respect to these options upon the adoption of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (Revised 2004),Share-Based Payment(“SFAS 123R”). SFAS l23R, which was required to be adopted by the Company on October 1, 2005,would require that compensation expense associated with stock options be recognized in the statement of operations, rather than as a footnote disclosure in the Company’s consolidated financial statements.
The acceleration of the vesting of these options resulted in the Company recording a non-cash stock compensation expense of approximately $1.2 million during the Company’s fourth quarter using the intrinsic value method. However, the related future compensation expense to be recorded upon adoption of SFAS 123R that is eliminated as a result of the acceleration of the vesting of these options is approximately $4.1 million.
The Company has reserved for issuance an aggregate of 366,970 shares of Common Stock under the 1988 Stock Option Plan and 750,000 under the 2002 Stock Option Plan. However, the Company does not currently intend to grant any stock options to employees in the future. .
The following table summarizes the Company’s activity for all of its stock option awards during the years ended September 30, 2005, 2004 and 2003:
| | | | | | |
| | | Shares
| | | Weighted Average
Exercise Prices
|
Options outstanding, September 30, 2002 | | 938,430 | | | $ | 19.49 |
Granted | | 301,300 | | | $ | 18.98 |
Exercised | | (23,064 | ) | | $ | 14.30 |
Cancelled | | (29,950 | ) | | $ | 18.62 |
| | |
|
| | | |
Options outstanding September 30, 2003 | | 1,186,716 | | | $ | 19.49 |
Granted | | 265,850 | | | $ | 18.09 |
Exercised | | (27,516 | ) | | $ | 16.69 |
Cancelled | | (39,450 | ) | | $ | 19.76 |
| | |
|
| | | |
Options outstanding September 30, 2004 | | 1,385,600 | | | $ | 19.27 |
Granted | | 14,000 | | | $ | 20.88 |
Exercised | | (280,880 | ) | | $ | 18.46 |
Cancelled | | (80,230 | ) | | $ | 20.07 |
| | |
|
| | | |
Options outstanding September 30, 2005 | | 1,038,490 | | | $ | 19.43 |
| | |
|
| | | |
F-27
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 13. | Stock Option Plan (continued) |
The following table summarizes additional information about stock options outstanding at September 30, 2005:
| | | | | | | | | | | | |
| | | Options Outstanding
| | Options Exercisable
|
Exercise Price Per Share
| | Number of
Shares
| | Weighted-
Average
Remaining
Life
| | Weighted-
Average
Exercise
Price
| | Number
Exercisable
| | Weighted-
Average
Exercise
Price
|
$ 2.00 – 19.99 | | 633,730 | | 3.36 Years | | $ | 18.25 | | 633,730 | | $ | 18.25 |
$20.00 – 39.99 | | 404,760 | | 2.14 Years | | $ | 21.30 | | 404,760 | | $ | 21.30 |
| | |
| |
| |
|
| |
| |
|
|
| | | 1,038,490 | | 2.88 Years | | $ | 19.45 | | 1,038,490 | | $ | 19.43 |
| | |
| |
| |
|
| |
| |
|
|
The fair value of the options granted is estimated on the date of the grant using the Black-Scholes options pricing model. The following table shows the assumptions used for the grants that occurred in each fiscal year.
| | | | | | | | | |
| | | 2005
| | | 2004
| | | 2003
| |
Expected volatility | | 46.0 | % | | 57.7 | % | | 55.6 | % |
Risk free interest rate | | 3.8 | % | | 3.9 | % | | 2.9 | % |
Dividend yield | | .68 | % | | .01 | % | | None | |
Expected lives | | 5.00 years | | | 5.92 years | | | 5 years | |
The weighted average fair values of options granted during the years ended September 30, 2005, 2004 and 2003, were $8.90, $10.34 and $10.45, respectively.
| 14. | Stockholder’s Equity Transactions |
During fiscal years 2005, 2004 and 2003, the Company reacquired 8,100, 16,750, and 331,721 shares of its stock for a total cost of $145,470, $277,388, and $6,297,920, respectively.
| 15. | Foreign Currency Exchange Contracts |
The Company periodically uses foreign currency exchange contracts to hedge risk associated with its European long-term contracts. Under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” all derivative instruments must be recorded on the balance sheet as an asset or liability with any gain or loss recorded as a component of accumulated other comprehensive income until recognized in earnings. The fair value of the exchange contracts is based upon quoted market prices. If a derivative does not qualify for hedge accounting the gain or loss is recorded through earnings. For the years ended September 30, 2005 and 2004, the Company recorded an unrealized gain of $20,843 and $84,536, respectively, as accumulated other comprehensive income. The Company also recorded a realized loss of $7,630 and $14,884 during the years ended September 30, 2005 and 2004. As of September 30, 2005, the Company does not have any derivatives which qualify for hedge accounting.
F-28
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 16. | Supplemental Cash Flow Information |
For the years ended September 30, 2005, 2004, and 2003, income taxes paid were $5,370,250, $3,766,212, and $1,945,474 respectively, and interest expense paid was $7,693, $7,145, and $9,345 respectively.
| 17. | Business Segment Information |
Effective October 1, 2004, the Company reorganized its operations into four reportable segments. The primary purpose of the reorganization was to place the Company’s commercially oriented operations under common marketing and management leadership and to more efficiently sell and promote its products to common customers. The four segments are:
| | • | | Ground Systems - Government |
| | • | | Ground Systems - Commercial |
| | • | | Space Communications Systems |
The Ground Systems – Government segment provides ground systems products and services to the U.S. Government. It is currently the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force and NOAA.
The Ground Systems – Commercial segment provides ground systems products and services to commercial enterprises and international governments and organizations. It consists of the Company’s core command and control business for commercial applications and three of the Company’s wholly owned subsidiaries as follows:
| | • | | SAT and Newpoint, acquired by the Company in August 2000 and January 2002, respectively, offer complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring and control and satellite data processing. |
| | • | | ISI Europe, the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business. |
The Space Communications Systems segment, consisting exclusively of the Company’s wholly owned subsidiary, RT Logic, designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range operations.
F-29
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 17. | Business Segment Information (continued) |
The Corporate segment is the Company’s “all other” segment. It includes the Company’s Product Division, which is responsible for the Company’s core command and control product line (EPOCH IPS); business areas in the development stage and businesses being disbanded (the Company’s Antenna Division, the Company’s Skylight product, and the Company’s Integration and Test (I&T) Division). The Product Division licenses the Company’s EPOCH IPS product line to other operating segments and to third party customers. It is also the segment responsible for EPOCH IPS maintenance and support revenue and expenses.
The accounting policies of the segments are the same as those described in Note 1. The Company evaluates the performance of each segment based on operating income. There are no inter-segment allocations of overhead.
On November 17, 2004, the Company disposed of the intellectual property rights, inventory and certain other assets of the Antenna Division to LJT & Associates, Inc. of Montgomery, Alabama (“LJT”), effective as of November 1, 2004. As consideration, LJT agreed to pay the Company $215,000 and executed a promissory note requiring payment of that sum in eight equal installments of $26,875 due on each July 1 and January 1 beginning on July 1, 2005. As additional consideration, LJT agreed to make future contingent payments to the Company for the period beginning November 1, 2004 through December 31, 2006. The contingent payments are calculated every December 31 beginning December 31, 2005 based on pretax income as defined in the Asset Purchase Agreement. Under the Asset Purchase Agreement, the Company will continue to fulfill its obligations under existing customer contracts but will engage LJT as a subcontractor to perform the actual work. The Company did not record a material gain or a loss as a result of this transaction.
In addition, the Company loaned LJT $100,000 to assist with initial expenses arising from use of the acquired assets in operations. LJT executed a promissory note requiring payment of that sum in installments to coincide with milestone payments on a certain contract. The Company disbursed the loan to LJT by issuing a cash disbursement in the amount of $54,906, which represents the loan balance after deducting the net assumed obligations with an aggregate total of $45,094.
F-30
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 17. | Business Segment Information (continued) |
Summarized financial information by business segment is as follows:
| | | | | | | | | | | | |
| | | Fiscal Year
Ended Sept. 30, 2005
| | | Fiscal Year
Ended Sept. 30, 2004
| | | Fiscal Year
Ended Sept. 30, 2003
| |
Revenue | | | | | | | | | | | | |
Ground Systems - Government | | $ | 47,608,911 | | | $ | 45,048,212 | | | $ | 39,964,653 | |
Ground Systems - Government intersegment | | | N/A | | | | 251,447 | | | | N/A | |
Ground Systems - Commercial | | | 17,544,380 | | | | 17,111,902 | | | | 15,328,954 | |
Ground Systems - Commercial intersegment | | | 380,475 | | | | 84,579 | | | | 15,000 | |
Space communication Systems | | | 28,535,121 | | | | 22,821,419 | | | | 20,141,634 | |
Space communication Systems intersegment | | | 3,947,900 | | | | 3,444,505 | | | | 3,027,066 | |
Corporate | | | 4,036,423 | | | | 5,329,744 | | | | 7,149,823 | |
Corporate intersegment | | | 3,419,206 | | | | 4,311,013 | | | | 6,393,026 | |
Elimination of intersegment sales | | | (7,747,581 | ) | | | (8,091,544 | ) | | | (9,435,092 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total Revenue | | $ | 97,724,835 | | | $ | 90,311,277 | | | $ | 82,585,064 | |
| | |
|
|
| |
|
|
| |
|
|
|
Operating Income | | | | | | | | | | | | |
Ground Systems - Government | | $ | 3,930,106 | | | $ | 4,958,600 | | | $ | 2,815,120 | |
Ground Systems - Government intersegment | | | N/A | | | | N/A | | | | N/A | |
Ground Systems - Commercial | | | 1,085,888 | | | | (208,507 | ) | | | (1,434,034 | ) |
Ground Systems - Commercial intersegment | | | (14,248 | ) | | | (25,740 | ) | | | 14,690 | |
Space communication Systems | | | 9,449,147 | | | | 8,903,736 | | | | 7,496,904 | |
Space communication Systems intersegment | | | 346 | | | | (547 | ) | | | (8 | ) |
Corporate | | | (4,640,945 | ) | | | (3,302,848 | ) | | | (76,247 | ) |
Corporate intersegment | | | (8,456 | ) | | | (3,096 | ) | | | 3,163 | |
Elimination of intersegment operating income | | | 22,358 | | | | 29,383 | | | | (17,845 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total Operating Income | | $ | 9,824,196 | | | $ | 10,350,981 | | | $ | 8,801,743 | |
| | |
|
|
| |
|
|
| |
|
|
|
Depreciation and Amortization | | | | | | | | | | | | |
Ground Systems - Government | | $ | 357,497 | | | $ | 311,371 | | | $ | 256,064 | |
Ground Systems - Commercial | | | 543,575 | | | | 987,995 | | | | 1,034,435 | |
Space communication Systems | | | 809,931 | | | | 1,045,340 | | | | 1,362,188 | |
Corporate | | | 2,776,330 | | | | 3,246,978 | | | | 3,220,326 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total Depreciation and Amortization | | $ | 4,487,333 | | | $ | 5,591,684 | | | $ | 5,873,013 | |
| | |
|
|
| |
|
|
| |
|
|
|
Goodwill | | | | | | | | | | | | |
Ground Systems - Government | | $ | N/A | | | $ | N/A | | | $ | N/A | |
Ground Systems - Commercial | | | 2,415,180 | | | | 2,415,180 | | | | 2,415,180 | |
Space communication Systems | | | 38,706,668 | | | | 31,079,977 | | | | 23,679,486 | |
Corporate | | | (110,004 | ) | | | (238,971 | ) | | | (379,401 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total Goodwill | | $ | 41,011,844 | | | $ | 33,256,186 | | | $ | 25,715,265 | |
| | |
|
|
| |
|
|
| |
|
|
|
Total Assets | | | | | | | | | | | | |
Ground Systems – Government | | $ | 19,883,124 | | | $ | 23,469,345 | | | $ | 13,500,404 | |
Ground Systems – Commercial | | | 12,201,723 | | | | 13,523,712 | | | | 11,413,012 | |
Space communication Systems | | | 60,781,553 | | | | 55,032,197 | | | | 49,601,871 | |
Corporate | | | 73,970,145 | | | | 55,402,803 | | | | 60,062,386 | |
Elimination of intersegment accounts receivable | | | (17,640,262 | ) | | | (14,961,615 | ) | | | (11,784,474 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Total Assets | | $ | 149,196,283 | | | $ | 132,466,442 | | | $ | 122,793,199 | |
| | |
|
|
| |
|
|
| |
|
|
|
F-31
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 18. | Quarterly Financial Data (unaudited) |
The Company’s first three quarters ended on December 31, March 31 and June 30. The fourth quarter ended on September 30, 2005.
The following tables contain selected unaudited Consolidated Statement of Operations data for each quarter of fiscal years 2005 and 2004 (in thousands, except per share amounts).
| | | | | | | | | | | | |
| | | Fiscal 2005 Quarter Ended
|
| | | December 31
| | March 31
| | June 30
| | September 301
|
Revenue | | $ | 21,919 | | $ | 23,347 | | $ | 25,379 | | $ | 27,080 |
Gross margin | | | 7,135 | | | 7,332 | | | 7,345 | | | 7,901 |
Income from Operations | | | 1,866 | | | 3,034 | | | 2,629 | | | 2,295 |
Net Income | | $ | 1,186 | | $ | 2,049 | | $ | 1,864 | | $ | 1,202 |
Earnings per share – basic | | $ | 0.12 | | $ | 0.20 | | $ | 0.18 | | $ | 0.12 |
Earnings per share – diluted | | $ | 0.11 | | $ | 0.20 | | $ | 0.18 | | $ | 0.11 |
Weighted average common and equivalent shares outstanding – basic | | | 10,045 | | | 10,259 | | | 10,393 | | | 10,433 |
Weighted average common and equivalent shares outstanding – diluted | | | 10,369 | | | 10,405 | | | 10,630 | | | 10,734 |
| |
| | | Fiscal 2004 Quarter Ended
|
| | | December 31
| | March 31
| | June 30
| | September 30
|
Revenue | | $ | 20,054 | | $ | 22,508 | | $ | 22,632 | | $ | 25,117 |
Gross margin | | | 6,624 | | | 7,944 | | | 7,202 | | | 8,756 |
Income from Operations | | | 1,894 | | | 2,716 | | | 2,137 | | | 3,604 |
Net Income | | $ | 1,174 | | $ | 1,780 | | $ | 1,384 | | $ | 2,423 |
Earnings per share – basic | | $ | 0.12 | | $ | 0.18 | | $ | 0.14 | | $ | 0.24 |
Earnings per share – diluted | | $ | 0.12 | | $ | 0.18 | | $ | 0.14 | | $ | 0.24 |
Weighted average common and equivalent shares outstanding – basic | | | 9,731 | | | 9,956 | | | 9,950 | | | 9,944 |
Weighted average common and equivalent shares outstanding – diluted | | | 10,005 | | | 10,076 | | | 10,100 | | | 10,184 |
| 1. | Net income for the quarter ended September 30, 2005 includes approximately $1.2 million of operating expense related to non-recurring compensation for the vesting acceleration of stock options. |
F-32
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
On October 3, 2005, Lumistar, Inc. (the “Acquisition Subsidiary”), a newly-formed subsidiary of RT Logic, a subsidiary of the Company, acquired substantially all of the assets of Lumistar, LLC (the “Seller”) relating to the Seller’s business of providing system level and board level telemetry acquisition products (“the Business”) pursuant to an Asset Purchase Agreement dated as of October 3, 2005 by and among the Company, RT Logic, the Acquisition Subsidiary, the Seller and certain members of the Seller. The primary reason for acquiring Lumistar was to expand the Company’s existing products to Lumistar’s client base.Total initial consideration paid to the Seller at the closing was $10,000,000, of which $5,000,000 was paid in cash and $5,000,000 paid in the form of the Company’s common stock. The Company’s common stock issued to the Seller at the closing was valued for this purpose at the average closing price per share of the Company’s common stock over the 30-day trading period ending on September 30, 2005, or approximately $22.23 per share. This resulted in the Company issuing to the Seller 224,931 shares of its common stock at the closing.
Pursuant to the Asset Purchase Agreement and upon final determination of the Balance Sheet as of the closing date (“Closing Balance Sheet”), if the net tangible assets set forth in the Closing Balance Sheet are equal to or greater than $500,000, the amount of the excess, if any, shall be paid to the Seller as additional purchase price in cash. Likewise, if the net tangible assets set forth in the Closing Balance Sheet are less than $500,000, the amount of the difference shall be returned to the Company in cash.
The Seller is also entitled to contingent consideration payments based on the Business’s pre-tax earnings, at a maximum of 100% of earnings, for a period of up to four years after the closing. Any contingent earn-out payments will be payable in fifty percent cash and fifty percent stock, although the Company has the option to pay the full amount of the contingent consideration to the Seller in cash.
The acquisition was accounted for using the purchase method of accounting under the guidance in FASB Statement 141, Business Combinations. Accordingly, a portion of the purchase price has been allocated to assets acquired and liabilities assumed and other identified intangible assets based on estimated fair values on the acquisition date. Approximately $1,401,658, $159,500 and $241,559 was allocated to net assets assumed, technology, customer related intangibles. The excess of the net assets assumed and the purchase price over the identified intangible assets acquired of approximately $7,111,118 was allocated to goodwill. The identified intangible assets will be amortized on a straight-line basis over an estimated useful life of approximately 4 years for the technology and approximately 9 months for the customer related intangibles. Goodwill will be reviewed at least annually for impairment in accordance with SFAS 142. Amounts allocated to goodwill and intangibles assets will be deductible for tax purposes over 15 years in accordance with IRC Sec. 197. The purchase price allocation is based on preliminary estimates and is subject to change as final valuations are made.
F-33
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2005, 2004 and 2003
| 19. | Subsequent Events (continued) |
On October 27, 2005, the Company entered into the Fourth Amendment to Lease (the “Fourth Amendment”) with 5000 Philadelphia Way, LLC and 5200 Philadelphia Way, LLC (collectively, the “Landlord”) for the lease of the Company’s headquarters located at 5000 Philadelphia Way and 5200 Philadelphia Way, both in Lanham, Maryland. The Fourth Amendment expands the space leased by approximately 12,000 square feet, resulting in a new, combined total of 83,974 square feet leased from the Landlord. The Fourth Amendment also provides for the Company’s lease with the Landlord to terminate 10 years from the date of delivery of the expanded premises, which delivery occurred on November 1,2005. All other material provisions of the Company’s lease with the Landlord remained the same.
F-34
| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
On December 30, 2003, the Company dismissed Ernst & Young LLP (“Ernst & Young”) as the Company’s independent auditors and notified Ernst & Young of their dismissal.
On December 30, 2003, the Company engaged Grant Thornton LLP (“Grant Thornton”) as the Company’s independent auditors to audit the Company’s books and records for fiscal year 2004. Each of the dismissal of Ernst & Young and the engagement of Grant Thornton was recommended and approved by the Audit Committee of the Company on December 30, 2003.
| b. | Disagreements with Accountants on Accounting and Financial Disclosure. |
Not applicable.
| ITEM 9A. | CONTROLS AND PROCEDURES |
| a. | Disclosure Controls and Procedures. |
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company’s management carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as of the end of the fiscal year subject to this annual report. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s chief executive officer and chief financial officer. Based upon that evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures.
| b. | Changes in Internal Control Over Financial Reporting. |
As required by Rule 13a-15 under the Exchange Act, the Company’s management carried out an evaluation of any changes in the Company’s internal control over financial reporting that occurred during the Company’s fourth quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the chief executive officer and chief financial officer. Based upon that evaluation, the Company concluded that there was no change in the Company’s internal control over financial reporting during this period that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s chief executive officer and chief financial officer, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company, (2) provide reasonable assurance that transactions are
41
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
| c. | Management’s Report on Internal Control over Financial Reporting |
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our management, with the participation of our chief executive officer and chief financial officer (our principal executive officer and principal financial officer, respectively), assessed the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO Framework”). Based on our assessment under the COSO Framework, our management concluded that our internal control over financial reporting was effective as of September 30, 2005. Grant Thornton LLP, the Company’s independent registered public accounting firm, has issued an opinion on the Company’s assessment of its internal control over financial reporting. This opinion appears in the Report of Independent Registered Public Accounting Firm on page F-2 of this Annual Report on Form 10-K.
| ITEM 9B. | OTHER INFORMATION |
Not applicable.
42
PART III
| ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT |
| | |
Name
| | Position with the Company
|
Steven R. Chamberlain | | Chairman of the Board, Chief Executive Officer and Director |
| |
Thomas L. Gough | | President, and Director |
| |
Peter J. Gaffney | | Chief Operating Officer, Executive Vice President, Government Division |
| |
Elaine M. Brown | | Executive Vice President, Chief Financial Officer, Secretary and Treasurer |
| |
Stuart C. Daughtridge | | Executive Vice President, Commercial Division |
| |
Patrick R. Woods | | Executive Vice President, Business Development |
| |
Dominic A. Laiti | | Outside Director |
| |
R. Doss McComas | | Outside Director |
| |
Bonnie K. Wachtel | | Outside Director |
Directors of the Company serve until the next annual meeting of stockholders or until successors have been duly elected and qualified. Officers of the Company serve at the discretion of the Board of Directors.
Steven R. Chamberlain, 49, a Company founder, has been Chief Executive Officer and Chairman of the Board since June 1992 and a Director since 1982. He served as President from May 1988 until June 1992 and as Vice President from 1982 until he became President. From 1978 to 1982, Mr. Chamberlain was employed by OAO Corporation where he progressed from Systems Analyst to Manager of the Offutt Air Force Base field support office. Mr. Chamberlain holds a B.S. degree in Physics from Memphis State University and has done graduate work in Physics and Mathematics at Memphis State and the University of Maryland. Mr. Chamberlain has been charged in the District Court for Howard County, Maryland, with two misdemeanors, sex offense in the fourth degree and assault in the second degree. Trial is scheduled for January 2006. Mr. Chamberlain maintains his innocence and has stated that he will vigorously fight the charges. The Board of Directors of the Company recently appointed a committee of independent directors to review and apprise the Company on this matter.
Thomas L. Gough, 57, became a member of the Company’s staff in January 1984. In March 1996, he was elected to the Board of Directors of the Company. He has served as President of the Company since June 1992. He served as Chief Operating Officer from June 1992 until August 2005. For three years before being named President, Mr. Gough served as Vice President and Chief Financial Officer. Prior to joining the Company, Mr. Gough was employed by Business and Technological Systems, Inc., where he managed the Software Systems Division. From 1972 to 1977, he was employed by Computer Sciences Corporation, where he progressed from Programmer Analyst to Section Manager. Mr. Gough earned a B.S. degree from the University of Maryland with a major in Information Systems Management in the School of Business and Public Administration.
43
Peter J. Gaffney, 45, joined the Company in 1986. He has served as Chief Operating Officer and Executive Vice President, Government Division since August 2005. He served as Executive Vice President, Commercial Products from April 2002 until August 2005. From February 2000 until April 2002, Mr. Gaffney served as Vice President, Commercial Products. From May 1999 until February 2000, he served as Vice President, Commercial Division. From 1986 to 1992, he worked on simulators for the Company’s DMSP and Tiros programs. In 1992, he became a project manager for EPOCH 2000 ground systems programs, which included the Command and Range Generator project for GE Americom, the Loral Skynet Telstar 3, 4, and 5 ground systems, and the Echostar 1, 2, 3, and 4 ground systems. Prior to joining Integral Systems, Mr. Gaffney was a design engineer for the General Electric Co., where he worked on the DSCS, Milstar, Landsat, and Spot satellite programs. Mr. Gaffney graduated from the University of Maryland in 1981 with a B.S. degree in Electrical Engineering.
Elaine M. Brown, 42, joined the Company in 1983. Ms. Brown has served Chief Financial Officer since March 1997 and as Executive Vice President since April 2002. In February 2000, she was appointed Secretary and Treasurer. She served as Staff Accountant/Personnel Administrator until January 1995, when she was promoted to Controller/Director of Accounting. In March 1997, Ms. Brown was appointed Vice President. She holds a B.S. degree in Accounting from the University of Maryland and is a Certified Public Accountant.
Stuart C. Daughtridge,42, joined Integral Systems in January 1999. In October 2004, Mr. Daughtridge was promoted to Executive Vice President of the Commercial Division. In February 2000, he was appointed Vice President of the Commercial Division. From January 1999 to February 2000, he was a senior program manager for the Orion 1, 2 and 3 and New Skies Satellite programs. Prior to joining Integral Systems, Mr. Daughtridge worked in several management positions in the spacecraft engineering and satellite operations division of Orion Satellite Corporation (which later became part of Loral). His last position at Orion was Director of Satellite Operations. From 1990 to 1992, he worked at INTELSAT in spacecraft engineering and satellite operations for the INTELSAT-K spacecraft and the INTELSAT V, IV and VII series of satellites. From 1986 to 1990, he worked for Contel (which later became part of GTE) as a spacecraft engineer for NASA’s Tracking and Data Relay Satellite System. Mr. Daughtridge graduated from Lafayette College in 1986 with a B.S. degree in electrical engineering.
Patrick R. Woods, 50, joined the Company in 1995 as Director of Program Development. He has served as Executive Vice President, Business Development since August 2005, and as Executive Vice President, Government Programs from April 2002 until August 2005. Prior to becoming Executive Vice President, Mr. Woods served as Vice President of Government Programs from April 1998 until April 2002. From 1996 to April 1998, Mr. Woods served as Vice President, NOAA Programs. From 1994 to 1995, he worked for Space Systems/Loral (SS/L), and from 1985 to 1994, he worked for the Lockheed Martin Corporation (formerly Loral Aerospace). Mr. Woods served as the Director of Mission Operations for both SS/L and the AeroSys Division of Loral Aerospace. Mr. Woods holds a B.S. degree in Public Administration and a M.P.A. in Public Management from Indiana University.
Dominic A. Laiti, 73, has served as an outside director of the Company since July 1995. Mr. Laiti presently provides independent consulting services to several companies. He was founder, President and Director of Globalink, Inc. (an AMX company) from January 1990 to December 1994. He has over 30 years of experience in starting, building, and managing high-technology private and public companies with annual revenues from $2 million to over $120 million. Mr. Laiti was President of Hadron, Inc. from 1979 to 1989; Vice President of Xonics, Inc. from 1972 to 1979; and Vice President of KMS Industries from 1968 to 1972. He is a Director of Pantheon Software Inc.
R. Doss McComas, 52, has served as an outside director of the Company since July 1995. He is Vice President of TECORE Wireless Systems, Inc., a supplier of cellular protocol based wireless systems. Previously he was President of LynxConnect and Cybercommunitys, Chairman of Plexsys International, President of Fortel Technologies, Inc., and held positions with COMSAT RSI and Radation Systems, Inc., including Group Vice President, Vice President of Acquisitions, Strategic Planning and International Marketing, and General Counsel. Mr. McComas was previously a Board member of AirNet Communications Corp. (NASDAQ: ANCC), a supplier of software defined radios for cellular and special applications. He holds a B.A. degree from Virginia Polytechnic Institute; an M.B.A. from Mt. Saint Mary’s; and a J.D. from Gonzaga University.
44
Bonnie K. Wachtel, 50, has served as an outside director of the Company since May 1988. Since 1984, she has been Vice President, General Counsel, and a Director of Wachtel & Co., Inc., an investment-banking firm in Washington, DC. Ms. Wachtel serves as a Director of several corporations, including VSE Corporation and Information Analysis, Inc. She holds a B.A. and M.B.A. from the University of Chicago and a J.D. from the University of Virginia, and is a Certified Financial Analyst.
AUDIT COMMITTEE
The Company’s Audit Committee consists of Dominic A. Laiti, R. Doss McComas and Bonnie K. Wachtel, each of whom is independent within the meaning of applicable rules and regulations. At least one member of the Company’s Audit Committee is a financial expert. The member serving as the Audit Committee’s financial expert is Bonnie K. Wachtel, whose relevant experience is set forth above. Ms. Wachtel is considered independent in accordance with Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s officers and directors, and persons who own more than 10% of the Company’s Common Stock, to file reports of ownership and changes in ownership of the Company’s Common Stock with the Securities and Exchange Commission and NASDAQ. Based on a review of the copies of such reports, the Company believes that during the fiscal year ending September 30, 2005 its executive officers, directors and greater than ten percent stockholders filed on a timely basis all reports due under Section 16(a) of the Exchange Act, with the following exceptions: Stuart C. Daughtridge, an executive officer of the Company, inadvertently filed late a Form 4 for December 2004, reporting one transaction; and Bonnie K. Wachtel an outside Director of the Company, inadvertently filed late a Form 4 for May 2005, reporting one transaction.
CODE OF ETHICS
The Company has adopted the Integral Systems’ Code of Ethical Conduct that applies to its principal executive officer, principal financial officer, principal accounting officer and controller, and others. The Company has posted the Integral Systems’ Code of Ethical Conduct on its website at www.integ.com.
45
| ITEM 11. | EXECUTIVE COMPENSATION |
| a. | Summary Compensation Table |
The following table sets forth compensation received by the Company’s CEO and four highest paid executive officers who were serving as executive officers of the Company at the end of fiscal year 2005 and who earned over $100,000 during the fiscal year ended September 30, 2005:
| | | | | | | | | | | | | |
| | | Annual Compensation
| | Long-Term Compensation
Awards
|
Name and Principal Position
| | Year
| | Salary
| | Bonus
| | Shares
Underlying
Options
| | All Other
Compensation(1)
|
| Chief Executive Officer | | | | | | | | | | | | | |
Steven R. Chamberlain | | 2005
2004
2003 | | $
$
$ | 299,960
288,532
272,263 | | $
$
$ | 60,000
60,000
50,000 | | 0
10,000
15,000 | | $
$
$ | 23,100
23,332
23,223 |
| President | | | | | | | | | | | | | |
Thomas L. Gough | | 2005
2004
2003 | | $
$
$ | 235,345
223,682
216,047 | | $
$
$ | 50,000
35,000
35,000 | | 0
6,000
10,000 | | $
$
$ | 23,505
24,264
22,012 |
| Chief Operating Officer, Exec. Vice Pres., Government Programs | | | | | | | | | | | | | |
Peter J. Gaffney | | 2005
2004
2003 | | $
$
$ | 208,150
197,808
180,305 | | $
$
$ | 65,000
45,000
35,000 | | 0
18,000
10,000 | | $
$
$ | 22,859
21,595
18,187 |
| Exec. Vice Pres., Commercial Division | | | | | | | | | | | | | |
Stuart Daughtridge | | 2005
2004
2003 | | $
$
$ | 197,988
185,856
170,586 | | $
$
$ | 55,000
35,000
15,000 | | 0
6,000
4,000 | | $
$
$ | 21,746
20,087
17,113 |
| Exec. Vice Pres., Chief Financial Officer | | | | | | | | | | | | | |
Elaine M. Brown | | 2005
2004
2003 | | $
$
$ | 195,180
197,808
180,305 | | $
$
$ | 60,000
45,000
35,000 | | 0
6,000
10,000 | | $
$
$ | 21,432
21,501
18,353 |
| (1) | All Other Compensation represents employer pension contributions. It does not include the value of insurance premiums paid by or on behalf of the Company with respect to term life insurance for the benefit of each identified individual in the amounts of $598, $689 and $747 for fiscal years 2005, 2004 and 2003, respectively. |
46
Option/SAR Grants in Last Fiscal Year
No such stock option/SAR grants were made during the last fiscal year to any of the named executive officers.
| b. | Compensation Pursuant to Plans |
The Company’s Board of Directors awards annual bonuses to officers and employees on a discretionary basis. In fiscal year 2005, no formal plan existed for determining bonus amounts.
Effective October 1, 1987, the Company established a 401(K) pension and profit sharing plan (the “Plan”) under Section 401 of the Internal Revenue Code (the “Code”). Under the Plan, the Company currently contributes a discretionary amount equal to 11% of eligible employee’s salary. The employee may contribute up to an additional 25% as salary deferral.
Effective May 1, 2002, the Company established the 2002 Stock Option Plan (the “2002 Stock Option Plan”), which was amended and restated effective May 1, 2005, to create additional incentives for the Company’s employees, consultants and directors to promote the financial success of the Company. Stockholders approved the 2002 Stock Option Plan at the Annual Meeting which was held April 17, 2002. The maximum number of shares of Common Stock, which may be issued pursuant to the Amended and Restated 2002 Stock Option Plan, is 1,150,000 shares. The Stock Option Committee has the authority to select full-time employees, directors or consultants to receive awards of options for the purchase of stock of the Company under this plan. Options to purchase a total of 14,000 shares of Common Stock were issued under the 2002 Stock Option Plan in fiscal year 2005. Options to purchase 45,730 shares of Common Stock were exercised during the 2005 fiscal year under this plan. The Company has reserved for issuance an aggregate of 704,270 shares of Common Stock under the 2002 Stock Option Plan, of which options to purchase 671,520 shares are outstanding. Pursuant to the 2002 Stock Option Plan, options may be incentive stock options within the meaning of Section 422 of the Code or non-statutory stock options, although incentive stock options may be granted only to employees.
Effective May 25, 1988, the Company established a stock option plan, as amended and restated in 1994 and 1998 (the “1988 Stock Option Plan”), to create additional incentives for the Company’s employees, consultants and directors to promote the financial success of the Company. The Stock Option Committee had the authority to select full-time employees, directors or consultants to receive awards of options for the purchase of stock of the Company under this plan. The maximum number of shares of Common Stock which may be issued pursuant to the 1988 Stock Option Plan was increased from 300,000 to 1,200,000 during fiscal year 1994. At the Annual Meeting of stockholders of the Company held on July 22, 1998, the stockholders approved an amendment and restatement of the 1988 Stock Option Plan, which, among other changes, increased the number of shares subject to options under the 1988 Stock Option Plan from 1,200,000 to 1,800,000 shares. No shares of Common Stock were granted during the 2005 fiscal year under the 1988 Stock Option Plan. Options to purchase 235,150 shares of Common Stock granted under the 1988 Stock Option Plan were exercised during fiscal year 2005. The Company has reserved for issuance an aggregate of 366,970 shares of Common Stock under the 1988 Stock Option Plan, all of which are outstanding at September 30, 2005. Pursuant to the approval by stockholders at the April 17, 2002 Annual Meeting of Shareholders, no further options will be granted under the 1988 Stock Option Plan.
On August 19, 2005, the Board of Directors adopted resolutions to accelerate the time of vesting of all of the Company’s outstanding and unvested stock options as of August 31, 2005, subject to approval by the optionholder in certain circumstances. As a result , options to purchase 456,268 shares of the Company’s common stock became fully exercisable as of August 31, 2005.
The primary purpose of the accelerated vesting was to eliminate future compensation expense the Company would otherwise recognize in its statement of operations with respect to these options upon the adoption of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (Revised 2004),Share-Based
47
Payment(“SFAS 123R”). SFAS l23R, which was required to be adopted by the Company on October 1, 2005,would require that compensation expense associated with stock options be recognized in the statement of operations, rather than as a footnote disclosure in the Company’s consolidated financial statements.
The acceleration of the vesting of these options resulted in the Company recording a non-cash stock compensation expense of approximately $1.2 million during the Company’s fourth quarter of fiscal year 2005 using the intrinsic value method. However, the related future compensation expense to be recorded upon adoption of SFAS 123R that is eliminated as a result of the acceleration of the vesting of these options is approximately $4.1 million.
The Company does not currently intend to grant any stock options to employees in the future.
48
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
Five of the executives named below exercised options during the fiscal year ended September 30, 2005.
Steven R. Chamberlain exercised 20,000 Incentive Stock Options. Peter J. Gaffney exercised 23,000 Incentive Stock Options. Patrick R. Woods exercised 10,600 Incentive Stock Options. Elaine M. Brown exercised 10,000 Incentive Stock Options. Stuart C. Daughtridge exercised 1,000 Incentive Stock Options.
| | | | | | | | | |
Name
| | Shares Acquired
on Exercise (#)
| | Value Realized
| | Number of
Securities Underlying
Unexercised Options/
SARS at FY end (#)
Exercisable/
Unexercisable
| | Value of Unexercised In-the-Money Options/
SARS at FY end ($)1
Exercisable/
Unexercisable
|
Chief Executive Officer Steven R. Chamberlain | | 20,000 | | $ | 401,977 | | 61,000
(exercisable)
0
(unexercisable) | | $83,380
(exercisable)
$0
(unexercisable) |
| | | | |
President Thomas L. Gough | | — | | $ | 0 | | 45,000
(exercisable)
0
(unexercisable) | | $69,700
(exercisable)
$0
(unexercisable) |
| | | | |
Chief Operating Officer/ Executive Vice President, Government Programs Peter J. Gaffney | | 23,000 | | $ | 454,825 | | 50,000
(exercisable)
0
(unexercisable) | | $82,300
(exercisable)
$0
(unexercisable) |
| | | | |
Executive Vice President, Chief Financial Officer Elaine M. Brown | | 10,000 | | $ | 198,331 | | 37,000
(exercisable)
0
(unexercisable) | | $48,580
(exercisable)
$0
(unexercisable) |
| | | | |
Executive Vice President, Commercial Division Stuart C. Daughtridge | | 1,000 | | $ | 19,450 | | 20,000
(exercisable)
0
(unexercisable) | | $32,700
(exercisable)
$0
(unexercisable) |
| (1) | Value for “In the Money” options represents the difference between the exercise prices of outstanding options and the fair market value of the Company’s common stock of $20.64 per share at September 30, 2005. |
| d. | Compensation of Directors |
Directors who are employees of the Company do not receive any compensation for their service as directors. The Company pays each director who is not an employee of the Company an aggregate of $18,500 per year for their services, which was increased from $16,000 effective December 1, 2004. The amount is paid in equal quarterly installments. Prior to August 2005, outside directors were are also annually granted options to purchase 5,000 shares of the Company’s common stock pursuant to the Stock Option Plan. The following table sets forth compensation received by the Company’s outside directors during fiscal year 2005:
| | | | | |
Name
| | Annual
Compensation
| | Option Shares
Granted
|
Dominic A. Laiti | | $ | 18,500 | | — |
R. Doss McComas | | $ | 18,500 | | — |
Bonnie K. Wachtel | | $ | 18,500 | | — |
49
| e. | Employment Contracts, Termination of Employment and Change of Control Termination |
The Company has no employment contracts and no compensatory plan or arrangement with respect to any individual named in the Summary Compensation Table (Item 11(a)) which results or will result from the resignation, retirement or any other termination of such individual’s employment with the Company or its subsidiaries or from a change in control of the Company or a change in the individual’s responsibilities following a change in control.
| f. | Compensation Committee Interlocks and Insider Participation. |
The Compensation Committee is, and was during fiscal year 2005, made up of Dominic A. Laiti, R. Doss McComas and Bonnie K. Wachtel, each of whom is an outside non-employee director.
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
| a. | Security Ownership of Certain Beneficial Owners (as of 9/30/05) |
The following table sets forth certain information regarding the beneficial ownership of the Company’s Common Stock, par value $.01, as of September 30, 2005, by each person (other than directors and executive officers of the Company) known by the Company to beneficially own more than 5% of the outstanding shares of Common Stock of the Company. The Company believes that all persons named in the following table have sole voting and investment power with respect to all shares of the Company’s Common Stock beneficially owned by them.
| | | | | |
Name and Address of Beneficial Owner
| | Amount and Nature
of Beneficial Ownership
| | Percent of Class
| |
Kern Capital Management, LLC 114 West 47th Street, Suite 1926 New York, NY 10036-1510 | | 1,502,200 | | 14.4 | % |
| | |
Royce & Associates, LLC 1414 Avenue of the Americas, 9th Floor New York, NY 10019-2578 | | 1,087,329 | | 10.4 | % |
| | |
Ashford Capital Management, Inc. 1 Walkers Mill Road Wilmington, DE 19807-2317 | | 810,529 | | 8.0 | % |
| | |
Wachovia Securities 901 East Byrd Street Richmond, Va 23219-4047 | | 546,400 | | 5.2 | % |
50
| b. | Security Ownership of Management (as of 9/30/05) |
The following table sets forth certain information regarding the beneficial ownership of the Company’s Common Stock, par value $.01, as of September 30, 2005, by (i) each director and executive officer of the Company and (ii) all directors and executive officers as a group. The Company believes that all persons named in the following table have sole voting and investment power with respect to all shares of the Company’s Common Stock beneficially owned by them. Except as indicated in the table, the address of the below-named directors and executive officers is that of the Company’s principal executive offices.
| | | | | | |
Name and Address of Beneficial Owner
| | Amount and Nature
of Beneficial Owner
| | | Percent
of Class
| |
Executive Officers, Directors | | | | | | |
Steven R. Chamberlain | | 446,405 | (1) | | 4.3 | % |
Thomas L. Gough | | 187,600 | (2) | | 1.8 | % |
Peter J. Gaffney | | 54,000 | (3) | | * | |
Elaine M. Brown | | 45,400 | (4) | | * | |
Patrick Woods | | 49,521 | (5) | | * | |
Stuart Daughtridge | | 23,100 | (6) | | * | |
Dominic A. Laiti
12525 Knoll Brook Drive
Clifton, VA 22024
| | 20,000 | (7) | | * | |
R. Doss McComas
409 Biggs Drive
Front Royal, VA 22630 | | 20,000 | (8) | | * | |
Bonnie K. Wachtel
1101 Fourteenth Street, N.W.
Suite 800
Washington, D.C. 20036 | | 68,000 | (9) | | * | |
All Directors and Executive Officers as a group
(9 persons). | | 914,026 | | | 8.49 | % |
| * | Less than one percent of the Common Stock outstanding. |
| (1) | Includes outstanding options to purchase 61,000 shares of Common Stock which are exercisable within 60 days. |
| (2) | Includes outstanding options to purchase 45,000 shares of Common Stock which are exercisable within 60 days. |
| (3) | Includes outstanding options to purchase 50,000 shares of Common Stock which are exercisable within 60 days. |
| (4) | Includes outstanding options to purchase 37,000 shares of Common Stock which are exercisable within 60 days. |
| (5) | Includes outstanding options to purchase 45,000 shares of Common Stock which are exercisable within 60 days. |
| (6) | Includes outstanding options to purchase 20,000 shares of Common Stock which are exercisable within 60 days. |
| (7) | Includes outstanding options to purchase 20,000 shares of Common Stock which are exercisable within 60 days. |
| (8) | Includes outstanding options to purchase 20,000 shares of Common Stock which are exercisable within 60 days. |
| (9) | Includes outstanding options to purchase 20,000 shares of Common Stock which are exercisable within 60 days. |
51
| c. | Equity Compensation Plan Information |
The following table sets forth certain equity compensation plan information as of September 30, 2005:
| | | | | | | |
Plan category
| | Number of securities to be issued upon exercise of outstanding options,
warrants and rights
| | Weighted-average
exercise price of
outstanding options,
warrants and rights
| | Number of securities
remaining available
for future issuance under equity compensation plans
(excluding securities
reflected in column (a))
|
| | | (a) | | (b) | | (c) |
Equity compensation plans approved by security holders | | 1,038,490 | | $ | 19.43 | | 32,750 |
Equity compensation plans not approved by security holders | | 0 | | | 0 | | 0 |
Total | | 1,038,490 | | $ | 19.43 | | 32,750 |
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
On October 1, 2002, the Company acquired all of the issued and outstanding stock of RT Logic pursuant to the Reorganization Agreement for an initial purchase price payable to the shareholders of RT Logic of $13.25 million in cash and 683,870 shares of Integral Systems common stock, par value $0.01 per share. Pursuant to the terms of the Reorganization Agreement with RT Logic, in November 2002, the former shareholders of RT Logic subsequently received additional aggregate consideration equal to $500,000 in cash and 25,806 shares of Integral Common Stock.
The Reorganization Agreement further provides that the former RT Logic shareholders will be entitled to receive contingent purchase price, which will be payable in accordance with the Reorganization Agreement in the event that RT Logic’s business meets certain earnings performance targets during a period of up to four (4) years following the merger. Fifty percent (50%) of any contingent purchase price will be payable in cash and fifty percent (50%) thereof will be payable in shares of the Company’s common stock. Any of the Company’s common stock issued in connection with the contingent purchase price will be valued based on a 30-trading-day average leading up to the end of each applicable earn out period. The contingent purchase price is subject to claims by the Company under the indemnification provisions of the Reorganization Agreement. For the year ended September 30, 2003 and pursuant to the Reorganization Agreement, in January 2004 the former shareholders of RT Logic received additional consideration of $3.8 million in cash and 209,926 shares of the Company’s common stock. For the year ended September 30, 2004 and pursuant to the Reorganization Agreement, in January 2005, the former shareholders of RT Logic received additional consideration of $4.2 million in cash and 230,349 shares of the Company’s common stock. For the year ended September 30, 2005 and pursuant to the Reorganization Agreement, in January 2006, the former shareholders of RT Logic will receive additional consideration of $3.8 million in cash and 171,396 shares of the Company’s common stock. This will be the final payment relating to the contingent purchase price in accordance with the Reorganization Agreement.
Patrick R. Woods, Executive Vice President, Business Development, of the Company, served as an independent director of RT Logic from June 26, 2000 until the consummation of the acquisition of RT Logic by the Company and held approximately 0.3% of the outstanding shares of RT Logic common stock at the effective time of such acquisition.
52
| ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Principal Accountant Fees and Services – Grant Thornton LLP
The following is a summary of fees recorded by the Company in fiscal years 2005 and 2004 for professional services rendered by Grant Thornton LLP.
| | | | | | |
Fee Category
| | Fiscal 2005
| | Fiscal 2004
|
Audit fees | | $ | 261,000 | | $ | 90,000 |
Audit-related fees | | | 40,000 | | | 30,000 |
Tax fees | | | 28,000 | | | 32,000 |
All other fees | | | 6,000 | | | 4,000 |
| | |
|
| |
|
|
Total fees | | $ | 335,000 | | $ | 156,000 |
| | |
|
| |
|
|
Accountant Fees and Services – Ernst & Young LLP
The following is a summary of fees recorded by the Company in fiscal years 2005 and 2004 for professional services rendered by Ernst & Young LLP. The audit fees billed by Ernst & Young in fiscal year 2004 pertain to the audit of the Company’s financial statements for fiscal year 2003.
| | | | | | |
Fee Category
| | Fiscal 2005
| | Fiscal 2004
|
Audit fees | | $ | 0,000 | | $ | 108,000 |
Audit-related fees | | | 22,000 | | | 15,000 |
Tax fees | | | 0 | | | 0 |
All other fees | | | 0 | | | 0 |
| | |
|
| |
|
|
Total fees | | $ | 22,000 | | $ | 123,000 |
| | |
|
| |
|
|
Audit Fees.Audit fees consist of the aggregate fees billed for professional services rendered for the audit of the Company’s annual financial statements, the audit of management’s assessment of its internal controls, review of the interim financial statements included in the Company’s quarterly reports on Form 10-Q, and services that are normally provided by an auditor in connection with statutory and regulatory filings.
Audit-Related Fees.Audit-related fees represent professional services rendered for assurance and related services that are reasonably related to the audit of the Company’s annual financial statements for the 2005 and 2004 fiscal years and the review of the financial statements included in the Company’s quarterly reports on Form 10-Q for the 2005 and 2004 fiscal years. These services included the review of a Registration Statement of the Company on Form S-3, employee benefit plan audits, and consultations concerning financial accounting and reporting standards and transactions.
Tax Fees.Tax fees consist of the aggregate fees billed for professional services rendered for tax compliance, tax advice and tax planning.
All other Fees.Consists of fees billed for professional services, other than the services reported as “Audit Fees”, “Audit-Related Fees”, or “Tax Fees”.
Pre-Approval of Non-Audit Services
In accordance with the Company’s Audit Committee Charter, the Audit Committee approves in advance any and all audit services, including audit engagement fees and terms, and non-audit services provided to the Company by its independent auditors (subject to the de minimus exception for non-audit services contained in Section 10A(i)(1)(B) of the Securities Exchange Act of 1934, as amended), all as required by applicable law or listing standards. The independent auditors and the Company’s management are required to periodically report to the Audit Committee the extent of services provided by the independent auditors and the fees associated with these services.
53
PART IV
| ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
| 2. | Financial Statement Schedules. |
Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission (the “Commission”) are not required under the related instruction or are inapplicable and therefore have been omitted.
| | |
| 3.1 | | Articles of Restatement of the Company (Incorporated by reference to the Registration Statement on Form S-3 (File No. 333-82499) filed with the Commission on July 8, 1999). |
| |
| 3.2 | | Amended and Restated Bylaws of the Company (Incorporated by reference to the Company’s Annual Report on Form 10-K for the Fiscal Year ended September 30, 2000 filed with the Commission on December 21, 2000). |
| |
| 4.1 | | Specimen Common Stock Certificate (Incorporated by reference to the Registration Statement on Form S-1 (File No. 333-58453) filed by the Company with the Commission on July 2, 1998). |
| |
| 10.1+ | | 1988 Stock Plan (Incorporated by reference to the Registration Statement on Form S-8 (File No. 333- 61559) filed by the Company with the Commission on August 14, 1998). |
| |
| 10.2+ | | 2002 Stock Option Plan (Incorporated by reference to the Registration Statement on Form S-8 (File No. 333- 87694) filed by the Company with the Commission on May 7, 2002). |
| |
| 10.3+ | | Form of Indemnification Agreement between the Company and certain of its officers and all of its directors (Incorporated by reference to the Company’s Form 10-Q for the quarter ended March 31, 2003 filed with the Commission on May 15, 2003). |
| |
| 10.4 | | Lease dated June 1, 1999, between Integral Systems Inc. and ASP Washington, L.L.C. (Incorporated by reference to the Company’s Form 10-QSB for the quarter ended June 30, 1999 filed with the Commission on August 12, 1999) and amendment thereto (Incorporated by reference to the Company’s Form 8-K dated October 27, 2005 filed with the Commission on November 2, 2005). |
54
| | |
| 10.5 | | Master Equipment Lease Agreement dated December 3, 1997 between NationsBanc Leasing Corporation and Integral Systems Inc. (Incorporated by reference to the Registration Statement on Form S-1 (File No. 333-58453) filed by the Company with the Commission on July 2, 1998). |
| |
| 10.6 | | Line of Credit Extensions to Revolving Line of Credit Loan Agreement dated August 31, 2001, by and between Bank of America N.A. and Integral Systems, Inc. (Incorporated by reference to the Company’s Form 10-Q for the quarter ended March 31, 2004 filed with the Commission on May 13, 2004 and to the Company’s Form 8-K dated January 19, 2005 and filed with the Commission on January 24, 2005). |
| |
| 10.7 | | Award/Contract No. F04701-01-C-0012 from MCK Space & Missile Systems Center, effective as of February 7, 2001 (Incorporated by reference to the Company’s Form 10-Q for the quarter ended March 31, 2002 filed with the Commission on May 15, 2002). |
| |
| 10.8 | | Lease dated May 8, 2002, between Integral Systems Inc. and Science Park II L.L.C. (Incorporated by reference to the Company’s Form 10-K for the year ended September 30, 2004 filed with the Commission on December 10, 2004). |
| |
| 10.9 | | Lease dated September 18, 2000, between Real Time Logic, Inc. and John J. Gogian Jr. Revocable Trust of 1983 (Incorporated by reference to the Company’s Form 10-K for the year ended September 30, 2004 filed with the Commission on December 10, 2004) and amendment thereto. |
| |
| 10.10 | | Award/Contract No. FA8819-05-C-0018 from Space and Missiles Systems Center (SMC) on behalf of U.S. Air Force, effective as of February 25, 2005 (Incorporated by reference to the Company’s Form 10-Q for the quarter ended March 31, 2005 filed with the Commission on May 10, 2005). |
| |
| 11.1 | | Computation of Per Share Earnings. |
| |
| 21.1 | | List of Subsidiaries of the Registrant. |
| |
| 23.1 | | Consent of Grant Thornton, LLP. |
| |
| 23.2 | | Consent of Ernst & Young LLP. |
| |
| 31.1 | | Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended. |
| |
| 31.2 | | Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended. |
| |
| 32.1 | | Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| |
| 32.2 | | Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| + | Indicates management or compensatory plan or arrangement |
55
Pursuant to the requirements of the Securities Exchange Act of 1933, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | | | |
Signature
| | Titles
| | Date
|
| | |
/s/ STEVEN R. CHAMBERLAIN
Steven R. Chamberlain | | Chairman of the Board, Director, Chief Executive Officer | | December 14, 2005 |
| | |
/s/ THOMAS L. GOUGH
Thomas L. Gough | | President, Director | | December 14, 2005 |
| | |
/s/ ELAINE M. BROWN
Elaine M. Brown | | Chief Financial Officer, Principal Accounting Officer | | December 14, 2005 |
| | |
/s/ DOMINIC A. LAITI
Dominic A. Laiti | | Director | | December 14, 2005 |
| | |
/s/ R. DOSS MCCOMAS
R. Doss McComas | | Director | | December 14, 2005 |
| | |
/s/ BONNIE K. WACHTEL
Bonnie K. Wachtel | | Director | | December 14, 2005 |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | | | | | | |
| | | | | INTEGRAL SYSTEMS, INC. |
| | | |
DATE: December 14, 2005 | | | | BY: | | /s/ STEVEN R. CHAMBERLAIN |
| | | | | | | | | Steven R. Chamberlain Chairman of the Board and Chief Executive Officer |
| | | |
DATE: December 14, 2005 | | | | BY: | | /s/ THOMAS L. GOUGH |
| | | | | | | | | Thomas L. Gough President, Director |
| | | |
DATE: December 14, 2005 | | | | BY: | | /s/ ELAINE M. BROWN |
| | | | | | | | | Elaine M. Brown Chief Financial Officer, Principal Accounting Officer |
