SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
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
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SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2002
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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
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INTEGRAL SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
Maryland 52-1267968
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation of organization)
5000 Philadelphia Way, Lanham, MD 20706
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 731-4233
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
___________________________________ _________________________________________
___________________________________ _________________________________________
Securities registered pursuant to Section 12(g) of the Act:
Common
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(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 ___
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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 ___
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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 $172,155,935.
As of November 15, 2002, 9,683,258 shares of the Common Stock of the Registrant
were outstanding.
INDEX
PART 1
ITEM 1. BUSINESS
Company Overview................................................................... 1
Industry Background................................................................ 2
The Company Solution............................................................... 2
Company Strategy................................................................... 3
Products........................................................................... 4
Services........................................................................... 6
Customers.......................................................................... 7
Marketing.......................................................................... 8
Contract Revenue................................................................... 8
U.S. Government Contracts.......................................................... 9
Non-U.S. Government Contracts...................................................... 10
Sale of Software Products.......................................................... 11
Backlog............................................................................ 12
Competition........................................................................ 13
Proprietary Rights................................................................. 13
Employees.......................................................................... 14
Financial Information in Industry Segments......................................... 14
Available Information.............................................................. 14
ITEM 2. PROPERTIES......................................................................... 14
ITEM 3. LEGAL PROCEEDINGS.................................................................. 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................ 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS................................................................ 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA............................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.......................................................... 18
Overview........................................................................... 18
Results of Operations.............................................................. 19
Revenue............................................................................ 19
Cost of Revenue/Gross Margin....................................................... 20
Fiscal Year 2002 Compared to Fiscal Year 2001...................................... 20
Fiscal Year 2001 Compared to Fiscal Year 2000...................................... 21
Discontinued Operations............................................................ 22
Acquisition of SAT Corporation..................................................... 22
Acquisition of Newpoint Technologies............................................... 23
Acquisition of Real Time Logic..................................................... 23
Outlook............................................................................ 23
Liquidity and Capital Resources.................................................... 24
Forward-Looking Statements......................................................... 25
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INDEX (CONTINUED)
ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................... 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................ F-1
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................................................ 27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................. 28
ITEM 11. EXECUTIVE COMPENSATION............................................................. 30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS..................................... 34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................... 36
ITEM 14. CONTROLS AND PROCEDURES............................................................ 36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.................... 37
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PART 1
ITEM 1. BUSINESS
Company Overview
Integral Systems, Inc. (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
190 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.
For 20 years, the Company has provided flexible, reliable and affordable
ground system solutions. This has allowed the Company to stay ahead of the
competition and perform well in an industry that has traditionally been
dominated by much larger aerospace firms. The Company believes that it has a
unique combination of competitive advantages, including the following:
. Experience. More experience with different types of satellites and
operational scenarios than any competitor.
. Technology. Internationally recognized and proven COTS products that
were first to market and that continue to lead the competition in functionality.
. Capabilities. Turnkey systems for customers who need a comprehensive
range of products and services.
. Delivery schedule and price. Ability to deliver systems faster and at a
lower cost than the competition.
Through its wholly owned subsidiary SAT Corporation, acquired in August
2000 under the pooling interest method of accounting, the Company also offers
turnkey systems and software for satellite and terrestrial communications signal
monitoring.
Through its wholly owned subsidiary Newpoint Technologies, Inc. (Newpoint),
acquired in January 2002, the Company provides software products and systems for
network monitoring and ground equipment monitoring & control. The acquisition
was accounted for as a purchase.
In October 2002, the Company acquired Real Time Logic, Inc. ("RT Logic"),
which manufactures telemetry processing components and systems for military
applications, including tracking stations, control centers, and range
operations. The acquisition was accounted for as a purchase. Since the
acquisition was completed after the end of the Company's fiscal year in 2002,
the results of the operations of this subsidiary will appear in the public
filings from 2003 onwards.
The Company's wholly-owned subsidiary formed in March 2001, Integral
Systems' Europe S.A.S. ("ISI Europe"), with headquarters in Toulouse, France,
serves as the focal point for the support of all of Integral's European
business.
Integral Systems, Inc. is a Maryland corporation incorporated in 1982.
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Industry Background
The space industry can be broken down into the following industry sectors:
infrastructure, communications, emerging applications, and support services.
Each of these sectors is funded by both government and commercial investments.
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 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 market 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.
According to a recent study by the International Space Business Council,
space industry revenues were $96 billion in 2000 and will grow at a rate of
approximately 10% per year. The 2000 space infrastructure revenues were
approximately $54 billion, comprising over half of the total space market. The
ground sector, which includes ground equipment, installations, and operations,
accounted for approximately $35 billion of total space infrastructure revenues.
The Company estimates that the current worldwide command and control market
represents approximately $4 billion in annual revenues. However, the Company
also believes that the increasing acceptance of COTS products will lead to
substantial price reductions and a subsequent decrease in market volume. 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 space industry exhibits certain general characteristics. First, the
space industry is by nature global. There is a trend towards privatization and
deregulation in the communications and space industries which has engendered
numerous opportunities for private concerns to become players in these
traditionally government dominated markets. Opportunities in the space industry
have also been generated by the rapid growth in the information technology
industry.
Second, there is an increasing demand for satellite-based applications.
Improvements in space and communications technologies have resulted in modern
communications satellites with power, capacity, switching capabilities and
longevity significantly greater than those of their predecessors. These
improvements in performance, together with satellites' inherent geographic
coverage and technical advantages, have made satellite-based communications
increasingly competitive with other communications technologies, broadening the
market for satellite support services.
Third, government and business organizations are increasingly demanding
that satellite ground systems be designed for interoperability with computer
hardware and software products and that such products be usable with existing
legacy systems. In addition, concerns over excessive development costs and the
rapid pace of technological change have led both government and business
organizations to demand flexible systems created by adapting COTS software and
hardware, rather than systems built to customized specifications. This emphasis
on system flexibility using readily available commercial products creates
extensive opportunities for flexible COTS products and for systems integration.
The Company Solution
The Company offers satellite ground systems that provide low-cost,
efficient and flexible operations. The principal characteristics of the
Company's approach are as follows:
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Open Systems and Ease of Integration. The Company's family of products
addresses the dynamic environment of satellite operation through a commitment to
open systems architecture. The Company's products are implemented as open
systems with full adherence to industry hardware and software standards. The
Company's software can be hosted on any UNIX or Windows NT/2000 platform. The
open architecture of the Company's products allows interoperability with
existing systems. Although the Company's software components are typically sold
as bundled products, they may be purchased and operated separately or integrated
with existing command and control software.
Advanced Architecture. Unlike the traditional host-based approach, the
Company's ground systems are fully distributed, consisting of a set of
workstations 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.
Depth of Functionality. The Company's command and control software supports
all aspects of satellite operation through a bundle of four inter-operable
software products: a real-time package; an off-line package; an orbit analysis
package; and a database package. The Company's real-time package performs daily
and routine satellite operations, including commanding, telemetry processing and
fault detection and correction. The off-line 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. That is, the database defines the telemetry and command
characteristics and the desired orbital elements and tolerances.
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 hardware, including antenna, radio frequency ("RF") and baseband equipment,
allowing the total system to be delivered in the most efficient configuration
for each mission. Finally, the software is platform independent and can run on
any UNIX or Windows NT/2000 computer. This platform independence makes it
possible for the Company and its customers to take full advantage of rapidly
declining computer costs.
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 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 software 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 products. In addition, because the satellite
infrastructure industry is increasingly requiring standards compliance, 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
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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 command and control software through direct sales to
satellite operators and systems integrators in North America, Europe and Asia.
The Company plans to invest significantly in expanding its sales, support and
service capabilities in these geographic regions while simultaneously gaining
entry into other international emerging markets. In 2001 the Company formed a
wholly owned European subsidiary, Integral Systems Europe S.A.S., with
headquarters in Toulouse, France. This company provides sales, marketing,
support, and engineering services to the European market. The Company also
intends to augment its direct marketing efforts with U.S. Government
organizations to capitalize on the growing acceptance of COTS solutions in the
government sphere. As part of this strategy, the company opened an office in
Colorado Springs, Colorado to serve as the focal point for the Company's support
of its services, products and operations provided to the U.S. Air Force.
In addition to expanding its market share in its core business, the Company
intends to draw on its capabilities and reputation in the command and control
area to develop opportunities in related areas. The key aspects of this growth
strategy are as follows:
New Suite of Off-the-Shelf Applications. The Company intends to continue to
broaden its COTS line beyond command and control to include other applications
currently utilizing customized solutions. These applications, which include
payload data processing, payload integration and test ("I&T") and ground
equipment monitoring and control, have overlapping functionality with the
Company's command and control applications and provide significant market growth
opportunities. To date, the Company has delivered more than a dozen systems for
payload data processing and satellite I&T.
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 organization in areas such as hardware testing, pre- and
post-sale software support, quality assurance, project installation management
and training. The Company is ISO 9000 certified.
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.
Command and Control Software.
EPOCH 2000, the Company's COTS software solution for satellite command and
control, is designed to operate a variety of satellites with a minimum of
personnel. EPOCH 2000's success has placed the Company at the forefront of
replacing antiquated satellite control centers with smaller systems that can fly
multiple satellites produced by any manufacturer. EPOCH 2000'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 2000 features a modern, distributed architecture consisting of a
series of user workstations interconnected via an Ethernet LAN. This approach
provides better performance than traditional mini-computer based ground systems
at a lower cost. EPOCH 2000 provides end-to-end satellite command and control
capabilities,
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including telemetry processing and display, commanding and command verification
("CV"), ground station automation, alarm/event processing and data archive and
retrieval. These functions are driven by the EPOCH 2000 database, 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.
The typical EPOCH 2000 installation consists of a front-end processor which
provides the interface to the front-end hardware (e.g., bit syncs, command
encoders) and a series of user analysis workstations, all interconnected via the
LAN. The front-end processor executes a real-time version of UNIX and services
all the time-critical requirements. The analyst stations, operating under either
UNIX or Windows NT/2000, provide the mechanism for users to control and monitor
the satellite and the ground equipment. With this approach, the processing
burden is distributed across the network. The system can be expanded
indefinitely (up to the capacity of the network) by adding new workstation
nodes. Even the network capacity limitations can be overcome by dividing the
system into subnets inter-connected by bridges and routers. Thus, additional
users can be accommodated during peak loads with no degradation in system
response times.
Functionally, the software addresses all of the requirements for real-time
satellite control, including:
Telemetry Processing. The EPOCH 2000 software provides end-to-end telemetry
processing support, including frame decommutation, engineering unit ("EU")
conversion and limits checking.
Commanding. EPOCH 2000 provides full support for satellite commanding and
CV. The commanding software is mnemonic-based; the user can transmit a command
to the satellite by typing in the mnemonic from a pull-down list arranged
alphabetically or by spacecraft subsystem.
Automation. Routine satellite and ground system control procedures can be
fully automated via the EPOCH 2000 Satellite Test and Operations Language
("STOL"). STOL allows frequently used command and configuration sequences to be
stored in ASCII procedure files for automatic execution.
Alarms/Events. EPOCH 2000 provides a centralized alarm/events processor for
detecting and optionally correcting the following conditions: command or
telemetry verification failure, telemetry out-of-limits condition, front-end
processor failure or network communication problems.
Data Archive and Retrieval. A built-in archive capability provides a
permanent record of all significant ground system activity for long-term
trending and analysis.
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 package, provides trending and
statistical analysis of the information recorded in the real-time EPOCH 2000
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.
All of these applications are tailored to specific customer requirements
through a fourth package, the database. The database application is based on a
commercial package for Relational Data Base Management System ("RDBMS"), with a
top-level user interface and functional extensions developed by the Company. The
database provides "fill-in-the-blank" menu edit forms allowing the operator to
specify every relevant operational characteristic and threshold for the
satellite, its orbit and the associated ground equipment.
Signal Monitoring.
The Company's wholly owned subsidiary SAT Corporation (SAT) also offers a
range of software products and turnkey systems for communications signal
monitoring, including MONICS, a family of software products for stand-
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alone and distributed satellite transponder monitoring, and SIGMON, a turnkey
system for detecting terrestrial communications interference.
Equipment Monitoring and Control
The Company's wholly owned subsidiary Newpoint Technologies, Inc.,
(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 Processing.
The Company's wholly owned subsidiary RT Logic, offers an entire product
family, the Telemetrix line, ranging from single board components to
fully-integrated systems. Telemetrix products support telemetry processing,
commanding, ranging, and remote site interfaces for a variety of military
applications, including tracking stations, control centers, spacecraft and
payload integration, and launch range operations.
Image Data Reception, Processing and Distribution.
SKYLIGHT, the Company's first turnkey product for image data processing,
provides automatic, un-manned acquisition, processing, and distribution of
satellite imagery to the scientific, meteorological, and military communities.
The SKYLIGHT bundle of hardware and software automatically tracks satellites of
interest, captures their images, performs first order data processing, and
distributes the processed images over the internet.
The Company also offers a military version of the Skylight system,
consisting of a set of standard Skylight terminals interlinked to a central
command via a commercial communication satellite network. This version allows
military planners to view and process weather and related imagery data in
near-real time across an entire theater of operations.
Services
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 tailoring of 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 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.
Applications.
The Company believes that it has strengthened its position in the
marketplace by developing a business base in certain critical application areas
that offer continued growth potential. The Company provides products and
services in different combinations in order to deliver systems for the following
applications:
Command and Control. The Company's EPOCH 2000 product line provides the
complete spectrum of capabilities for operating satellites from any
manufacturer. The Company sells the EPOCH 2000 software as a
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stand-alone product or bundled as a turnkey system with third-party hardware
(e.g., antenna, RF, baseband and computer equipment).
Integration and Test. The Company provides I&T systems for the spacecraft
bus and payload. The I&T systems are based on the EPOCH 2000 product line and
software tools developed by the Company for data visualization and analysis for
payload I&T.
Data Processing. The Company's SKYLIGHT product provides acquisition and
processing of satellite image data. The Company has also built custom systems
for meteorological data processing.
Simulation. The Company builds satellite simulators which are used for
ground systems checkout, training, spacecraft anomaly resolution and flight
software validation.
Signal Monitoring. The Company's subsidiary SAT Corporation manufactures
software and systems for monitoring of space-based and terrestrial
communications.
Network Monitoring. The Company's subsidiary Newpoint Technologies, Inc.,
manufactures software and hardware for monitoring & control of commercial
communications networks and their associated ground equipment.
Military Environment. The Company's subsidiary RT Logic, Inc. manufactures
a range of products designed specifically for military applications, including
the Air Force Satellite Control Network (a collection of satellite tracking
stations) and assorted launch and test ranges.
Customers
In general, there are three major applications for satellites:
communications, 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.
Communications.
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 using a single software package
to operate their satellites.
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, Astrium, and Alcatel. The Company's
customers include NewSkies, Echostar, GE Americom, Loral Skynet, Shin Satellite,
Binariang Satellite Systems, 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
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
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Meteorological Satellite Program ("DMSP"), whose operations were recently
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.
Scientific Research.
The Company has supported a variety of diverse and complex science
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 to support the first NASA Discovery Mission, the Near Earth Asteroid
Rendezvous Program ("NEAR"). NEAR is the first in a series of low-cost,
small-planet exploratory missions designed to gather data about asteroids in the
solar system. The Company's EPOCH 2000 product forms the core of the mission's
command and control ground system and also supports the spacecraft I&T. The
Applied Physics Laboratory is also using the Company's products for their next
series of scientific missions for NASA. These include the Contour, Solar Stereo,
and Messenger missions.
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 to carry out 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 in Space News Magazine and
other industry publications.
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 that are highly adaptable to growth and change in the requirements of
each user.
Contract Revenue
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 company.
8
The percentages of revenues received by the Company from prime contracts
and subcontracts for fiscal years 2002, 2001, and 2000 are as follows:
Fiscal Year
Contract Source 2002 2001 2000
--------------- ---- ---- ----
Prime Contract 74% 76% 71%
Subcontract 26% 24% 29%
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 Company generates revenue under three types of contracts: cost plus,
fixed price, and time and material ("T&M") contracts. 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 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 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 fixed labor
rate contracts.
The following table summarizes the percentage of revenues attributable to
each contract type for the period indicated:
Fiscal Year
Contract Type 2002 2001 2000
------------- ---- ---- ----
Cost Plus 20% 14% 23%
Fixed Price 72% 77% 71%
Time and Materials 8% 9% 6%
U.S. Government Contracts
Company 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
2002, 2001, and 2000 approximately 60%, 55%, and 54%, respectively, of the
Company's revenues were derived from contracts or subcontracts funded by the
U.S. Government.
The Department of the Air Force represented 22%, 11%, and 3% of
revenues, respectively, for fiscal years 2002, 2001, and 2000. The Company
expects that at least 45% of its revenue for fiscal year 2003 will be derived
from Department of the 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 2003 revenue. Under this contract, Integral Systems will
lead a team of subcontractors to produce a modern, consolidated command and
control infrastructure for the military's fleet of communication satellites,
including Milstar, DSCS III, Advanced EHF, and Wideband Gapfiller.
NOAA, another Federal Government agency, represented 31%, 38%, and 41% of
revenues, respectively, for fiscal years 2002, 2001, and 2000. The Company
expects that at least 20% of its revenue for fiscal year 2003 will be derived
from NOAA contracts. The loss of any one of these NOAA 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
9
estimated that no single NOAA contract will represent 10% or more of the
Company's fiscal year 2003 revenue.
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 DCAA
through fiscal year 2000.
The Company's contracts and subcontracts with federal 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
appropriations are made by Congress for future fiscal years. In addition,
contractors often experience revenue uncertainties during the first quarter of
the government's fiscal year, which begins October 1, until differences between
budget requests and appropriations are resolved. To date, Congress has funded
all years of the multi-year major program 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
In addition to having contracts with the U.S. Government, the Company also
has contracts with commercial and international organizations. For fiscal years
2002, 2001, and 2000 approximately 40%, 45%, and 46%, 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 2002, 2001, and 2000 approximately 21%, 23%, and
23%, respectively, of the Company's revenues were derived from international
organizations. Revenues from foreign sources are discussed in Footnote Number 1
of the Notes to
10
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 one
contract that is subject to currency fluctuations in foreign markets, which is
not material. However, there can be no assurance that the Company will not enter
into these types of contracts 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. The Company does not currently have blanket authorization for
export of its products or services and cannot assure that it will be able to
obtain 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 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.
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 (i) software only (a "Software-Only Sale"), (ii) software and services
together, or (iii) 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. For a
Software-Only Sale, the Company recognizes revenue upon shipment. 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.
11
Backlog
The Company's estimated backlog is as follows:
Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2000
-------------- -------------- --------------
Outstanding Commitments (1) $34,816,846 $37,884,159 $27,578,292
General Commitments (2) 45,898,091 5,126,065 13,405,022
----------- ----------- -----------
Total $80,714,937 $43,010,224 $40,983,314
=========== =========== ===========
(1) Represents orders that are firm and funded.
(2) Represents orders that are firm but not yet funded and contracts
awarded but not yet signed.
The increase in backlog between fiscal 2002 and fiscal 2001 relates
primarily to a contract awards with the Air Force.
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 year-to-year decision to fund
the 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 57% of backlog as of September 30, 2002 will be completed during
fiscal year 2003. Estimated backlog includes contract options through June 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.
12
Competition
The Company experiences significant competition in all of the areas in
which it does business. The Company believes it is one of four companies in the
United States that derive the major portion of their revenue from the
development of satellite ground systems. The Company competes with numerous
companies having similar capabilities, some of which are larger and have
considerably greater financial resources, including Lockheed Martin Corporation,
Boeing Satellite Systems, Loral Space & Communications Ltd., Raytheon Company,
L3, TRW, Orbital Sciences Corporation, Honeywell International Inc., Computer
Sciences Corporation, Alcatel Espace, and Astrium. 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.
In general, the markets in which the Company and its subsidiaries competes
are not dominated by a single company; instead, a large number of companies
offer services that overlap and are competitive with those offered by the
Company. There can be no assurance that the Company will be able to compete
successfully.
Because its command and control business is specialized and the Company is
a leader in COTS software products, the market for this business is somewhat
less competitive. In the command and control software market, the Company
competes against other companies in the space industry. 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 has begun the process of registering many of
its trademarks and the copyrights with respect to 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. The Company does not have
non-competition agreements with all of its employees. 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.
13
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.
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 October 30, 2002, the Company had approximately 358 employees,
including employees of SAT Corporation in Sunnyvale, California, Newpoint
Technologies in Salem, New Hampshire and RT Logic in Colorado Springs, Colorado.
Of the 358 employees, 350 are full-time employees of whom 303 are considered
professionals in engineering related disciplines. Of the engineering
professionals, 88% have undergraduate degrees in a scientific discipline and 34%
of those have advanced degrees in a scientific discipline. Approximately 78% of
the engineering staff has at least seven years relevant experience.
The Company believes that its relations with its employees are good. None
of the Company's employees are covered by collective bargaining agreements.
There is significant competition for employees with the computer,
engineering and information technology skills required to perform the services
the Company offers. In addition, the Company must often comply with provisions
in government contracts that require specified levels of education, work
experience, and security clearances for our employees. The Company cannot assure
that it will be successful in attracting or retaining a sufficient number of
highly skilled and qualified employees in the future. The Company's success will
depend in part upon the Company's ability to attract, retain, train and motivate
highly skilled employees.
Financial Information in Industry Segments
During the year ended September 30, 2002, the Company's operations
included one reportable segment: satellite ground systems.
See Footnote Number 1 of the notes to the Financial Statements included
elsewhere herein for financial information regarding this segment.
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.
ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 46,700 square feet at 5000
Philadelphia Way, Lanham, Maryland 20706. The headquarters' lease expires May
31, 2009.
During April 1999, the Company contracted for 24,224 square feet and during
July 2001, the Company contracted for an additional 1,050 square feet at 5200
Philadelphia Way, Lanham, Maryland 20706. This lease
14
expires May 31, 2009.
The Company opened offices in Colorado Springs, Colorado in March 2001,
occupying 3,651 square feet at 1330 Iverness Drive, One Gateway Plaza, Suite
500, Colorado Springs, Colorado 80903. The lease for the office in Colorado
Springs expired June 15, 2002. During June 2002, the Company contracted for
22,546 square feet at The Science Park II Office Building, 980 Technology Court,
Colorado Springs, Colorado 80915. That lease for the Colorado offices expires on
May 31, 2007.
During September 2000, the Company contracted for 157.73 square meters at
High Tech Buro, Bat. C, Voie 3, Labege, France. The lease for the offices in
France expires September 14, 2009.
During July 2002, the Company contracted for an additional 83.78 square
meters at the same address in France. The lease for the supplemental offices in
France expires on June 30, 2011.
The Company's subsidiary SAT Corporation occupies approximately 9,940
square feet at 1151 Sonora Court, Sunnyvale, California 94086. This lease
expires July 30, 2004.
The Company's subsidiary Newpoint Technologies, Inc. occupies approximately
18,000 square feet at 13 Red Roof Lane, Salem, New Hampshire 03079. This lease
expires July 14, 2008.
The Company believes that it has adequate insurance coverage to protect its
properties and assets.
ITEM 3. LEGAL PROCEEDINGS
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, 2002.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the
Company's common stock as reported by The Nasdaq National Market, where the
common stock trades under the Symbol "ISYS."
2002 Fiscal Year High Low
---------------- ---- ---
First Quarter 22.00 17.82
Second Quarter 23.74 17.90
Third Quarter 23.98 19.00
Fourth Quarter 22.45 14.31
2001 Fiscal Year High Low
---------------- ---- ---
First Quarter 17.56 10.81
Second Quarter 17.50 12.81
Third Quarter 24.50 15.50
Fourth Quarter 23.14 15.75
As of September 30, 2002, there were approximately 2,453 holders of record
of the Company's common stock.
Historically, the Company has not paid any cash dividends. Instead, the
Company intends to invest earnings in the operations, development and growth of
its business. The payment of future dividends on the common stock and the rate
of such 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."
The information required by this item regarding equity compensation plans
is set forth in Item 12 of this Annual Report on Form 10-K.
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") 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 $.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. See "Item 13. Certain Relationships and Related Transactions." The shares
of Integral Systems common stock issued in connection with the Reorganization
Agreement were issued pursuant to an exemption from registration provided by
Section 4(2) of the Securities Act.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents summary consolidated financial data of the
Company for the fiscal years ended September 30, 2002, 2001, 2000, 1999, and
1998. The financial data for the fiscal years ended September 30, 1998, 1999,
2000 and 2001 has been derived from the financial statements of the Company
which have been audited by Rubino & McGeehin, Chartered, independent public
accountants, as set forth in the financial statements and notes thereto
presented elsewhere herein. The financial data for the fiscal year ended
September 30, 2002 has been derived from the financial statements of the Company
which have been audited by Ernst & Young LLP, independent auditors, as set forth
in the financial statements and notes thereto presented elsewhere herein. The
consolidated financial statements of the Company presented herein have been
restated for all periods prior to the acquisition of SAT Corporation to include
the combined financial results of the Company and SAT Corporation. The following
16
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."
Years Ended September 30,
---------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(in thousands, except for per share data)
Statement of Operations Data:
Revenue $50,923 $40,532 $40,455 $42,937 $31,012
Gross margin 13,291 11,826 11,869 12,001 8,675
Income from operations 1,817 3,457 2,919 4,723 3,024
Income from continuing operations 2,623 4,011 3,713 2,983 1,727
Net income $ 2,623 $ 4,011 $ 4,177 $ 3,200 $ 2,024
Income from continuing operations per common
and equivalent share--basic $ 0.29 $ 0.42 $ 0.42 $ 0.43 $ 0.27
Income from continuing operations per common
and equivalent share--diluted $ 0.28 $ 0.41 $ 0.40 $ 0.41 $ 0.25
Net income per common and equivalent
share--basic $ 0.29 $ 0.42 $ 0.47 $ 0.46 $ 0.31
Net income per common and equivalent
share--diluted $ 0.28 $ 0.41 $ 0.45 $ 0.43 $ 0.29
Weighted average common and equivalent
shares outstanding--basic 9,175 9,462 8,829 6,969 6,443
Weighted average common and equivalent
shares outstanding--diluted 9,233 9,673 9,284 7,423 6,883
Balance Sheet Data:
Cash and cash equivalents $16,064 $ 2,380 $17,558 $ 9,267 $ 4,589
Working capital 71,164 71,427 77,080 30,748 8,239
Total assets 96,617 90,413 89,858 45,280 19,166
Long-term obligations, net of current 2,540 2,005 1,340 714 748
Stockholders' equity 82,256 78,177 81,698 34,152 9,981
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.
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.
17
Provision 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
underestimates 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. These assets are 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
intangible assets or goodwill are determined to be impaired, then these balances
are written down to their estimated fair value on the date of the 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. The results
reported in any given period could be impacted by management's determination as
to when an impairment has occurred.
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 190 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 any manufacturer. These systems offer
significant cost savings for customers that have traditionally purchased a
separate custom control center for each of their satellites.
18
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, 2002, 2001 and 2000:
Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
2002 2002 2001 2001 2000 2000
---- ---- ---- ---- ---- ----
(in thousands) % of (in thousands) % of (in thousands) % of
Revenue Revenue Revenue
Revenue $50,923 100.0 $40,532 100.0 $40,455 100.0
Cost of revenue 37,632 73.9 28,706 70.8 28,586 70.7
------- ----- ------- ----- ------- -----
Gross margin 13,291 26.1 11,826 29.2 11,869 29.3
SG&A 8,929 17.5 6,799 16.8 7,019 17.4
Acquisition Costs 0 0 0 0 445 1.1
Research & Development 362 .7 200 .5 536 1.3
Product Amortization 2,183 4.3 1,370 3.4 950 2.3
------- ----- ------- ----- ------- -----
Income from operations 1,817 3.6 3,457 8.5 2,919 7.2
Other income (exp.) net 1,953 3.8 2,117 5.2 1,976 4.9
------- ----- ------- ----- ------- -----
Income before taxes 3,770 7.4 5,574 13.7 4,895 12.1
Income taxes 1,147 2.2 1,563 3.8 1,182 2.9
------- ----- ------- ----- ------- -----
Income from continuing
Operations 2,623 5.2 4,011 9.9 3,713 9.2
Income from Discontinued
Segment (net of tax) 0 0 0 0 129 .3
Gain on sale of Discontin.
Segment (net of tax) 0 0 0 0 335 .8
------- ----- ------- ----- ------- -----
Net Income $ 2,623 5.2 $ 4,011 9.9 $ 4,177 10.3
======= ===== ======= ===== ======= =====
Revenue
The Company earns revenue from sales of its products and services through
contracts that are funded by the U.S. Government, both as a prime contractor or
a subcontractor, as well as commercial and international organizations
Internally, the Company classifies revenues in two separate categories on
the basis of the contracts' procurement and development requirements: (i)
contracts which require compliance with Government procurement and development
standards ("Government Services") are classified as government revenue, and (ii)
contracts conducted according to commercial practices ("Commercial Products and
Services") are classified as commercial revenue, regardless of whether the end
customer is a commercial or government entity. Sales of the Company's COTS
products are classified as Commercial Products and Services revenue.
For the fiscal years ended September 30, 2002, 2001, and 2000, the
Company's revenues were generated from the following sources:
19
Fiscal Year Fiscal Year Fiscal Year
Revenue Type 2002 2001 2000
------------ ---- ---- ----
Commercial Products & Services
Commercial Users 40% 45% 46%
U.S. Government Users 0 1 2
---- ---- ----
Subtotal 40 46 48
---- ---- ----
Government Services
NOAA 31 38 41
USAF 22 10 3
Other U.S. Government Users 7 6 8
---- ---- ----
Subtotal 60 54 52
---- ---- ----
Total 100% 100% 100%
==== ==== ====
Based on the Company's revenue categorization system, the Company
classified 40%, 46%, and 48% of its revenue as Commercial Products and Services
revenue with the remaining 60%, 54%, and 52% classified as Government Services
revenue for fiscal years ended September 30, 2002, 2001, and 2000, respectively.
By way of comparison, if the revenues were classified strictly according to
end-user (independent of the Company's internal revenue categorization system),
the U.S. Government would account for 60%, 55%, and 54%, of the total revenues
for fiscal years 2002, 2001, and 2000 respectively.
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 rates for
equipment and subcontract pass-throughs seldom exceed 15%. Engineering service
gross margins typically range between 20% and 35%.
Fiscal Year 2002 Compared to Fiscal Year 2001
On a consolidated basis, revenue increased 25.6% or $10.4 million, to
$50.9 million for fiscal year 2002 from $40.5 million for fiscal year 2001. All
revenue functional components (i.e. licenses, services and pass throughs) were
greater during fiscal year 2002 when compared to fiscal year 2001 due to
increased sales. Further, during the current fiscal year, approximately $2.5
million in Commercial Products and Services revenue was recorded for Newpoint,
which was acquired by the Company in January 2002, whereas the Company recorded
no Newpoint revenue during fiscal year 2001. Other than the revenue increase
attributable to Newpoint, most of the remaining increases in revenue pertain to
the Company's new contract awards (specifically the CCS-C and SCNC programs)
with the U.S. Air Force that occurred in the Spring of 2002.
During fiscal year 2002, cost of revenue increased 31% or $8.9 million to
$37.6 million from $28.7 million during fiscal year 2001. The increase was due
to increases in direct labor, related overhead costs, travel costs and equipment
and subcontract pass-throughs necessary to support the increase in revenue
discussed above. Further, cost of sales amounts attributed to Newpoint
(approximately $2.1 million) were not included with the Company's results from
operations in fiscal year 2001.
The Company's gross margin increased approximately $1.5 million to $13.3
million for fiscal year 2002 from $11.8 million for fiscal year 2001. The
increase was principally due to the $10.4 million increase in revenue discussed
above. Gross margin as a percentage of revenue was 26.1% during fiscal year 2002
compared to 29.2% for fiscal year 2001. This decrease is primarily attributable
to a decrease in gross margin at SAT as a result of overruns on two fixed price
contracts that were recorded during the three months ended March 31, 2002.
Further,
20
Newpoint's gross margin percentage was only 17% for fiscal year ended 2002,
thereby reducing the Company's overall gross margin percentage.
Selling, general & administrative expenses ("SG&A") increased to
approximately $8.9 million in fiscal year 2002 from $6.8 million in fiscal year
2001. The change was primarily due to increases in the Company's product related
selling expenses and from $1.1 million of SG&A expenses at Newpoint which were
not recorded by the Company in fiscal year 2001. The Company also recorded a bad
debt expense of approximately $300,000 in fiscal year 2002 (at SAT) and recorded
no similar expenses in fiscal year 2001. As a percentage of revenue, SG&A
accounted for 17.5% of revenue in fiscal year 2002 compared to 16.8% in 2001.
Product amortization was $2,180,000 in fiscal year 2002 compared to $1,370,000
in fiscal year 2001 resulting from an increased capitalized cost base.
Income from operations was $1.8 million in fiscal year 2002 compared to
$3.5 million in fiscal year 2001. The decrease is principally related to
operating losses at SAT and Newpoint. SAT incurred an operating loss of $1.1
million in fiscal year 2002 compared to operating income of $650,000 in fiscal
year 2001. Newpoint posted an operating loss of $720,000 in fiscal year 2002
while Newpoint's operating results were not consolidated with the Company's in
fiscal year 2001. Operating income for the Company's core command control
business increased to $3.7 million in fiscal year 2002 from $2.8 million in
fiscal year 2001.
During fiscal year 2002, the Company recorded approximately $1.2 million
of gains on the sale of marketable securities and realized no such gain in
fiscal year 2001. The Company also recorded $930,000 of interest income in
fiscal year 2002 (compared to $2.5 million in fiscal year 2001), which was
principally derived from investments of the cash proceeds from the Company's two
private equity placements that occurred in June 1999 and February 2000. Since a
significant portion of such investment was related to tax-free debt securities,
the Company's effective tax rate was only 30.4% for fiscal year 2002 and 28.0%
for fiscal year 2001
Fiscal Year 2001 Compared to Fiscal Year 2000
On a consolidated basis, revenue was essentially flat at $40.5 million for
both periods. Although revenue at SAT Corporation decreased by approximately
$2.1 million in fiscal year 2001 compared to fiscal year 2000, this decrease was
offset by gains in the remainder of the Company's Commercial Products and
Services revenues and the Company's Government Services revenues.
During fiscal year 2001, cost of revenue was also flat compared to fiscal
year 2000 increasing slightly to $28.7 million from $28.6 million. Generally,
the components of cost of revenue (direct labor, overhead, travel, other direct
costs, direct equipment and subcontracts) in fiscal year 2001 were also
comparable to amounts recorded in fiscal year 2000. There was no cost of revenue
component that varied more than 5% between the two fiscal periods. Cost of
revenue expressed as a percentage of revenues increased insignificantly to 70.8%
for fiscal year 2001 from 70.7% for fiscal year 2000.
The Company's gross margin decreased by less than 1%, or $40,000, to $11.8
million for fiscal year 2001 from $11.9 million for fiscal year 2000. As a
percentage of revenue, gross margin decreased to 29.2% during fiscal year 2001
compared to 29.3% for fiscal year 2000. The gross margin percentages for both
fiscal year 2001 and fiscal year 2000 are reasonably representative of the
Company's gross margin profile.
SG&A expenses decreased to approximately $6.8 million in fiscal year 2001
from $7.0 million in fiscal year 2000. The change was primarily due to decreases
in the Company's bid and proposal expenses. As a percentage of revenue, SG&A
accounted for 16.8% of revenue in fiscal year 2001 compared to 17.4% in 2000.
Product amortization was $1,370,000 in fiscal year 2001 compared to $950,000 in
fiscal year 2000 resulting from an increased capitalized cost base. In addition,
the Company recorded one time acquisition costs amounting to approximately
$445,000 in fiscal year 2000, principally related to the acquisition of SAT
Corporation and a previously reported unsuccessful acquisition attempt of an
unrelated entity. Such acquisition costs did not recur in fiscal year 2001.
21
Income from operations increased 18.4% to $3.5 million for fiscal year
2001 from $2.9 million for fiscal year 2000. As a percentage of revenue, income
from operations was 8.5% for fiscal year 2001 up from 7.2% in fiscal year 2000.
This increase was principally the result of lower SG&A expenses and the
elimination of one time acquisition related costs, partially offset by higher
product amortization expenses in fiscal year 2001 versus fiscal year 2000.
During fiscal year 2001, the Company recorded $2.5 million of interest
income (compared to $2.3 million in fiscal year 2000), which was principally
derived from investments of the cash proceeds from the Company's two private
equity placements that occurred in June 1999 and February 2000. Since a
significant portion of such investment was related to tax-free debt securities,
the Company's effective tax rate was only 28.0% for fiscal year 2001 and 24.2%
for fiscal year 2000.
Discontinued Operations
On July 5, 2000, the Company announced its plan to divest its wholly owned
subsidiary Integral Marketing, Inc. Integral Marketing earned commission revenue
by representing a number of electronic product manufacturers in Maryland,
Virginia and the District of Columbia, principally in space-related markets. The
sale of Integral Marketing was effective July 1, 2000 and closed on August 31,
2000 (see Footnote Number 2 of Notes to the Consolidated Financial Statements).
As a result of this sale, the results of operations for Integral Marketing have
been reported as discontinued operations (the "Discontinued Operations") and
previously reported financial statements have been restated.
Income from Discontinued Operations was $130,000 in fiscal year 2000. There
was no income from Discontinued Operations recorded in fiscal year 2002 or 2001.
Acquisition of SAT Corporation
In August 2000, the Company entered into an agreement and plan of
reorganization, by and among the Company, SAT Corporation, ISI Acquisition
Corporation and Herbert Pardula, the sole shareholder of SAT Corporation. The
reorganization agreement provided for the acquisition of SAT Corporation by the
Company. Pursuant to the terms of the reorganization agreement, ISI was merged
with and into SAT Corporation, with SAT Corporation as the surviving entity. At
the time of the merger, SAT Corporation became a wholly owned subsidiary of the
Company. Pursuant to the reorganization agreement, the purchase price paid to
the sole shareholder by the Company in connection with the acquisition of SAT
Corporation consisted of 650,000 shares of the Company's common stock, par value
$.01 per share. The acquisition was accounted for as a pooling of interests. All
prior period consolidated financial statements presented herein have been
restated to include the results of operations, financial position and cash flows
of the Company and SAT Corporation as a single entity. Certain reclassifications
were made to the SAT Corporation financial statements to conform to the
Company's presentations.
22
Acquisition of Newpoint Technologies
On January 30, 2002, the Company acquired Newpoint Technologies, Inc.
pursuant to an agreement and plan of reorganization dated December 19, 2001, by
and among the Company, Newpoint Technologies Inc., and ISI Merger Corp., a
Delaware corporation and wholly owned subsidiary of the Company ("ISI Merger").
The reorganization agreement provided for the acquisition of Newpoint
Technologies by the Company. Pursuant to the terms of the reorganization
agreement, Newpoint Technologies, Inc. was merged with and into ISI Merger, with
ISI Merger (which changed its name to "Newpoint Technologies, Inc.") as the
surviving entity. At the time of the merger, Newpoint Technologies effectively
became a wholly owned subsidiary of the Company. As consideration for all of the
shares issued and outstanding 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. 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. There were no contingent payments due to
the former shareholders of Newpoint for the period February 1, 2002 through
September 30, 2002.
Acquisition of Real Time Logic
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 $.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. See "Item 13. Certain Relationships and Related
Transactions."
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 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 Integral Systems common stock. Any Integral Systems 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
earnout period. The contingent purchase price is subject to claims by Integral
under the indemnification provisions of the Reorganization Agreement.
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.
Looking forward to fiscal year 2003 in its entirety, the Company is
anticipating growth in revenue, net income, and fully diluted earnings per
common share of approximately 50% over FY02 levels. Anticipated growth in net
income and earnings per share for FY03 would have been much greater were it not
for FY02 gains on marketable securities of approximately $1.2 million which are
not forecasted for FY03. It is also anticipated that operating income for FY03
will be almost triple the amounts recorded in FY02, increasing from $1.8 million
in FY02 to approximately $5.4 million in FY03.
23
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 it common
stock. With respect to the capital raised in the private placements, at
September 30, 2002, $35,421,000 was invested in variable rate State of Maryland
debt securities, $10,000,000 was invested in Banc of America Preferred Funding
Corporation "Dividends Received Eligible Auction Market" preferred stock
("DREAMS"), and $2,295,527 was invested in common stock. See Footnote Number 1
and 4 of the Notes to the Financial Statements included elsewhere herein.
For fiscal year 2002, the Company generated approximately $6.4 million of
cash from operating activities and $6.4 million from investing activities.
Included in the Company's investing activities were approximately $3.6 million
for newly capitalized software development costs and approximately $1.3 million
for fixed assets (principally new computers and equipment).
During fiscal year 2002, 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 expire February 29, 2004. At September 30,
2002, 2001, and 2000, the Company had no amounts outstanding under the lines of
credit.
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.
The Company also has access to a $2.0 million equipment lease line of
credit under which it had $122,161 outstanding as of September 30, 2002. The
outstanding balance is payable over a 45-month period from lease inception and
bears interest at a rate of 8.8% per annum.
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. The Company
believes that inflation did not have a material impact on the Company's revenues
or income from operations in fiscal years 2002, 2001, and 2000.
24
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 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 effect 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 our financial performance.
. Risks related to the Company's acquisition strategy. In
particular, the Company may not be able to find any attractive
candidates or it may find that the acquisition terms proposed by
potential acquisition candidates are not favorable to the
Company. In addition, the Company may compete with other
companies for these acquisition candidates, which competition may
make an acquisition more expensive for the Company. If the
Company is unable to identify and acquire any suitable
candidates, the Company may not be able to find alternative uses
for the cash proceeds of its previous private placements that
improve the Company's business, financial conditions, or results
of operations to the extent that an acquisition could. In
addition, if the Company is able to identify and acquire one or
more businesses, the integration of the acquired business or
businesses may be costly and may result in a decrease in the
value of the Company's common stock for the following reasons,
among others:
. 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 than it planned, which may
adversely affect its ability to pursue other more
profitable activities;
. the difficulties of integration 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 acquisition candidates;
and an acquisition candidate may have liabilities or
adverse operating issues that the Company failed to
discover through its due diligence prior to the
acquisition.
. Changes in activity levels in the Company's core markets.
25
While sometimes presented with numerical specificity, these forward-looking
statements are based upon a variety of assumptions relating to the business of
the Company, which although considered reasonable by the Company, 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 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
Not applicable.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
DESCRIPTION PAGES
Independent Auditors' Reports F-2 - F-3
Consolidated Balance Sheets as of September 30, 2002 and 2001 F-4
Consolidated Statements of Operations for the Years Ended
September 30, 2002, 2001 and 2000 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 2002, 2001 and 2000 F-6
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2002, 2001 and 2000 F-7
Notes to Consolidated Financial Statements F-8 - F22
F-1
Report of Ernst & Young LLP, Independent Auditors
To the Board of Directors of Integral Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Integral
Systems, Inc. and subsidiaries as of September 30, 2002, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the 2002 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Integral Systems, Inc. and subsidiaries at September 30, 2002, and the
consolidated results of their operations and their cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States.
/s/ Ernst & Young LLP
McLean, Virginia
December 6, 2002
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Integral Systems, Inc.
We have audited the accompanying consolidated balance sheet of Integral
Systems, Inc. and its subsidiaries as of September 30, 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended September 30, 2001 and 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Integral
Systems, Inc. and its subsidiaries as of September 30, 2001, and their
consolidated results of operations and consolidated cash flows for the years
ended September 30, 2001 and 2000, in conformity with accounting principles
generally accepted in the United States.
/s/
Rubino & McGeehin, Chartered
November 21, 2001
Bethesda, Maryland
F-3
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2002 and 2001
___________
ASSETS
2002 2001
---- ----
Current assets
--------------
Cash and cash equivalents $ 16,064,363 $ 2,379,503
Marketable securities 46,885,581 57,890,170
Accounts receivable, net 16,918,780 18,245,423
Employee receivables and other receivables 82,613 139,460
Prepaid expenses 916,756 340,677
Notes receivable - current portion 118,226 112,495
Deferred income tax - current portion 887,832 611,395
Income taxes receivable 1,110,703 1,940,573
------------- -------------
Total current assets 82,984,854 81,659,696
Property and equipment, at cost, net of accumulated
depreciation and amortization 3,467,907 3,193,690
Notes receivable - long term portion 288,500 406,727
Goodwill and intangible assets, net 3,047,680 0
Software development costs, net of accumulated amortization 6,490,640 5,080,629
Deposits and deferred charges 337,274 72,702
------------- -------------
Total assets $ 96,616,855 $ 90,413,444
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
-------------------
Accounts payable - trade $ 5,916,194 $ 5,131,229
Accrued expenses 3,249,323 2,926,443
Capital leases payable - current portion 29,653 137,791
Billings in excess of revenue for contracts in progress 2,625,602 2,036,795
------------- -------------
Total current liabilities 11,820,772 10,232,258
Capital leases payable - long-term portion 92,508 122,161
Deferred income taxes - long-term portion 2,447,395 1,882,384
------------- -------------
Total liabilities 14,360,675 12,236,803
------------- -------------
Stockholders' Equity
--------------------
Common stock, $.01 par value, 40,000,000 shares authorized, and
9,322,783 and 9,071,113 shares issued and outstanding 93,228 90,711
Additional paid-in capital 65,070,787 63,246,985
Retained earnings 17,599,042 15,095,953
Accumulated other comprehensive loss (506,877) (257,008)
------------- -------------
Total stockholders' equity 82,256,180 78,176,641
------------- -------------
Total liabilities and stockholders' equity $ 96,616,855 $ 90,413,444
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended September 30, 2002, 2001 and 2000
2002 2001 2000
---- ---- ----
Revenue $ 50,922,741 $ 40,531,600 $ 40,455,143
Cost of Revenue
Direct Labor 13,229,088 10,648,052 10,882,228
Overhead Costs 9,552,535 7,555,391 7,544,122
Travel and Other Direct Costs 1,958,575 1,508,543 1,566,665
Direct Equipment & Subcontracts 12,891,703 8,993,849 8,593,346
----------------- --------------- -----------------
Total Cost of Revenue 37,631,901 28,705,835 28,586,361
----------------- --------------- -----------------
Gross Margin 13,290,840 11,825,765 11,868,782
Selling, General & Administrative 8,928,938 6,798,430 7,019,000
Terminated Acquisition Costs 0 0 444,847
Research & Development 361,921 199,987 536,177
Product Amortization 2,182,910 1,370,000 950,000
----------------- --------------- -----------------
Income From Operations 1,817,071 3,457,348 2,918,758
Other Income (Expense)
Interest Income 929,243 2,480,113 2,335,524
Interest Expense (15,351) (50,671) (96,587)
Gain on sale of marketable securities 1,216,031 0 0
Miscellaneous, net (176,791) (312,387) (262,369)
----------------- --------------- -----------------
Total Other Income 1,953,132 2,117,055 1,976,568
Income from continuing operations before income taxes 3,770,203 5,574,403 4,895,326
Provision for Income Taxes 1,146,788 1,563,283 1,182,498
----------------- --------------- -----------------
Income from Continuing Operations 2,623,415 4,011,120 3,712,828
Discontinued Operations
Income From Discontinued Segment
(net of tax of $42,867) 0 0 129,374
Gain on disposal of Discontinued Segment
(net of deferred tax of $210,895) 0 0 335,181
----------------- --------------- -----------------
Net Income $ 2,623,415 $ 4,011,120 $ 4,177,383
================= =============== =================
Weighted Avg. Number of Common Shares:
Basic 9,174,831 9,462,166 8,829,182
Diluted 9,232,619 9,672,833 9,283,546
Earnings per Share (Basic)
Continuing Operations $ 0.29 $ 0.42 $ 0.42
Discontinued Segment 0.00 0.00 0.01
Gain on disposal of Discontinued Segment 0.00 0.00 0.04
----------------- ---------------- -----------------
Net Income $ 0.29 $ 0.42 $ 0.47
================= ================ =================
Earnings per Share (Diluted)
Continuing Operations $ 0.28 $ 0.41 $ 0.40
Discontinued Segment 0.00 0.00 0.01
Gain on disposal of Discontinued Segment 0.00 0.00 0.04
----------------- ---------------- -----------------
Net Income $ 0.28 $ 0.41 $ 0.45
================= ================ =================
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 2002, 2001 and 2000
Common Accumulated
Number Stock Additional Other
of at Par Paid-in Retained Comprehensive
Shares Value Capital Earnings Loss Total
------------ ------------ ------------ ------------ -------------- ------------
Balance September 30, 1999 7,813,908 $ 78,139 $ 22,349,932 $ 11,723,880 $ - $ 34,151,951
Private placement offering 1,400,000 14,000 40,933,758 - - 40,947,758
Stock options exercised 213,460 2,135 982,869 - - 985,004
Tax benefit of stock options
exercised - - 1,435,754 - 1,435,754
Net income - - - 4,177,383 - 4,177,383
------------ ------------ ------------ ------------ ------------ ------------
Balance September 30, 2000 9,427,368 94,274 65,702,313 15,901,263 - 81,697,850
Comprehensive income
Net income - - - 4,011,120 - 4,011,120
Unrealized loss on marketable
securities (net of deferred
tax benefit of $164,317) - - - - (257,008) (257,008)
------------
Comprehensive income - - - 3,754,112
Repurchased shares (420,015) (4,200) (2,927,505) (4,816,430) - (7,748,135)
Stock options exercised 63,760 637 287,288 - - 287,925
Tax benefit of stock options
exercised - - 184,889 - - 184,889
------------ ------------ ------------ ------------ ------------ ------------
Balance September 30, 2001 9,071,113 $ 90,711 $ 63,246,985 $ 15,095,953 ($ 257,008) $ 78,176,641
Comprehensive income
Net income - - - 2,623,415 - 2,623,415
Unrealized loss on marketable
securities (net of deferred
tax benefit of $159,752) - - - - (249,869) (249,869)
------------
Comprehensive income - - - 2,373,546
Repurchased shares (10,800) (108) (74,988) (120,326) - (195,422)
Stock options exercised 262,470 2,625 1,226,822 - - 1,229,447
Tax benefit of stock options
exercised - - 671,968 - - 671,968
------------ ------------ ------------ ------------ ------------ ------------
Balance September 30, 2002 9,322,783 $ 93,228 $ 65,070,787 $ 17,599,042 ($ 506,877) $ 82,256,180
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 2002, 2001 and 2000
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income $ 2,623,415 $ 4,011,120 $ 4,177,383
Reconciling adjustments:
Gain on disposal of discontinued segment - - (335,181)
Depreciation and amortization 3,583,351 2,326,920 1,997,785
Gain on sale of marketable securities (1,216,031) - -
Loss on disposal of fixed assets 34,344 2,229 32,498
Disposal of non-cash assets of discontinued segment - - (53,924)
Provision for deferred income taxes 437,279 1,302,382 (140,113)
(Increase) decrease in assets, net of effects of
acquisition:
Accounts receivable and other receivables 1,749,891 (4,882,590) 122,198
Reserve for doubtful accounts 232,507 - -
Prepaid expenses and deposits (713,919) (177,580) (64,587)
Income taxes receivable, net 1,324,677 (100,394) (666,712)
(Decrease) increase in liabilities, net of effects of
acquisition
Accounts payable (1,658,281) 3,216,244 (1,020,878)
Accrued expenses (72,698) 307,930 (1,092,065)
Billings in excess of revenue 82,693 204,275 (824,554)
------------- ------------- -------------
Total adjustments 3,783,813 2,199,416 (2,045,533)
------------- ------------- -------------
Net cash provided by operating activities 6,407,228 6,210,536 2,131,850
------------- ------------- -------------
Cash flow from investing activities:
Purchases of marketable securities (7,697,927) (10,955,495) (31,830,000)
Sale of marketable securities 19,508,926 2,610,000 -
Proceeds from payments on notes receivable 112,496 80,778 -
Acquisition of fixed assets (1,349,396) (1,948,438) (1,209,571)
Software development costs (3,625,621) (3,261,846) (2,132,589)
Net advances to Newpoint Technologies (448,332) - -
Acquisition of Newpoint Technologies (118,749) - -
------------- ------------- -------------
Net cash provided by (used in) investing activities 6,381,397 (13,475,001) (35,172,160)
------------- ------------- -------------
Cash flow from financing activities:
Proceeds from issuance of common stock 1,229,448 287,925 41,932,762
Payments on stock repurchase (195,422) (7,748,135) -
Payments on capital lease obligations (137,791) (454,153) (601,328)
------------- ------------- -------------
Net cash provided by (used in) financing activities 896,235 (7,914,363) 41,331,434
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 13,684,860 (15,178,828) 8,291,124
Cash and cash equivalents - beginning of year 2,379,503 17,558,331 9,267,207
------------- ------------- -------------
Cash and cash equivalents - end of year $ 16,064,363 $ 2,379,503 $ 17,558,331
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
_______________
1. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Integral Systems, Inc. (the Company) and its wholly owned subsidiaries, SAT
Corporation, Newpoint Technologies (see Note 2), and ISI Europe. InterSys,
Inc., an inactive subsidiary of the Company, was formally closed during the
fiscal year. The assets of the Company's former subsidiary Integral
Marketing, Inc. (IMI) were disposed of during the year ended September 30,
2000 (see Note 2) and is presented as discontinued operations in the
consolidated statement of operations. 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.
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 No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." The Investments are
carried at fair market value, with unrealized gains and losses reported in
stockholders' equity as a component of accumulated other comprehensive
income (loss), net of any related tax effect.
Contract Revenue
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 fixed-price contracts is recognized on the
percentage-of-completion method, measured by the cost-to-cost method for
each contract. 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. 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 such losses are
determined. 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
revisions are determined. The Company's contracts vary in length from one
to four years.
The fees under certain government contracts may be increased or decreased
in accordance with cost or performance incentive provisions which 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. The liability, billings in excess of revenue for contracts
in progress, represents billings in excess of revenue recognized.
F-8
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
_______________
1. Summary of Significant Accounting Policies (continued)
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 (i) software only (a "Software-Only Sale"), (ii) software and
services together, or (iii) 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.
For a Software-Only Sale, the Company recognizes revenue upon shipment. 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
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.
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 gain or loss is credited or charged to income.
F-9
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
_______________
1. Summary of Significant Accounting Policies (continued)
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, 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 is being amortized
may have to be modified.
Earnings Per Share
Basic earnings per share is computed using the weighted average number of
shares outstanding during the period. The only reconciling item between the
shares used for basic and diluted earnings per share related to outstanding
stock options. No reconciling items existed between the net income used for
basic and diluted earnings per share. The earnings per share computations
have been adjusted retroactively where appropriate for the pooling of
interest discussed in Note 2.
Cash Concentrations and Cash Equivalents
The Company considers all highly-liquid debt instruments purchased with a
maturity of forty five 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.
Segment Information
In 1999, the Company adopted Statement of Financial Accounting Standard
(SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related
Information". SFAS No. 131 supercedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise". Under the new standard, the Company is
required to use the "management" approach to reporting its segments. The
management approach designates the internal organization, used by
management for making operating decisions and assessing performance, as the
source of the Company's segments. The adoption of SFAS No. 131 had no
impact on the Company's consolidated financial position, results of
operations or cash flows.
During the years ended September 30, 2002, 2001, and 2000, the Company's
operations included one reportable segment for satellite ground systems.
These continuing operations include all of the operations of the Company,
SAT Corporation, Newpoint Technologies, Inc. and ISI Europe for the years
then ended. The equipment marketing operations of IMI are included in
discontinued operations for the years above. The Company provides satellite
ground systems - computer systems for satellite command and control, data
processing, simulation and flight software validation, equipment monitoring
and control, and signal monitoring. Customers for these systems include
U.S. Government organizations such as National Aeronautics and Space
Administration (NASA), the National Oceanic and Atmospheric Administration
(NOAA), and the U.S. Air Force, as well as commercial satellite operators,
both domestic and foreign.
There were no significant intercompany sales.
F-10
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
__________________
1. Summary of Significant Accounting Policies (continued)
Major customer information and revenue by customer category is discussed in
Note 3. Revenue from foreign sources, primarily with corporations located
in France, the Netherlands, Thailand, and Mexico, totaled $10,706,529,
$9,408,532, and $9,319,638, for the years ended September 30, 2002, 2001,
and 2000, respectively. The Company has no significant long-lived assets
located in foreign countries.
Reclassifications
Certain reclassifications have been made to prior year balances in order to
conform to the current year presentation.
Stock Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), allows companies to account for
stock-based compensation either under the provisions of SFAS 123 or under
the provisions of Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25"), as amended by FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25)," but requires pro
forma disclosure in the footnotes to the financial statements as if the
measurement provisions of SFAS 123 had been adopted. The Company has
elected to account for its stock-based compensation in accordance with the
provisions of APB 25.
Recent Accounting Pronouncements
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 "Business Combinations" ("SFAS 141") and Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"). SFAS 141 requires all business combinations to be accounted for
using the purchase method of accounting and is effective for all business
combinations initiated after June 30, 2001. SFAS 142 requires goodwill to
be tested for impairment under certain circumstances, and written off when
impaired, rather than being amortized as previous standards required. SFAS
142 is effective for fiscal years beginning after December 15, 2001.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS
143 provides guidance on the initial measurement and subsequent accounting
for obligations associated with the sale, abandonment, or other type of
disposal of long-lived tangible assets. SFAS 143 is effective for fiscal
years beginning after June 15, 2002. Management does not expect a material
impact of SFAS 143 on its results of operations and financial condition.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets"
("SFAS 144"). SFAS 144 provides updated guidance concerning the recognition
and measurement of an impairment loss for certain types of long-lived
assets. SFAS 144 also expands the scope of a discontinued operation to
include a component of an entity, and it eliminates the current exemption
to consolidation when control over a subsidiary is likely to be temporary.
SFAS 144 is effective for fiscal years beginning after December 15, 2001,
and interim periods within those fiscal years. Management does not expect a
material impact of SFAS 144 of its results of operations and financial
condition.
F-11
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
___________________
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (continued)
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, " Costs Associated With Disposal Activities " ("SFAS 146").
SFAS146 (which nullifies EITF 94-3) requires that a liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred. An entity's commitment to a plan does not, by
itself, create an obligation that meets the definition of a liability.
Severance pay may be required to be recognized over time rather than up
front. If the benefit arrangement requires employees to render future
service beyond a "minimum retention period" a liability should be
recognized as employees render service over the future service period even
if the benefit formula used to calculate the termination benefit is based
on length of service. SFAS 146 is effective for exit or disposal activities
initiated after December 31, 2002, with earlier application encouraged.
2. Acquisitions and Dispositions
Effective August 31, 2000, in connection with the Agreement and Plan of
Reorganization, the Company issued 650,000 shares of its common stock in
exchange for all of the outstanding common stock of SAT Corporation (SAT),
a privately-held company with 4.0 million shares outstanding, for a total
value of $9.831 million. The merger qualified as a tax-free reorganization
and has been accounted for as a pooling of interests. Accordingly, the
Company's consolidated financial statements have been restated for all
periods prior to the business combination to include the combined financial
results of Integral and SAT.
In July 2000, the Company announced a plan to sell the assets of its
wholly-owned subsidiary Integral Marketing, Inc. (IMI). IMI acts as a
manufacturer's representative, selling electronic test instrumentation and
equipment to customers primarily in Maryland, Virginia and the District of
Columbia. On August 31, 2000, the sale was completed, effective July 1,
2000, for $1,300,000 comprised of $700,000 in cash and $600,000 in the form
of a secured note due in quarterly installments through October 15, 2005
with interest at 5%. The net assets sold consisted primarily of cash,
accounts receivable, and property and equipment. The disposal of IMI has
been accounted for as a discontinued operation and, accordingly, its
operating results are segregated and reported as discontinued operations in
the accompanying consolidated statements of operations.
On January 30, 2002, the Company completed its acquisition of Newpoint
Technologies, Inc. (Newpoint). As consideration for all of the shares
issued and outstanding 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. 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.
A total of $118,749 represents Integral Systems' direct transaction costs
relating to the acquisition. To retire debt and fund operations, the
Company made advances to Newpoint in the amounts of $490,000 and $1,837,849
immediately prior to and immediately following consummation of the
acquisition. The operations of Newpoint are included in the consolidated
statement of operations as of February 1, 2002.
F-12
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
_____________________
2. Acquisitions and Dispositions (continued)
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
$2,796,431, $400,000, $100,000, $195,000 and $2,610,180 were allocated to
net liabilities assumed, technology, customer base, deferred tax liability
and goodwill, respectively. The excess of the net liabilities assumed and
the direct transaction costs over the identified intangible assets
acquired, or $500,000 was allocated to goodwill. The Company's primary
reason for acquiring Newpoint was to gain entrance to new markets and
increase exposure to a certain class of customer. The technology and
specific customers acquired were incidental to the transaction.
Accordingly, a significant portion of the excess of net liabilities
assumed and the purchase price was allocated to goodwill. The net
liabilities assumed include amounts previously advanced by the Company.
The identified intangible assets are being amortized on a straight-line
basis over an estimated useful life of four years for the technology and
customer base. Goodwill is not being amortized but is being reviewed
annually for impairment in accordance with FAS 142. The purchase price
allocation is based on preliminary estimates and is subject to change as
final valuations are made. During the year ended September 30, 2002, the
Company made adjustments to the purchase price allocation that resulted in
an immaterial addition to goodwill associated with the acquisition.
3. Accounts Receivable and Revenue
Accounts receivable at September 30, 2002 and 2001, consist of the
following:
Billed 2002 2001
---- ----
Government services
Prime contracts $ 714,908 $ 1,653,784
Subcontracts 2,015,363 5,338,782
Commercial products and services 1,675,800 3,160,284
Allowance for doubtful accounts (323,868) (71,361)
----------- ------------
Total billed 4,082,203 10,081,489
----------- ------------
Unbilled
Government services
Prime contracts 5,734,718 3,631,661
Subcontracts 2,580,556 489,899
Commercial products and services 4,521,303 4,042,374
----------- ------------
Total unbilled 12,836,577 8,163,934
----------- ------------
Total accounts receivable, net $16,918,780 $ 18,245,423
=========== ============
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.
F-13
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
____________________
3. Accounts Receivable and Revenue (continued)
Internally, the Company classifies contract revenues in two separate
categories on the basis of the contract's procurement and development
requirements: (i) contracts which require compliance with government
procurement and development standards are classified as government revenue
(government services) and (ii) contracts conducted according to commercial
practices are classified as commercial revenue (commercial products and
services), regardless of whether the end customer is a commercial or
government entity. Sales of the Company's commercial off-the-shelf software
products are classified as commercial products and services revenue.
During the years ended September 30, 2002, 2001 and 2000, approximately
60%, 54%, and 52%, respectively, of the Company's revenue was from
government services, primarily the National Oceanic and Atmospheric
Administration (NOAA) and the United States Air Force (USAF). The remaining
revenue is from commercial products and services as defined above.
By the way of comparison, if revenues were reclassified according to end
customer, the Company's revenue from U.S. Government customers, both as a
prime contractor and a subcontractor, for each of the years ended September
30, 2002, 2001 and 2000, was 60%, 55% and 54%, respectively. Revenue from
non-U.S. Government customers for each of the years ended September 30,
2002, 2001, and 2000, was 40%, 45% and 46%, respectively.
4. Marketable Securities
The following summarizes the Company's investments in debt and equity
securities at September 30, 2002 and 2001:
Gross Unrealized
2002 Cost Losses Fair Market Value
---- ---- ------ -----------------
State Debt Securities $ 35,421,000 $ -- $ 35,421,000
Preferred Stock 10,000,000 -- 10,000,000
Common Stock 2,295,527 (830,946) 1,464,581
------------ --------- ------------
Total $ 47,716,527 $(830,946) $ 46,885,581
============ ========= ============
Gross Unrealized
2001 Cost Losses Fair Market Value
---- ---- ------ -----------------
State Debt Securities $ 47,356,000 $ -- $ 47,356,000
Preferred Stock 10,000,000 -- 10,000,000
Common Stock 955,495 (421,325) 534,170
------------ --------- ------------
Total $ 58,311,495 $(421,325) $ 57,890,170
============ ========= ============
At September 30, 2002, and September 30, 2001 the Company held $35,421,000
and $47,356,000 respectively, in variable rate State of Maryland debt
securities, which were carried at cost, which approximates fair market
value.
The investments in variable rate State of Maryland debt securities and Banc
of America Preferred Funding Corporation "Dividends Received Eligible
Auction Market" preferred stock ("DREAMS") are carried at cost which
approximates fair market value. The investment in common stock is based on
quoted market price. At September 30, 2002, and September 30, 2001 the
unrealized loss of $830,946 and $421,325 from the investment in common
stock is reported in stockholders' equity as other comprehensive income
(loss), net of deferred tax benefit of $324,069 and $164,317, respectively.
F-14
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
__________
4. Marketable Securities (continued)
During fiscal 2002, the Company bought and sold common stock and municipal
bonds that resulted in a gain of $1,216,031. The gain was determined using
specific identification method.
5. Property and Equipment
Property and equipment as of September 30, 2002 and 2001 are as follows:
2002 2001
---- ----
Electronic equipment $ 4,223,787 $ 3,318,309
Furniture and fixtures 665,840 523,324
Leasehold improvements 425,634 237,133
Software 646,009 396,107
Equipment under capital lease 579,496 1,378,461
----------- ------------
Total property and equipment 6,540,766 5,853,334
Less: accumulated depreciation and amortization (3,072,859) (2,659,644)
----------- ------------
Property and equipment, net $ 3,467,907 $ 3,193,690
=========== ============
6. Goodwill and Intangibles
The following summarizes the Company's Goodwill and Intangibles at
September 30, 2002 and 2001:
2002 2001
---- ----
Goodwill $ 2,610,180 0
Intangibles
Technology 400,000 0
Customer Base 100,000 0
----------- ------------
Total 3,110,180 0
Less Accumulated Amortization 62,500 0
----------- ------------
Goodwill and Intangibles, net 3,047,680 0
=========== ============
Amortization expense for the years ended September 30, 2002, 2001 and 2000
was $62,500, 0, and 0, respectively.
F-15
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
____________
7. Software Development
Software development costs as of September 30, 2002 and 2001, consist of
the following:
2002 2001
---- ----
Costs incurred $ 14,100,891 $ 10,550,070
Less: accumulated amortization (7,610,251) (5,469,441)
------------ --------------
Software development costs, net $ 6,490,640 $ 5,080,629
============ ==============
Amortization expense for the years ended September 30, 2002, 2001 and 2000,
was $2,182,910, $1,370,000, and $950,000, respectively. Research and
development expense for the years ended September 30, 2002, 2001, and 2000,
was $361,921, $199,987 and $536,177, respectively.
8. Line of Credit
The Company has a line of credit agreement with a local bank for
$10,000,000 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 lines of credit are
secured by the Company's billed and unbilled accounts receivable and have
certain financial covenants, including minimum net worth and liquidity
ratios. The lines expire February 29, 2004. The Company had no balance
outstanding at September 30, 2002, 2001 and 2000 under any of its lines.
The Company has $270,000 and $310,000 letter of credit outstanding as of
September 30, 2002 and 2001, respectively with a bank given to a lessor in
connection with a leased facility.
9. Accrued Expenses
Accrued expenses at September 30, 2002 and 2001, consist of the following:
2002 2001
---- ----
Accrued payroll and withholdings $ 1,540,434 $ 1,222,145
Accrued vacation 1,121,680 939,994
Accrued profit sharing 586,157 618,111
Accrued warranty 0 135,000
Other accrued expenses 1,052 11,193
----------- -----------
Total accrued expenses $ 3,249,323 $ 2,926,443
=========== ===========
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.
F-16
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
____________
10. Commitments and Contingencies (Continued)
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, 2002, 2001 and 2000, respectively. Future payments
under the capital lease obligations at September 30, 2002, are as follows:
Years ending September 30, 2003 $ 38,877
2004 38,877
2005 38,877
2006 29,158
------------
Total payments 145,789
Less amount representing interest at 8.8% per annum (23,628)
------------
Present value of future lease payments $ 122,161
============
Operating Leases
The Company leases its office space in Maryland, Colorado, California, New
Hampshire and Toulouse, France. The current leases for offices in the
United States expire in 2009, 2007, 2004, and 2008, respectively. The
current leases for offices in France expire in 2009 and 2011. Approximate
future minimum lease payments under the office leases are as follows:
Years ending September 30, 2003 $ 1,570,000
2004 1,519,000
2005 1,332,000
2006 1,365,000
2007 1,327,000
Thereafter 1,826,000
------------
Total payments $ 8,939,000
============
Lease payments do not include operating expenses or utilities, which are
adjusted annually. Rent expense was $1,581,516, $1,252,880 and $1,117,665
for the years ended September 30, 2002, 2001 and 2000, 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. 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, 2000. Management is of the opinion that any
disallowances of costs for subsequent fiscal years by the government
auditors, other than amounts already provided, will not materially affect
the Company's financial statements.
F-17
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
____________________
11. Income Taxes
For the years ended September 30, 2002, 2001 and 2000, the provision for
income taxes consists of the following:
2002 2001 2000
---- ---- ----
Current tax expense
Federal $ 626,545 $ 195,678 $ 952,280
State 82,964 65,223 370,331
------------- ----------- ----------
709,509 260,901 1,322,611
Deferred tax expense (benefit) 437,279 1,302,382 (140,113)
------------- ----------- ----------
Total expense attributed to
Continuing operations 1,146,788 1,563,283 1,182,498
Total expense attributable to
discontinued operations 0 0 253,762
------------- ----------- ----------
Total provision $ 1,146,788 $ 1,563,283 $1,436,260
============= =========== ==========
At September 30, 2002 and 2001, the tax effect of significant temporary
differences representing deferred tax assets and liabilities are as
follows:
Asset (Liability)
2002 2001
---- ----
Purchase accounting $ (170,625) $ -
Depreciation and amortization (2,460,723) (1,882,384)
Vacation accrual 437,455 366,598
Allowance for Doubtful accounts 126,309 27,830
Warranty reserve - 52,650
Unrealized loss on marketable securities 324,069 164,317
Other 183,952 -
------------ -------------
Net $ (1,559,563) $ (1,270,989)
============ =============
The temporary differences are presented in the balance sheet as follows:
Asset (Liability)
2002 2001
---- ----
Deferred income tax asset - current portion $ 887,832 $ 611,395
Deferred income tax liability - long term portion (2,447,395) (1,882,384)
----------- -----------
Net $(1,559,563) $(1,270,989)
=========== ===========
The effective income tax rates differ from the statutory U.S. income tax
rate due principally to the following:
2002 2001 2000
---- ---- ----
Federal statutory rate 34.0% 34.0% 34.0%
State tax, net of federal income tax benefit 2.9 4.6 4.6
Tax benefit of tax free investment income (6.5) (11.3) (12.1)
Other, primarily changes in estimates - .7 (2.3)
------ ------ ------
Effective rate 30.4% 28.0% 24.2%
====== ====== ======
F-18
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
_______________
12. Subsequent Events
On October 1, 2002, the Company completed its acquisition of RT Logic Inc.
The purchase price for the acquisition of all the outstanding shares of RT
Logic was approximately $27.725 million which consisted of $13.75 million
in cash, 709,676 shares of Integral common stock valued at $19.375 per
share and approximately $225,000 of transaction and direct acquisition
costs. The Company agreed to make future contingent earn-out payments to
the shareholders of RT Logic for the period beginning October 2, 2002
through September 30, 2006. The contingent payments are calculated every
September 30 in the period from October 2, 2002 through September 30, 2006
based on a formula of pre-tax income as defined in the acquisition
agreement. Any contingent earn-out payments will be payable in fifty
percent cash and fifty percent stock.
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
$10,390,586, $650,000, $1,621,082, 885,722 and $15,951,054 was allocated to
net assets assumed, technology, customer related intangibles, deferred tax
liabilities and goodwill. The excess of the net assets assumed and the
purchase price over the identified intangible assets acquired was allocated
to goodwill. The primary reason for acquiring RT Logic was to expand the
Company's existing products to RT Logic's government client base. The
identified intangible assets will be amortized on a straight-line basis
over an estimated useful life of 5 years for the technology and 18 months
for the customer related intangibles. Goodwill is not being amortized but
is being reviewed annually for impairment in accordance with FAS 142. The
purchase price allocation is based on preliminary estimates and is subject
to change as final valuations are made.
In October 2002, the Company reacquired 327,295 shares of its' common stock
for $6,148,300.
13. Profit Sharing and Employee Benefits Plans
The Company has a profit sharing and 401(k) plan for the benefit of
substantially all employees. Profit sharing contributions consist of
discretionary amounts determined each year by the Board of Directors of the
Company based upon net profits for the year and total compensation paid.
The 401(k) feature allows employees to make elective deferrals not to
exceed 25% of compensation. The Company also has a money purchase plan,
which obligates the Company to contribute 5% of eligible salaries under the
plan. For the years ended September 30, 2002, 2001 and 2000, contributions
to the plans totaled $1,832,550, $1,607,976 and $1,659,687, respectively.
14. Stock Option Plans
Effective May 1, 2002, the Company established the 2002 Stock Option Plan
to create additional incentives for the Company's employees, consultants
and directors to promote the financial success of the Company. 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, 2002, the maximum number of shares of common
stock which may be issued pursuant to the 2002 Stock Option Plan is
750,000. The price of each option is set at the stock's bid price on the
date of the Board of Directors meeting at which the option is granted.
Options expire no later than ten years from the date of grant (five years
for greater-than-10% owners) or when employment ceases, whichever comes
first, and vest from one to five years.
F-19
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
__________________
14. Stock Option Plans (continued)
Prior to adoption of the 2002 Stock Option Plan, effective May 25, 1988, as
amended on January 1, 1994 and May 8, 1998, the Company established 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 Board of Directors had 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, 2002, the maximum
number of shares of common stock which may be issued pursuant to the 1988
Stock Option Plan is 1,800,000. The price of each option was set at the
stock's bid price on the date of the Board of Directors meeting at which
the option was granted. Options expire no later than ten years from the
date of grant (five years for greater-than-10% owners) or when 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
2002 Stock Option Plan no further options will be granted after April 30,
2002 under the 1988 Stock Option Plan. The Company has reserved for
issuance an aggregate of 762,180 shares of Common Stock under the 1988
Stock Option Plan and 750,000 under the 2002 Stock Option Plan.
The following table summarizes the Company's activity for all of its stock
option awards during the years ended September 30, 2002, 2001 and 2000:
Weighted Average
Shares Exercise Prices
Options outstanding, September 30, 1999 850,228 $ 9.36
Granted 235,850 $ 17.36
Exercised (213,756) $ 4.57
Cancelled (41,122) $ 15.75
-----------
Options outstanding, September 30, 2000 831,200 $ 12.55
Granted 226,300 $ 20.66
Exercised (63,760) $ 4.51
Cancelled (44,640) $ 14.07
-----------
Options outstanding, September 30, 2001 949,100 $ 14.95
Granted 308,750 $ 20.96
Exercised (262,470) $ 4.68
Cancelled (56,950) $ 19.62
-----------
Options outstanding September 30, 2002 938,430 $ 19.49
===========
The following table summarizes additional information about stock options
outstanding at September 30, 2002:
Options Outstanding Options Exercisable
-----------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Exercise Number Average Average Average
Price Per of Remaining Exercise Number Exercise
Share Shares Life Price Exercisable Price
$ 2.00 - 19.99 477,730 2.86 Years $17.59 257,310 $17.53
$20.00 - 39.99 458,200 5.02 Years $21.35 63,290 $22.04
$40.00 - 45.00 2,500 2.28 Years $43.48 2,500 $43.48
------- ---------- ------ ------- ------
938,430 3.91 Years $19.49 323,100 $18.61
======= ========== ====== ======= ======
F-20
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
_________________
14. Stock Option Plan (continued)
Had compensation cost for the plans been determined based on the estimated
fair value of the options at the grant dates consistent with the method of
Statement of Financial Accounting Standards (SFAS) No. 123, the Company's
net income and earnings per share for the years ended September 30, 2002,
2001 and 2000, would have been:
2002 2001 2000
---- ---- ----
Net income:
As reported $ 2,623,415 $ 4,011,120 $ 4,177,383
Pro forma $ 1,380,443 $ 2,461,546 $ 2,983,688
Earnings per share:
As reported - basic $ .29 $ .42 $ .47
- dilutive $ .28 $ .41 $ .45
Pro forma - basic $ .15 $ .26 $ .34
- dilutive $ .15 $ .25 $ .32
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.
2002 2001 2000
---- ---- ----
Expected volatility 50% 40% 40%
Risk free interest rate 5.0% 5.0% 6.0%
Dividend yield None None None
Expected lives 5 years 4 years 4 years
The weighted average fair values of options granted during the years ended
September 30, 2002, 2001 and 2000, were $10.33, $7.85 and $6.75,
respectively.
15. Stockholder's Equity Transactions
In June 1999, the Company issued stock under a private placement. The
Company received approximately $20 million from this offering. The costs
associated with this private placement are included as a direct reduction
to paid in capital.
In February 2000, the Company issued stock under a private placement. The
Company received approximately $41 (net) million from this offering. The
costs associated with this private placement are included as a direct
reduction to paid-in capital.
In August 2000, the Company issued 650,000 shares of common stock to
acquire SAT Corporation. The acquisition was accounted for as pooling of
interests as discussed in Note 2
In September 2001, the Company reacquired 420,015 shares of its stock for a
total cost of $7,748,135. During fiscal year 2002, the Company reacquired
10,800 shares of its stock for a total cost of $195,422.
F-21
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 2002, 2001 and 2000
__________________
16. Supplemental Cash Flow Information
For the years ended September 30, 2002, 2001 and 2000, income taxes paid,
were $142,558, $562,277 and $2,131,803, respectively, and interest expense
incurred and paid was $15,351, $50,671 and $96,587, respectively.
17. Quarterly Financial Data (unaudited)
Integral Systems first three quarters in fiscal 2002 ended on December 31,
2001, March 31, 2002 and June 30, 2002. The fourth quarter ended on
September 30, 2002.
The following tables contain selected unaudited Consolidated Statement of
Operations data for each quarter of fiscal years 2002 and 2001 (in
thousands, except per share amounts).
Fiscal 2002 Quarter Ended
-------------------------------------------------------
December 31 March 31 June 30 September 30
----------- -------- ------- ------------
Revenue 10,257 10,558 14,440 15,668
Gross margin 3,114 3,051 3,636 3,490
Income from Operations 658 152 387 620
Net Income 616 434 960 614
Earnings per share - basic 0.07 0.05 0.10 0.07
Earnings per share - diluted 0.07 0.05 0.10 0.07
Weighted average common and equivalent
shares outstanding - basic 9,073 9,121 9,225 9,280
Weighted average common and equivalent
shares outstanding - diluted 9,316 9,317 9,382 9,310
Fiscal 2001 Quarter Ended
-------------------------------------------------------
December 31 March 31 June 30 September 30
----------- -------- ------- ------------
Revenue 8,469 9,545 10,392 12,126
Gross margin 2,871 2,749 2,676 3,530
Income from Operations 635 502 964 1,356
Net Income 1,052 788 1,006 1,165
Earnings per share - basic 0.11 0.08 0.11 0.12
Earnings per share - diluted 0.11 0.08 0.10 0.12
Weighted average common and equivalent
shares outstanding - basic 9,441 9,452 9,465 9,490
Weighted average common and equivalent
shares outstanding - diluted 9,564 9,609 9,690 9,743
F-22
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
27
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, Chief Operating Officer, and Director
Elaine M. Parfitt Executive Vice President, Chief Financial Officer,
Secretary and Treasurer
Patrick R. Woods Executive Vice President, Government Programs
Peter J. Gaffney Executive Vice President, Commercial Products
Bonnie K. Wachtel Outside Director
Dominic A. Laiti Outside Director
R. Doss McComas 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, 46, 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, OAO Corporation employed Mr. Chamberlain
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.
Thomas L. Gough, 54, 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 and Chief Operating Officer of the Company since June 1992.
For three years before being named President, he served as Vice President and
Chief Financial Officer. Prior to joining the Company, he 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.
Elaine M. Parfitt, 39, joined the Company in 1983. She served as Staff
Accountant/Personnel Administrator until January 1995, when she was promoted to
Controller/Director of Accounting. In March 1997, Ms. Parfitt was appointed Vice
President and Chief Financial Officer. In February 2000, she was appointed
Secretary and Treasurer followed by her promotion to Executive Vice President in
April of 2002. She holds a B.S. degree in Accounting from the University of
Maryland and is a Certified Public Accountant.
Patrick R. Woods, 47, joined the Company in 1995, and has been Executive Vice
President, Government Programs since April 2002. 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.
28
Peter J. Gaffney, 43, joined the Company in 1986. In April 2002, Mr. Gaffney was
promoted to Executive Vice President, Commercial Products. In February 2000, Mr.
Gaffney was appointed Vice President, Commercial Products. From May 1999 until
February 2000, Mr. Gaffney 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.
Bonnie K. Wachtel, 47 has served as an outside director 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
Dominic A. Laiti, 71, 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 26 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 Energy Recovery, Inc. and Pantheon Software Inc.
R. Doss McComas, 48, joined the Board as an outside director in July 1995. He is
President of e-Community Calendar Inc. a supplier of sponsor/advertising
supported community information. Previously, he was 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. 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.
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, 2002 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: Peter J. Gaffney, an executive officer of the Company,
inadvertently filed late a Form 4 for January 2002, reporting one transaction,
inadvertently filed late a Form 4 for March 2002, reporting three transactions,
and inadvertently filed late a Form 4 for May 2002, reporting 4 transactions;
Elaine M. Parfitt an executive officer of the Company, inadvertently filed late
a Form 4 for January 2002, reporting one transaction.
29
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 2002 and who earned over $100,000
during the fiscal year ended September 30, 2002:
Annual Compensation Long-Term Compensation
------------------- ----------------------
Awards Payouts
------ -------
Name and Principal Shares All Other
Position Year Salary Bonus Underlying Options Compensation (1)
-------- ---- ------ ------ ------------------ ----------------
Chief Executive Officer
Steven. R. Chamberlain 2002 $255,544 $40,000 12,000 $26,495
2001 $235,251 $25,000 12,000 $21,125
2000 $214,303 $25,000 12,000 $19,061
Chief Operating Officer/Pres.
Thomas L. Gough 2002 $207,939 $25,000 8,000 $21,261
2001 $195,494 $20,000 7,000 $20,137
2000 $180,648 $20,000 14,000 $18,781
Exec. Vice Pres., Government Programs
Patrick R. Woods 2002 $178,957 $25,000 20,000 $17,908
2001 $167,338 $12,500 7,000 $17,169
2000 $152,510 $10,000 2,000 $16,800
Exec. Vice Pres., Commercial Products
Peter J. Gaffney 2002 $171,425 $25,000 8,000 $17,173
2001 $155,012 $15,000 7,000 $15,456
2000 $132,423 $15,000 7,000 $12,918
Exec. Vice Pres., Chief Financial Officer
Elaine M. Parfitt 2002 $171,425 $25,000 8,000 $17,336
2001 $155,012 $15,000 7,000 $15,511
2000 $132,169 $15,000 6,000 $13,300
(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 $744, $745 and $745 for
fiscal years 2002, 2001 and 2000 respectively.
30
OPTION/SAR GRANTS IN LAST FISCAL YEAR
- --------------------------------------------------------------------------------------------------------------------
Individual Grants
- --------------------------------------------------------------------------------------------------------------------
Percent of Total
Number of Options/SARs
Options/ Granted to Grant Date
SARs Employees in Exercise/Base Expiration Present
Name Granted Fiscal Year Price($) Date Value/(1)/
- --------------------------------------------------------------------------------------------------------------------
CEO
Steven R. Chamberlain 12,000 3.9% $20.89 2008 $123,600
CHIEF OPERATING OFFICER/PRESIDENT
Thomas L. Gough 8,000 2.6% $20.89 2008 $ 82,400
EVP GOVERNMENT PROGRAMS 15,000 4.9% $21.87 2008 $161,700
Patrick R. Woods 5,000 1.6% $20.89 2008 $ 51,500
EVP COMMERCIAL PRODUCTS
Peter J. Gaffney 8,000 2.6% $20.89 2008 $ 82,400
EVP/CHIEF FINANCIAL OFFICER
Elaine M. Parfitt 8,000 2.6% $20.89 2008 $ 82,400
(1) Grant date present value is calculated on the date of the grant using
the Black-Scholes options pricing model assuming the following: no
dividend yield, risk-free interest rate of 5%, expected volatility of
50%, and an expected term of the option of five years. This value is
then multiplied by the number of options granted.
(2) All of the options granted to individuals in the above table in the
last fiscal year vest 20% per year for five years and expire 6 years
from the grant date of the option.
b. Compensation Pursuant to Plans
The Company's Board of Directors awards annual bonuses to officers and
employees on a discretionary basis. Currently, no formal plan exists 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 contributes annually an amount equal to
5% of the salary of an eligible Company employee, and may make additional
contributions of up to 7.0% of the salary of an eligible Company employee. The
employee may contribute up to an additional 25% as salary deferral. In fiscal
years 2002, 2001, and 2000 the Company contributed a total of 11% of eligible
Company employees' salaries to the plans.
c. Stock Option Plan
Effective May 1, 2002, the Company established the 2002 Stock Option Plan
(the "2002 Stock Option Plan") 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 2002 Stock Option Plan, is 750,000 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 176,250 shares of
Common Stock were issued under the 2002 Stock Option Plan in
31
fiscal year 2002. No shares of Common Stock were exercised during fiscal year
2002 under this plan. The Company has reserved for issuance an aggregate of
750,000 shares of Common Stock under the 2002 Stock Option Plan, of which
options to purchase 176,250 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 nonstatutory 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.
Options to purchase a total of 132,500 shares of Common Stock were issued under
the 1988 Stock Option Plan and options to purchase 262,470 shares of Common
Stock granted under the 1988 Stock Option Plan were exercised during fiscal year
2002. The Company has reserved for issuance an aggregate of 762,180 shares of
Common Stock under the 1988 Stock Option Plan, all of which are outstanding at
September 30, 2002. Pursuant to the approval by stockholders at the April 17,
2002 Annual Meeting of the 2002 Stock Option Plan, no further options will be
granted under the 1988 Stock Option Plan.
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
Four of the executives named below exercised stock options during the fiscal
year ended September 30, 2002.
Steven R. Chamberlain exercised 90,000 Incentive Stock Options. Thomas L. Gough
exercised 20,000 Incentive Stock Options. Peter J Gaffney exercised 24,000
Incentive Stock Options. Elaine M. Parfitt exercised 6,000 Incentive Stock
Options.
32
- ---------------------------------------------------------------------------------------------------------------------
Number of
Securities Underlying Value of Unexercised
Unexercised Options/ In-the-Money Options/
SARS at FY end (#) SARS at FY end ($)/1/
Shares Acquired Exercisable/ Exercisable/
Name on Exercise (#) Value Realized Unexercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------
Chief Executive Officer 90,000 $1,554,700 19,200 $8,148
Steven R. Chamberlain (exercisable) (exercisable)
36,800 $9,872
(unexercisable) (unexercisable)
- ---------------------------------------------------------------------------------------------------------------------
Chief Operating Officer/Pres. 20,000 $ 294,370 7,000 $6,216
Thomas L. Gough (exercisable) (exercisable)
22,000 $9,324
(unexercisable) (unexercisable)
- ---------------------------------------------------------------------------------------------------------------------
Executive Vice President, ___ ___ 8,000 $2,251
Government Programs (exercisable) (exercisable)
Patrick R. Woods 31,600 $2,460
(unexercisable) (unexercisable)
- ---------------------------------------------------------------------------------------------------------------------
Executive Vice President, 24,000 382,172 18,000 $6,351
Commercial Products (exercisable) (exercisable)
Peter J. Gaffney 27,000 $6,824
(unexercisable) (unexercisable)
- ---------------------------------------------------------------------------------------------------------------------
Executive Vice President, 6,000 $ 93,240 9,800 $4,074
Chief Financial Officer (exercisable) (exercisable)
Elaine M. Parfitt 21,200 $4,936
(unexercisable) (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 $19.11 per share at September 30, 2002.
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 $10,000 per year for their services,
which amount is paid in equal quarterly installments. Outside directors 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 2002:
- -------------------------------------------------------------------------------------------------
Name Annual Compensation Option Shares Granted
- -------------------------------------------------------------------------------------------------
Dominic A. Laiti $10,000 5,000
- -------------------------------------------------------------------------------------------------
R. Doss McComas $10,000 5,000
- -------------------------------------------------------------------------------------------------
John R. Murphy (former outside director) $ 2,500 0
- -------------------------------------------------------------------------------------------------
Bonnie K. Wachtel $10,000 5,000
- -------------------------------------------------------------------------------------------------
33
e. Termination of Employment and Change of Control Termination
The Company has no compensatory plan or arrangement with respect to any
individual named in the Summary Compensation Table (Item 10(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 made up of Dominic A. Laiti, R. Doss McComas
and Bonnie K. Wacthel, 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 9/30/02)
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock, par value $.01, as of September 30,
2002, 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.
Name and Address of Beneficial Owner Amount and Nature of Beneficial Percent of
- ------------------------------------ ------------------------------- ----------
Ownership Class
--------- -----
Ashford Capital Management, Inc 622,597 6.7%
3801 Kennett Pike, Suite B-107
Wilmington, DE 19807-2317
b. Security Ownership of Management (as of 9/30/02)
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock, par value $.01, as of September 30,
2002, by (i) each director and executive officer of the Company and (ii) all
directors and executive officers as a group. 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.
34
Name and Address of Beneficial Owner Amount and Nature of Beneficial Percent of
- ------------------------------------ -------------------------------- ----------
Owner Class
----- -----
Executive Officers, Directors
Steven R. Chamberlain 404,605 (1) 4.3%
Thomas L. Gough 186,600 (2) 2.0%
Elaine M. Parfitt 24,200 (3) *
Patrick Woods 9,000 (4) *
Peter J. Gaffney 40,000 (5) *
Bonnie K. Wachtel 57,500 (6) *
1101 Fourteenth Street, N.W.
Suite 800
Washington, D.C. 20036
R. Doss McComas 10,000 (7) *
409 Biggs Drive
Front Royal, VA 22630
Dominic A. Laiti 10,000 (8) *
12525 Knoll Brook Drive
Clifton, VA 22024
All Directors and Executive Officers as a group
(8 persons). 741,905 7.9%
* Less than one percent of the Common Stock outstanding.
(1) Includes outstanding options to purchase 19,200 shares of Common Stock which
are exercisable within 60 days.
(2) Includes outstanding options to purchase 7,000 shares of Common Stock which
are exercisable within 60 days.
(3) Includes outstanding options to purchase 9,800 shares of Common Stock which
are exercisable within 60 days.
(4) Includes outstanding options to purchase 8,000 shares of Common Stock which
are exercisable within 60 days.
(5) Includes outstanding options to purchase 18,000 shares of Common Stock which
are exercisable within 60 days.
(6) Includes outstanding options to purchase 10,000 shares of Common Stock which
are exercisable within 60 days.
(7) Includes outstanding options to purchase 10,000 shares of Common Stock which
are exercisable within 60 days.
(8) Includes outstanding options to purchase 10,000 shares of Common Stock which
are exercisable within 60 days.
c. Equity Compensation Plan Information
The following table sets forth certain equity compensation plan information
as of September 30, 2002:
-------------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted-average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
Plan category warrants and rights warrants and rights column (a)(1)
-------------------------------------------------------------------------------------------------------------
(a) (b) (c)
-------------------------------------------------------------------------------------------------------------
Equity compensation plans approved 938,430 $19.49 573,750
by security holders
-------------------------------------------------------------------------------------------------------------
Equity compensation plans not 0 0 0
approved by security holders
-------------------------------------------------------------------------------------------------------------
Total 938,430 $19.49 573,750
-------------------------------------------------------------------------------------------------------------
35
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 Integral Systems common stock. Any
Integral Systems 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 Integral Systems under the indemnification provisions of the
Reorganization Agreement.
Patrick R. Woods, Executive Vice President, Government Programs, 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.
ITEM 14. CONTROLS AND PROCEDURES
a. Evaluation of disclosure controls and procedures.
As required by Rule 13a-15 under the Exchange Act, within 90 days prior to
the filing date of this annual report (the "Evaluation Date"), the Company
carried out an evaluation of the effectiveness of the design and operation
of the Company's disclosure controls and procedures. 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 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 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 controls.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's internal
controls subsequent to the Evaluation Date, including any corrective
actions with regard to significant deficiencies and material weaknesses.
36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. Financial Statements.
DESCRIPTION OF FINANCIAL STATEMENTS PAGES
Independent Auditors' Reports F-2 - F-3
Consolidated Balance Sheets as of September 30, 2002 and 2001 F-4
Consolidated Statements of Operations for the Years Ended
September 30, 2002, 2001 and 2000 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 2002, 2001 and 2000 F-6
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2002, 2001 and 2000 F-7
Notes to Consolidated Financial Statements F-8 - F22
(a)2. Financial Statement Schedules.
Schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instruction or are inapplicable and therefore have been omitted.
(a)3. Index to Exhibits
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 By-Laws of the Company (Incorporated by
reference to the Company's September 30, 2000 Annual Report on Form
10-K filed by the Company 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 Contract effective May 17, 1996 between Integral Systems Inc. and
the U.S. National Oceanic and Atmospheric Administration
(Incorporated by reference to the Company's Annual Report on Form
10-KSBA filed by the Company with the Commission on July 10, 1997).
(Portions of this exhibit have been omitted pursuant to an order
for confidential treatment granted by the Commission).
10.3 Lease dated June 1, 1999, between Integral Systems Inc. and ASP
Washington, L.L.C. (Incorporated by reference to the Company's June
30, 1999 10-QSB filed by the Company on August 11, 1999).
10.4 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).
37
10.5 Line Credit Extension to that certain Line of Credit Loan and
Security Agreement dated December 9, 1999 between Bank of America
N.A. and Integral Systems, Inc. (Incorporated by reference to the
Company's March 31, 2001 10-Q filed by the Company with the
Commission on May 15, 2001).
10.6 Subcontract (J8-759124-C3JP) between Hughes Space and
Communications Company and Integral Systems, Inc. dated March 3,
1999 (Incorporated by reference to the Company's June 30, 1999
10-QSB filed by the Company on August 11, 1999). (Portions of this
exhibit have been omitted pursuant to a request for confidential
treatment filed with the commission).
10.7 2002 Stock 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).
10.8 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 March 31, 2001 10-Q filed by the Company
with the Commission on May 15, 2001).
11.1 Computation of Per Share Earnings
21.1 List of Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP
23.2 Consent of Rubino & McGeehin, Chartered
38
ITEM 15. EXHIBITS, LISTS, AND REPORTS ON FORM 8-K (CONTINUED)
(a) Exhibits (continued)
99.1 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(a) Reports on Form 8-K
The Company filed a report on Form 8-K (dated January 4, 2002) with the
Commission on January 10, 2002 reporting changes in its certifying
accountants.
The Company filed a report on Form 8-K (dated September 3, 2002) with the
Commission on September 3, 2002 reporting its signing of a letter of
intent proposing to acquire Real Time Logic, Inc. See "Item 13. Certain
Relationships and Related Transactions."
The Company filed a report on Form 8-K (dated October 1, 2002) with the
Commission on October 16, 2002 reporting its acquisition of Real Time
Logic, Inc. See "Item 13. Certain Relationships and Related
Transactions."
The Company is filing an amendment to its report on Form 8-K (dated
October 1, 2002) with the Commission on or about the date hereof
including financial statements required in connection with its
acquisition of Real Time Logic, Inc.
39
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/ Chairman of the Board, Director, 12/12/02
- ----------------------------------------- ----------------
Steven R. Chamberlain Chief Executive Officer
/s/ President, Chief Operating Officer, 12/12/02
- ----------------------------------------- ----------------
Thomas L. Gough Director
/s/ Chief Financial Officer, Principal, 12/12/02
- ----------------------------------------- ----------------
Elaine M. Parfitt Accounting Officer
/s/ Director 12/12/02
- ----------------------------------------- ----------------
Dominic A. Laiti
/s/ Director 12/12/02
- ----------------------------------------- ----------------
R. Doss McComas
/s/ Director 12/12/02
- ----------------------------------------- ----------------
Bonnie K. Wachtel
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: 12/12/02 BY: /s/
---------- ----------------------------------
Steven R. Chamberlain
Chairman of the Board and
Chief Executive Officer
DATE: 12/12/02 BY: /s/
---------- ----------------------------------
Thomas L. Gough
President, Chief Operating Officer
Director
DATE: 12/12/02 BY: /s/
---------- ----------------------------------
Elaine M. Parfitt
Chief Financial Officer, Principal
Accounting Officer
CHIEF EXECUTIVE OFFICER CERTIFICATION
I, Steven R. Chamberlain, Chairman and Chief Executive Officer of Integral
Systems, Inc. (the "Registrant"), certify that:
1. I have reviewed this annual report on Form 10-K of the Registrant;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) Evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the audit
committee of the Registrant's board of directors:
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the Registrant's
ability to record, process, summarize and report financial data
and have identified for the Registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Integral Systems, Inc.
Date: December 12, 2002 /s/
-------------------------------------
Steven R. Chamberlain
Chairman and Chief Executive Officer
CHIEF FINANCIAL OFFICER CERTIFICATION
I, Elaine M. Parfitt, Chief Financial Officer of Integral Systems, Inc.
(the "Registrant"), certify that:
1. I have reviewed this annual report on Form 10-K of the Registrant;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) Evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the audit
committee of the Registrant's board of directors:
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the Registrant's
ability to record, process, summarize and report financial data
and have identified for the Registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Integral Systems, Inc.
Date: December 12, 2002 /s/
-------------------------------------
Elaine M. Parfitt
Chief Financial Officer