================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 --------------------- FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended November 30, 1998 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 0-15295 NICHOLS RESEARCH CORPORATION (Exact name of registrant as specified in its charter) --------------------- DELAWARE 63-0713665 -------- ---------- (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification no.) 4090 Memorial Parkway, South Huntsville, Alabama 35802-1326 (256) 883-1140 (Address, including zip code, and telephone number of principal offices) --------------------- 4040 Memorial Parkway, South Huntsville, Alabama 35802-1326 (Former name, address and fiscal year if changed since last report) --------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO __ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. COMMON STOCK, $.01 PAR VALUE 14,074,693 SHARES OUTSTANDING ON November 30, 1998 --------------------- ================================================================================ FORM 10-Q NICHOLS RESEARCH CORPORATION QUARTERLY REPORT FOR THE PERIOD ENDED NOVEMBER 30, 1998 INDEX Page ---- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Income for the Three Months Ended November 30, 1998 and November 30, 1997 (Unaudited)............. 1 Consolidated Balance Sheets as of November 30, 1998 and August 31, 1998 (Unaudited)........................................... 2-3 Consolidated Statements of Changes in Stockholders' Equity for the Three Months Ended November 30, 1998 and November 30, 1997 (Unaudited)......................................... 4 Consolidated Statements of Cash Flows for the Three Months Ended November 30, 1998 and November 30, 1997 (Unaudited)........................................................... 5 Notes to Financial Statements (Unaudited)............................. 6-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................................ 9-19 Item 3. Quantitative and Qualitative Disclosures About Market Risk............ 19 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K...................................... 20 Signatures............................................................ 21 FORM 10-Q NICHOLS RESEARCH CORPORATION PART I - FINANCIAL INFORMATION Item 1 - Financial Statements CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) For the Three Months Ended November 30, November 30, 1998 1997 Restated --------------------------------------- (amounts in thousands except share data) Revenues............................................. $ 101,349 $ 88,540 Costs and expenses: Direct and allocable costs....................... 84,678 73,944 General and administrative expenses.............. 10,033 7,875 Amortization of intangibles...................... 1,021 1,095 --------------------------------------- Total costs and expenses.................. 95,732 82,914 --------------------------------------- Operating profit..................................... 5,617 5,626 Other income (expense): Interest expense................................. (70) (90) Other income, principally interest............... 146 285 Equity in earnings of unconsolidated affiliates.. 128 130 Minority interest in consolidated subsidiaries... (66) (331) --------------------------------------- Income before income taxes........................... 5,755 5,620 Income taxes ....................................... 2,266 2,172 --------------------------------------- Net income........................................... $ 3,489 $ 3,448 ======================================= Earnings per common share............................ $ .25 $ .26 ======================================= Earnings per common share assuming dilution.......... $ .25 $ .25 ======================================= Weighted average common shares....................... 13,849,824 13,463,386 ======================================= Weighted average number of common and common equivalent shares............................................... 14,142,861 14,022,045 ======================================= NOTE: The Company has not declared or paid dividends in any of the periods presented. All prior periods have been restated to reflect the acquisition of Welkin Associates, Ltd., which was accounted for as a pooling of interests. See accompanying notes. 1 FORM 10-Q NICHOLS RESEARCH CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) November 30, August 31, 1998 1998 Restated ----------------------------------- (amounts in thousands) ASSETS Current assets: Cash and temporary cash investments.................. $ 11,150 $ 11,275 Accounts receivable.................................. 121,538 113,392 Deferred income taxes................................ 2,513 2,488 Other................................................ 2,473 3,939 ----------------------------------- Total current assets............................. 137,674 131,094 Long-term investments..................................... 1,513 1,519 Property and equipment: Computers and related equipment...................... 31,443 29,465 Furniture, equipment and improvements................ 12,880 12,210 Equipment-contracts.................................. 5,934 5,771 ----------------------------------- 50,257 47,446 Less accumulated depreciation............................. 26,737 25,011 ----------------------------------- Net property and equipment........................... 23,520 22,435 Goodwill and other intangibles(net of accumulated amortization).......................................... 56,209 57,262 Software development costs (net of accumulated amortization).......................................... 4,024 3,928 Investment in affiliates.................................. 9,819 9,607 Other assets.............................................. 1,457 1,491 ----------------------------------- Total assets.............................................. $ 234,216 $ 227,336 =================================== NOTE: The Company has not declared or paid dividends in any of the periods presented. All prior periods have been restated to reflect the acquisition of Welkin Associates, Ltd., which was accounted for as a pooling of interests. 2 FORM 10-Q NICHOLS RESEARCH CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) CONTINUED November 30, August 31, 1998 1998 Restated ------------------------------------ (amounts in thousands) LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable....................................... $ 20,858 $ 24,278 Accrued compensation and benefits...................... 23,881 18,317 Income taxes payable................................... 3,546 1,681 Current maturities of long-term debt................... 997 997 Borrowings on line of credit........................... 5,000 5,000 Deferred revenue....................................... 797 1,797 Other.................................................. 238 1,040 ------------------------------------ Total current liabilities.......................... 55,317 53,110 Deferred income taxes....................................... 572 354 Long-term debt: Industrial development bonds........................... 1,335 1,335 Long-term notes........................................ 1,484 1,613 ------------------------------------ Total long-term debt............................... 2,819 2,948 Minority interest in consolidated subsidiaries.............. 1,190 1,177 Stockholders' equity: Common stock, par value $.01 per share Authorized - 30,000,000 shares Issued -14,074,693 and 13,997,455 shares........... 141 140 Additional paid-in capital............................. 96,712 95,631 Retained earnings...................................... 78,753 75,264 Less cost of treasury stock - 168,500 shares........... (1,288) (1,288) ------------------------------------ Total stockholders' equity......................... 174,318 169,747 ------------------------------------ Total liabilities and stockholders' equity.................. $ 234,216 $ 227,336 ==================================== NOTE: The Company has not declared or paid dividends in any of the periods presented. All prior periods have been restated to reflect the acquisition of Welkin Associates, Ltd., which was accounted for as a pooling of interests. 3 FORM 10-Q NICHOLS RESEARCH CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) Additional Total Common Stock Paid-In Retained Treasury Stockholders' Shares Amount Capital Earnings Stock Equity --------------------------------------------------------------------------------------------- (amounts in thousands except share data) For the Three Months Ended November 30, 1998 -------------------------------------------- Balance, August 31, 1998 (Restated) 13,997,455 $ 140 $ 95,631 $ 75,264 $ (1,288) $ 169,747 Exercise of stock options 43,988 1 477 -- -- 478 Employee stock purchases 33,250 -- 604 -- -- 604 Net Income -- -- -- 3,489 -- 3,489 --------------------------------------------------------------------------------------------- Balance, November 30,1998 14,074,693 $ 141 $ 96,712 $ 78,753 $ (1,288) $ 174,318 ============================================================================================= For the Three Months Ended November 30, 1997 - Restated ------------------------------------------------------- Balance, August 31, 1997 13,533,346 $ 135 $ 90,076 $ 61,545 $ (1,288) $ 150,468 Exercise of stock options 127,398 1 1,321 -- -- 1,322 Employee stock purchases 24,273 1 484 -- -- 485 Adjustment for Welkin -- -- -- (479) -- (479) Net Income -- -- -- 3,448 -- 3,448 --------------------------------------------------------------------------------------------- Balance, November 30,1997 13,685,017 $ 137 $ 91,881 $ 64,514 $ (1,288) $ 155,244 ============================================================================================= 4 FORM 10-Q NICHOLS RESEARCH CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Three Months Ended November 30, November 30, 1998 1997 Restated -------------------------------------- (amounts in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income.................................................... $ 3,489 $ 3,448 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for doubtful accounts.......................... 104 -- Depreciation ............................................ 1,858 1,303 Amortization............................................. 1,021 1,095 Equity in earnings of unconsolidated affiliates.......... (128) (130) Minority interest........................................ 66 331 Deferred Taxes........................................... 193 75 Changes in assets and liabilities net of effects of acquisitions: Accounts receivable...................................... (8,250) 820 Other assets............................................. 1,663 (716) Accounts payable......................................... (3,420) (3,846) Accrued compensation and benefits........................ 5,564 1,556 Income taxes payable..................................... 1,865 1,800 Other current liabilities................................ (1,802) (1,151) -------------------------------------- Total adjustments........................................ (1,266) 1,139 -------------------------------------- Net cash provided/(used) by operating activities........................................... 2,223 4,587 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment............................ (2,943) (2,854) Purchase of long-term investments............................. -- (100) Purchase of capitalized software.............................. (280) (62) Payment for investment in affiliates.......................... (84) (500) Proceeds from maturity of long-term investments............... 6 550 -------------------------------------- Net cash provided/(used) by investing activities......... (3,301) (2,966) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock........................ 1,082 1,807 Payments of long-term debt.................................... (129) (135) Proceeds from line of credit................................... 5,000 -- Payments on line of credit borrowings......................... (5,000) (10,000) -------------------------------------- Net cash provided/(used) by financing activities......... 953 (8,328) -------------------------------------- Net increase/(decrease) in cash and temporary cash investments.............................................. (125) (6,707) FORM 10-Q NICHOLS RESEARCH CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)CONTINUED For the Three Months Ended November 30, November 30, 1998 1997 Restated -------------------------------------- (amounts in thousands) Cash and temporary cash investments at beginning of period...................................... 11,275 23,964 -------------------------------------- Cash and temporary cash investments at end of period.......... $ 11,150 $ 17,257 ====================================== 5 FORM 10-Q NICHOLS RESEARCH CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) November 30, 1998 Note 1 - Basis of Presentation ---------------------- The condensed consolidated financial statements (and all other information in this report) have not been examined by independent auditors, but in the opinion of the Company, all adjustments, consisting of the normal recurring accruals necessary for a fair presentation of the results for the period, have been made. The condensed consolidated financial statements include the accounts of Nichols Research Corporation and its majority-owned subsidiaries and joint ventures. All significant intercompany balances and transactions have been eliminated in consolidation. The Company's earnings in unconsolidated affiliates and joint ventures are accounted for using the equity method. Note 2 - Accounting Pronouncements ------------------------- In February 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 128, Earnings Per Share. The overall objective of Statement No. 128 is to simplify the calculation of earnings per share (EPS) and achieve comparability with recently issued international accounting standards. The Company first reported on the new EPS basis in the second quarter ended February 28, 1998. All prior period EPS amounts (including information regarding EPS in interim financial statements, earnings summaries, and selected financial data) have been restated to conform to the provisions of Statement No. 128. In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income (SFAS 130). Statement No. 130 establishes new rules for the reporting and display of comprehensive income and its components. Adoption of Statement No. 130 by the Company on September 1, 1998 had no impact on the Company's consolidated results of operations or stockholders' equity. In June 1997, the FASB issued Statement No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS 131). Statement No. 131 changes the method of determining segments from that currently required, and requires the reporting of certain information about such segments. The Company has not finalized how its segments will be reported or whether and to what extent segment information will differ from that currently presented. Note 3 - Reclassification ---------------- Certain prior period amounts have been reclassified to conform with the current period's presentation and the final purchase price allocation for TXEN, Inc. 6 FORM 10-Q NICHOLS RESEARCH CORPORATION Note 4 - Investment in affiliates ------------------------ As of November 30, 1998 the Company holds a 50% interest in NCCIM, LLC. at an aggregate cost of $1,345,000. Undistributed equity earnings of $652,000 are included in the November 30, 1998 Retained Earnings balance reported in the Consolidated Balance Sheet. Note 5 - Line of Credit -------------- The Company has a bank line of credit which provides for unsecured borrowings up to $100,000,000. The credit agreement provides for interest at London Interbank Offered Rate (LIBOR) plus a margin ranging from 0.325% to 0.450% and a facility fee, payable quarterly, of approximately 0.125% on the unused portion of the line of credit. The short-term commitment agreement ($50,000,000) expired in November, 1998 and was renewed for one year. The 100,000,000 line of credit continues to be renewable annually and the long-term commitment agreement ($50,000,000) is renewable in November, 2000. At November 30, 1998, there was $5,000,000 outstanding on this line of credit at an effective interest rate of 5.62 percent. Note 6 - Earnings Per Share ------------------ The following table sets forth the computation of earnings per common share and earnings per common share assuming dilution: FORM 10-Q NICHOLS RESEARCH CORPORATION For the Three Months Ended November 30, November 30, 1998 1997 Restated ------------------------------------ Numerator: Net income and income available to common stockholders and income available to common stockholders after assumed conversions.................... $ 3,489,000 $ 3,448,000 ==================================== Denominator: Denominator for earnings per common share - weighted average common shares....... 13,849,824 13,463,386 Effect of dilutive securities: Employee stock options....................... 293,037 558,659 Denominator for earnings per common share assuming dilution - adjusted weighted average common shares and assumed coversions....................... 14,142,861 14,022,045 ==================================== Earnings per common share............................. $ .25 $ .26 ==================================== Earnings per common share assuming dilution......................................... $ .25 $ .25 ==================================== 7 FORM 10-Q NICHOLS RESEARCH CORPORATION Note 7 - Restatement ----------- In connection with the Company's filing of a Form S-3 registration statement unrelated to TXEN, the Company engaged in discussions with the Staff of the Securities and Exchange Commission (SEC) regarding the purchase price allocation related to its acquisition of TXEN. These discussions included the amount allocated to in-process research and development. The Company and its independent auditors, Ernst & Young LLP, believed the purchase price allocation recorded and related amortization charges, were in accordance with widely recognized appraisal practices and generally accepted accounting principles. However, the SEC Staff has recently expressed views on in-process research and development as set forth in a letter dated September 15, 1998 to the American Institute of Certified Public Accountants. The Company, in consultation with its independent auditor and based on its discussions with the Staff, has adjusted the amount originally allocated to acquired in-process research and development and, accordingly, has restated its 1997 and 1998 consolidated financial statements. As a result, the 1997 write-off of acquired research and development was decreased $3.5 million from the $12.0 million amount previously recorded to $8.5 million. Intangible assets and net income were increased by a like amount because the write-off was not tax deductible. Accordingly, 1997 earnings per common share and earnings per common share assuming dilution were increased $0.29 and $0.28 to $0.39 and $0.37, respectively. For 1998, amortization of intangibles increased $225 thousand or $0.02 per common share and $0.01 per common share assuming dilution, respectively. Accordingly, 1998 earnings per share and earnings per common share assuming dilution were reduced by $0.02 and $0.01 to $1.04 and $1.01, respectively. For the first quarter of 1999, amoritzation of intangibles increased $56 thousand but had no effect on earnings per common share assuming dilution. 8 FORM 10-Q NICHOLS RESEARCH CORPORATION ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS QUARTERLY REPORT CONTAINS FORWARD-LOOKING STATEMENTS AS DEFINED IN SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. THESE RISKS AND UNCERTAINTIES ARE DISCUSSED IN MORE DETAIL IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED AUGUST 31, 1998, AND IN THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SECTION OF THIS QUARTERLY REPORT. THESE FORWARD-LOOKING STATEMENTS CAN BE GENERALLY IDENTIFIED AS SUCH BECAUSE THE CONTENT OF THE STATEMENTS WILL USUALLY CONTAIN SUCH WORDS AS THE COMPANY OR MANAGEMENT "BELIEVES," "ANTICIPATES," "EXPECTS," "PLANS," OR WORDS OF SIMILAR IMPORT. SIMILARLY, STATEMENTS THAT DESCRIBE THE COMPANY'S FUTURE PLANS, OBJECTIVES, GOALS OR STRATEGIES ARE FORWARD-LOOKING STATEMENTS. Overview and Business Environment - --------------------------------- The Company is a leading provider of technical and information technology (IT) services, including information processing, systems development and systems integration. The Company provides these services to a wide range of clients, including the Department of Defense (DOD), other federal agencies, state and local governments, healthcare and insurance organizations, and commercial enterprises. The Company's business strategy consists of three key elements: (i) maintain the Company's leadership in technology; (ii) apply the Company's technology to create solutions for new clients; and (iii) make strategic acquisitions and investments to expand the business of the Company and gain industry knowledge. The Company is organized into four strategic business units, reflecting the particular market focus of each line of business. The Defense and Intelligence unit, formerly Nichols Federal, provides technical services primarily to U.S. Government defense agencies. The Government Information Technology unit, formerly Nichols InfoFed, provides information and technology solutions and services to a variety of governmental agencies. The Commercial Information Technology unit, formerly Nichols InfoTec, provides information and technology services to various commercial clients, other than healthcare clients. The Healthcare Information Technology unit, formerly Nichols SELECT, provides information and administrative services to clients in the healthcare and insurance industries. For the quarter ended November 30, 1998, the percentage of total revenues attributable to the four business units was approximately 60% for Defense and Intelligence, 18% for Government IT, 10% for Commercial IT, and 12% for Healthcare IT. Risk Factors - ------------ The Company's business and financial performance are subject to risks and uncertainties, including those discussed below. FORM 10-Q NICHOLS RESEARCH CORPORATION ACQUISITION STRATEGY Expansion through acquisitions is an important component of the Company's overall business strategy. The Company has successfully completed ten strategic acquisitions and alliances since September 1, 1994, most of which have centered on IT and healthcare information services markets. Since the respective dates of the acquisitions, the Company has integrated these acquired entities in order to draw on the Company's base of technical expertise and capabilities in designing solutions for government, commercial, and healthcare clients. The Company's continued ability to grow by acquisitions is dependent upon, and may be limited by, the availability of compatible acquisition candidates at reasonable prices, the Company's ability to fund or finance acquisitions on acceptable terms, and the Company's ability to maintain or enhance the profitability of any acquired business. 9 FORM 10-Q NICHOLS RESEARCH CORPORATION PERFORMANCE OF LARGE SYSTEMS INTEGRATION CONTRACTS As part of the Company's business strategy to enter new markets, the Company continues to pursue large systems integration contracts in both the government and commercial markets, although competition for such contracts is intense and many of the Company's competitors have greater resources than the Company. While such contracts are working capital intensive, requiring large equipment and software purchases to be funded by the Company before payment from the customer, the Company believes such contracts offer attractive revenue growth and margin expansion opportunities for the Company's range of technical expertise and capabilities. VARIABILITY OF QUARTERLY EARNINGS OR OPERATING RESULTS The Company's revenues and earnings may fluctuate from quarter to quarter based on such factors as the number, size, and scope of projects in which the Company is engaged, the contractual terms and degree of completion of such projects, expenditures required by the Company in connection with such projects, any delays incurred in connection with such projects, employee utilization rates, the adequacy of provisions for losses, the accuracy of estimates of resources required to complete ongoing projects, and general economic conditions. Under certain contracts, the Company is required to purchase, integrate and deliver to the customer large amounts of computer processing systems and other equipment. Revenues are accrued as costs to deliver these systems are incurred, and as a result, quarterly revenues will be impacted by fluctuations related to equipment purchases which occur on a periodic basis depending on contract terms and modifications. UNCERTAINTIES ASSOCIATED WITH GOVERNMENT CONTRACTS The Company performs its services under U.S. Government contracts that usually require performance over a period of one to five years. Long-term contracts may be conditioned upon continued availability of Congressional appropriations. Variances between anticipated budgets and Congressional appropriations may result in delay, reduction, or termination of such contracts. Contractors can experience revenue uncertainties with respect to available contract funding during the first quarter of the government's fiscal year beginning October 1, until differences between budget requests and appropriations are resolved. The Company's contracts with the U.S. Government and its prime contractors are subject to termination, in whole or in part, either upon default by the Company or at the convenience of the government. The termination for convenience provisions generally entitle the Company to recover costs incurred, settlement expenses, and profit on work completed prior to termination. Because the Company contracts to supply goods and services to the U.S. Government, it is also subject to other risks, including contract suspensions, audit adjustments, protests by disappointed bidders of contract awards which can result in the re-opening of the bidding process and changes in government policies or regulations. 10 FORM 10-Q NICHOLS RESEARCH CORPORATION CONTRACT PROFIT EXPOSURE The Company's services are provided primarily through three types of contracts: fixed-price, time-and-materials and cost-reimbursement contracts. Fixed-price contracts require the Company to perform services under a contract at a stipulated price. Time-and-materials contracts reimburse the Company for the number of labor hours expended at an established hourly rate negotiated in the contract, plus the cost of materials incurred. Under cost-reimbursement contracts, the Company is reimbursed for all actual costs incurred in performing the contract to the extent that such costs are within the contract ceiling and allowable under the terms of the contract, plus a fee or profit. The Company assumes greater financial risk on fixed-price contracts than on either time-and-materials or cost-reimbursement contracts. As the Company increases its commercial business, it believes that an increasing percentage of its contracts will be fixed-priced. Failure to anticipate technical problems, estimate costs accurately, or control costs during performance of a fixed-price contract, may reduce the Company's profit or cause a loss. In addition, greater risks are involved under time-and-materials contracts than under cost-reimbursement contracts because the Company assumes the responsibility for the delivery of specified skills at a fixed hourly rate. Although management believes that adequate provision for its fixed-price and time-and-materials contracts is reflected in the Company's financial statements, no assurance can be given that this provision is adequate or that losses on fixed-price and time-and-materials contracts will not occur in the future. 11 FORM 10-Q NICHOLS RESEARCH CORPORATION Results of Operations - --------------------- The following tables set forth, for the periods indicated, the percentages which certain items in the consolidated statements of income bear to consolidated revenues, and the percentage change of such items for the periods indicated: Percentage of Revenues for the Three Months Ended November 30, November 30, Percentage 1998 1997 Change Restated -------------------------------------------------- Revenues 100.0% 100.0% 14.5% Costs and expenses: Direct and allocable costs............. 83.6 83.5 14.5 General and administrative expenses.... 9.9 8.9 27.4 Amortization of intangibles............ 1.0 1.2 (6.8) ----------------------------------- Total costs and expenses........... 94.5 93.6 15.5 ----------------------------------- Operating profit............................ 5.5 6.4 (0.2) Other income (expense): Interest expense............................ (0.1) (0.1) 22.2 Other income, principally interest.......... 0.2 0.3 (48.8) Equity in earnings of unconsolidated affiliates............................... 0.2 0.1 (1.5) Minority interest in consolidated subsidiaries............................. (0.1) (0.4) (80.1) ----------------------------------- Income before income taxes.................. 5.7 6.3 2.4 Income taxes................................ 2.2 2.4 4.3 ----------------------------------- Net income.................................. 3.5% 3.9% 1.2% =================================== The table below presents contract award and backlog data for the periods indicated: Quarter Ended November 30, 1998 1997 ---------------------------------- (amounts in thousands) Contract award amount..................... $ 32,684 $ 42,428 Backlog (with options).................... $ 1,197,816 $ 1,227,338 Backlog (without options)................. $ 330,568 $ 380,574 12 FORM 10-Q NICHOLS RESEARCH CORPORATION COMPARISON OF OPERATING RESULTS FOR FIRST FISCAL QUARTER 1999 WITH FIRST FISCAL QUARTER 1998 REVENUES: Revenues increased $12.8 million (14.5%) for the fiscal quarter ended November 30, 1998 as compared to the fiscal quarter ended November 30, 1997. The revenues of the Defense and Intelligence unit, representing approximately 60% of the Company's consolidated revenues for the quarter, increased $ 7.7 million (14.6%), primarily the result of continued growth in existing contracts. The revenues of the Government IT unit, representing approximately 18% of the Company's consolidated revenues for the quarter, was $18.0 million as compared to $17.9 million in the prior year. The revenues of the Commercial IT unit, representing approximately 10% of the Company's consolidated revenues for the quarter, increased $ 2.3 million (28.4%), primarily the result of its expanded business base. The revenues of the Healthcare IT, representing approximately 12% of the Company's consolidated revenus for the quarter, increased $ 2.7 million (28.5%), primarily the result of continued growth in number of clients. OPERATING PROFIT: Operating profit was $5.6 million for the fiscal quarter ended November 30, 1998 as compared $5.6 million for the fiscal quarter ended November 30, 1997. Direct and allocable costs increased $10.7 million (14.5%) for the fiscal quarter ended November 30, 1998 as compared to the fiscal quarter ended November 30, 1997, as a result of the increase in revenues. General and administrative expenses increased $2.2 million (27.4%) for the fiscal quarter ended November 30, 1998 as compared to the fiscal quarter ended November 30, 1997, primarily the result of acquisition of Mnemonic System, Incorporated completed in April 1998. Total costs and expenses were 94.5% of revenues for the fiscal quarter ended November 30, 1998 as compared 93.6% for the fiscal quarter ended November 30, 1997. OPERATING MARGINS: The operating margin was 5.5% for the fiscal quarter ended November 30, 1998 as compared to 6.4% the fiscal quarter ended November 30, 1997. The Defense and Intelligence unit realized a 6.4% operating margin for the fiscal quarter ended November 30, 1998 as compared to 4.7% the fiscal quarter ended November 30, 1997. These improved margins are primarily the result of increased margins on time-and-material contracts. The Government IT unit realized a 5.7% operating margin for the fiscal quarter ended November 30, 1998 as compared to 7.8% the fiscal quarter ended November 30, 1997. This decrease in margins is primarily the result of a decrease in high margin contracts. The Commercial IT unit realized a -6.6% operating margin for the fiscal quarter ended November 30, 1998 as compared to 9.2% the fiscal quarter ended November 30, 1997. The decrease in margins is primarily the result of the expenses associated with overstaffing. Healthcare IT realized an 11.8% operating margin for the fiscal quarter ended November 30, 1998 as compared to 11.6% the fiscal quarter ended November 30, 1997. 13 FORM 10-Q NICHOLS RESEARCH CORPORATION OTHER INCOME (EXPENSE). Other income (expense) increased $0.1 million for the fiscal quarter ended November 30, 1998 as compared to the fiscal quarter ended November 30, 1997. Other income includes equity in earnings of unconsolidated affiliates and interest income; other expense includes interest expense and minority interest in consolidated subsidiaries. Substantially all available cash is invested in interest-bearing accounts or fixed income instruments. Interest expense includes the cost of long-term and short-term borrowings of the Company and the commitment fee on its unused line of credit. Equity in earnings of unconsolidated affiliates for the fiscal quarters ended November 30, 1998 and 1997 primarily represents the Company's share of the earnings of NCCIM, LLC a joint venture, 50% of which is owned by the Company. Minority interest in consolidated subsidiaries primarily represents the minority partner's share of earnings of Nichols ENTEC, LLC a joint venture, 60% of which is owned by the Company. The decrease in minority interest of $0.3 million for the fiscal quarter ended November 30, 1998 as compared to the fiscal quarter ended November 30, 1997 is primarily the result of expenses associated with overstaffing. INCOME TAXES. Income taxes as a percentage of income before taxes was 39.4% in the fiscal quarter ended November 30, 1998 as compared to 38.7% in the fiscal quarter ended November 30, 1997. NET INCOME. Net income increased $0.04 million (1.2%) for the fiscal quarter ended November 30, 1998 as compared to the fiscal quarter ended November 30, 1997. The increase is a result of the items discussed. EARNINGS PER COMMON SHARE ASSUMING DILUTION. Earnings per common share assuming dilution for the fiscal quarter ended November 30, 1998 were $.25 as compared to $.25 for fiscal quarter ended November 30, 1997. Net income increased 1.2% ($0.04 million), while weighted average number of common and common equivalent shares outstanding increased 0.9% (120,816 shares) for fiscal quarter ended November 30, 1998 as compared to fiscal quarter ended November 30, 1997. 14 FORM 10-Q NICHOLS RESEARCH CORPORATION Liquidity And Capital Resources - ------------------------------- Historically, the Company's positive cash flow from operations and available credit facilities have provided adequate liquidity and working capital to fully fund the Company's operational needs and support the acquisition program. Working capital was $82.4 million and $73.2 million at November 30, 1998 and 1997, respectively. Operating activities provided cash of $2.2 million for the quarter ended November 30, 1998 and cash of $4.6 million for the quarter ended November 30, 1997. Investing activities used cash of $3.3 million for the quarter ended November 30, 1998 and $3.0 million for the quarter ended November 30, 1997. Financing activities provided cash of $1.0 million for the quarter ended November 30, 1998 and used cash of $8.3 million for the quarter ended November 30, 1997. Cash provided by operating activities decreased $2.4 million for the quarter ended November 30, 1998 as compared to the quarter ended November 30, 1997. The primary difference is changes in operating assets and liabilities. Cash used for investing activities was $3.3 million for the quarter ended November 30, 1998. Purchases of property and equipment were $3.0 million and $2.9 million for the fiscal quarters ended November 30, 1998 and 1997, respectively. Cash provided from financing activities was $1.0 million for the quarter ended November 30, 1998. The Company realized proceeds from the sale of common stock of $1.1 million and $1.8 million for the the fiscal quarters ended November 30, 1998 and 1997, respectively. The Company renegotiated its bank line of credit in November, 1998. The agreement provides for unsecured borrowings up to $100,000,000. The credit agreement provides for interest at London Interbank Offered Rate (LIBOR) plus a margin ranging from 0.325% to 0.450% and a facility fee, payable quarterly, of approximately 0.125% on the unused portion of the line of credit. The short-term commitment agreement ($50,000,000) is renewable annually and the long-term commitment agreement ($50,000,000) is renewable in November, 2000. There was $5,000,000 in outstanding borrowings on this line of credit at November 30, 1998. The Company is regularly evaluating potential acquisition candidates and expects to complete other transactions in fiscal year 1999. 15 FORM 10-Q NICHOLS RESEARCH CORPORATION The Company continues to actively pursue contracts for information system development and computer system integration activities, which could require the Company to acquire substantial amounts of computer hardware for resale or lease to customers. The timing of payments to suppliers and payments from customers under the Company's system integration contracts could cause cash flows from operations to fluctuate from period to period. The Company believes that, for the next four fiscal quarters, its existing capital resources, together with available borrowing capacity, will be sufficient to fund operating needs, finance acquisitions of property and equipment, and make strategic acquisitions, if appropriate. EFFECTS OF INFLATION Substantially all contracts awarded to the Company have been based on proposals which reflect estimated cost increases due to inflation. Historically, inflation has not had a significant impact on the Company. YEAR 2000 Overview Historically, certain computerized systems have had two digits rather than four digits to define the applicable year, which could result in recognizing a date using "00" as the year 1900 rather than the year 2000. This could cause significant software failures or miscalculations and is generally referred to as the "Year 2000" problem. The Company recognizes that the impact of the Year 2000 problem extends beyond its computer hardware and software and may affect utility and telecommunication services, as well as the systems of customers and suppliers. In response to the Year 2000 problem, the Company has developed a compliance program to evaluate and address date related problems with the Company's internal systems, services, products, and the systems and products of the Company's vendors and suppliers. The compliance program is managed by the Vice President of Corporate Information Systems and Services, and is patterned after the United States General Accounting Office (GAO) and Office of Management and Budget project management model. The Company's Year 2000 compliance program includes five major phases: Awareness Phase. The Year 2000 problem is defined and managers at the executive level are educated about potential date related problems and the potential impact to the Company and its customers from Year 2000 date handling errors. A Year 2000 program team is established and an overall strategy is developed. 16 Assessment Phase. The Year 2000 program team assesses the Year 2000 impact on the Company by: (i) identifying core business areas and processes; (ii) performing an inventory and analysis of systems supporting the core business areas; (iii)contacting third party service providers, and software and hardware vendors to determine Year 2000 issues and their plans for becoming Year 2000 compliant; and (iv) prioritizing conversion or replacement of systems. Renovation Phase. The Year 2000 program team corrects Year 2000 problems identified in the Assessment Phase by modifying program software, updating databases, replacing systems or utilizing other appropriate methods. Implementation Phase. The Year 2000 program team tests, verifies, and validates converted or replaced systems, applications, databases and utilities within a limited operational environment. Validation Phase. The Year 2000 program team fully implements converted or replaced systems, applications, databases and utilities. The Year 2000 program team also performs extensive testing of all system changes. As part of the awareness phase the Company has reviewed - Mission Essential Software Systems - Mission Essential Computational Systems (hardware) - Mission Essential Facilities Systems, including elevators, heating and air conditioning systems, photocopying machines and utility services - Mission Essential Network Systems - Customer Software Services,provided by the Company's business units - Mission Essential Vendor-Supplied Software and Services The Company considers a system "mission essential" if a failure in that system would materially disrupt the ability of the Company to perform contractual services or to process business information in a timely manner. The Company monitors the status of its Year 2000 compliance program and routinely updates its Intranet to provide compliance data to its managers and employees. The Company provides services and products to the U.S. Government pursuant to specific contractual terms and exact specifications. The Company believes that it will be responsible for upgrading only those services or products that specify Year 2000 compliance and do not yet meet this requirement. The Company is not currently aware of any such services or products. Status and Timetable for Year 2000 Compliance Nichols Research has developed a master timetable for its year 2000 compliance program. The updated status of each major category of mission essential systems is as follows: 17 SYSTEM CATEGORY PHASE ESTIMATED DATE FOR COMPLIANCE ------------------------------------------------------- ----------------- ------------------------------ Mission Essential Software Systems Renovation April 1999 ------------------------------------------------------- ----------------- ------------------------------ Mission Essential Computational Systems Renovation April 1999 ------------------------------------------------------- ----------------- ------------------------------ Mission Essential Network Systems Validation Completed ------------------------------------------------------- ----------------- ------------------------------ Mission Essential Facilities Systems Validation Completed ------------------------------------------------------- ----------------- ------------------------------ Mission Essential Customer Systems Renovation April 1999 ------------------------------------------------------- ----------------- ------------------------------ Mission Essential Vendor-Supplied Services Validation Unknown ------------------------------------------------------- ----------------- ------------------------------ The phases listed above represent the status of the majority of products within each category. There may be, within each "system," components at a lower or higher phase in the Year 2000 assessment. While the Mission Essential Vendor Supplied Services category is listed as having an Unknown estimated date for compliance, many of the Services within this category have had their validation phase completed. Contingency Plans Because the Company's Year 2000 conversions are expected to be completed prior to any potential disruption to the Company's business, the Company has not yet completed the development of a comprehensive Year 2000 contingency plan. However, the Company has minimized its exposure to Year 2000 failures of vendor supplied products by adding Year 2000 compliance as a standard condition to its purchase orders. These contracts also reference Federal Acquisition Regulation 39.106, which addresses Year 2000 compliance issues. The Company is currently negotiating a Risk Management Insurance Policy designed to protect the Company in the event that it is involved in litigation arising from errors and omissions relating to Year 2000 issues. If the Company determines that its business is at material risk of disruption due to the Year 2000 problem, or anticipates that its Year 2000 conversions will not be completed in a timely fashion, the Company will work to develop a detailed contingency plan. Cost for Year 2000 Compliance The Company believes that the total cost of its Year 2000 compliance activity will not be material to the Company's operation, liquidity and capital resources. The Company estimates that the total cost for its Year 2000 compliance will be $688,500 which represents 11,475 hours of analysis, 18 modification and testing, and $34,500 for new equipment purchases. To date, the Company has completed 6,850 hours of Year 2000 compliance work, and purchased new equipment valued at $27,000, for a total cost of $438,000. Year 2000 Risks Faced by the Company Although the Company believes that its Year 2000 compliance program is comprehensive, the Company may not be able to identify, successfully remedy or assess all date-handling problems in its business systems or operations or those of its customers and suppliers. As a result, the Year 2000 problem could have a materially adverse affect on the Company's business financial condition or results of operations. Item 3 - Quantitative and Qualitative Disclosures About Market Risk Not Applicable. 19 FORM 10-Q NICHOLS RESEARCH CORPORATION PART II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits. Exhibit No. Description ----------- ----------- 10.1 Employment Agreement of Charles A. Leader* 10.2 Supplemental Retirement Benefit Plan between the Registrant and Charles A. Leader* 10.3 Form of Indemnification Agreement between Registrant and Its Directors 27 Financial Data Schedule (b) No reports on Form 8-K were filed during the fiscal quarter ended November 30, 1998. - ----------------- * Denotes management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. 20 FORM 10-Q NICHOLS RESEARCH CORPORATION SIGNATURES MANAGEMENT REPRESENTATION ------------------------- The accompanying unaudited Consolidated Balance Sheets at November 30, 1998 as well as the Consolidated Statements of Income, Consolidated Statements of Changes in Stockholders' Equity and Consolidated Statements of Cash Flows for the three months ended November 30, 1998 and 1997, have been prepared in accordance with instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair presentation have been included. January 14 , 1998 Allen E. Dillard ----------------- ---------------- Date Allen E. Dillard Corporate Vice President, Chief Financial Officer and Corporate Treasurer (Principal Financial and Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NICHOLS RESEARCH CORPORATION January 14 , 1998 Allen E. Dillard ----------------- ---------------- Date Allen E. Dillard Corporate Vice President, Chief Financial Officer and Corporate Treasurer (Principal Financial and Accounting Officer) 21