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UNITED STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One) Annual Report Pursuant to Section 13 or 15(d)
[X] of the Securities Exchange Act of 1934 [Fee Required]
For Fiscal Year Ended June 30, 1996
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 [No Fee Required]
For the Transition Period From ..... to .....
Registrant, State of Incorporation,
Address and Telephone Number
----------------------------
GRC INTERNATIONAL, INC.
(a Delaware Corporation)
Commission 1900 Gallows Road I.R.S. Employer
File No. Vienna, Virginia 22182 Identification No.
- - ------------ ------------------
1-7517 (703) 506-5000 95-2131929
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Common Stock, $.10 par value New York Stock Exchange
Pacific Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required 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 report(s), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO .
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of July 31, 1996, the aggregate market value of the Registrant's voting
common stock held by non-affiliates was $123,733,700. As of July 31, 1996,
there were 9,291,203 shares of the Registrant's $.10 par value common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Corporation's 1996 Annual Report to Stockholders for the
year ended June 30, 1996 are incorporated by reference into Parts I and II of
this report.
Portions of the Proxy Statement for the Corporation's 1996 Annual Meeting
of Shareholders are incorporated by reference into Part III of this report. The
Proxy Statement shall be filed in accordance with the rules of the Commission
within 120 days after the close of the fiscal year to which this report
pertains.
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TABLE OF CONTENTS
Page
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PART I.
Item 1. Business 1
Item 2. Properties 6
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 6
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations 9
Item 8. Financial Statements and Supplementary Data 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 40
PART III.
Item 10. Directors and Executive Officers of the Registrant 40
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and Management 40
Item 13. Certain Relationships and Related Transactions 40
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 40
Signatures 41
Forward-Looking Statements
In addition to historical information, this Form 10-K Annual Report
contains forward-looking statements. The forward-looking statements
contained herein are subject to certain risks and uncertainties that could
cause actual results to differ materially from those reflected in the
forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed in the "Risk Factors"
section of "Management's Discussion and Analysis". Readers are cautioned
not to place undue reliance on these forward-looking statements, which
reflect management's analysis only as of the date hereof. The Company
undertakes no obligation to publicly revise these forward-looking
statements, to reflect events or circumstances that arise after the date
hereof. Readers should carefully review the risk factors described in
other documents the Company files from time to time with the Securities and
Exchange Commission, including the Quarterly Reports on Form 10-Q to be
filed by the Company subsequent to this Form 10-K Annual Report and any
Current Reports on Form 8-K filed by the Company.
PART I
ITEM 1. BUSINESS
--------
General
GRC International, Inc. (the "Company") was organized in California in
1961. Since 1974, the Company has been a Delaware corporation. The
Company, headquartered in Vienna, Virginia, is organized in three
divisions: (1) a Professional Services Organization ("PSO"); (2) a
Telecommunications Division ("Telecom Division"); and (3) an Advanced
Products Division ("APD").
Professional Services Organization
Almost all of the Company's revenues have been generated from the
PSO professional service business. PSO's capabilities focus on information
technology consulting services provided primarily to the Department of
Defense ("DoD") and its instrumentalities. The number of active PSO
contracts at year-end 1996, 1995 and 1994 were 149, 175 and 189,
respectively, substantially all of which were with the DoD.
As a professional service provider, the revenues generated by PSO are
critically dependent upon the number and skill level of its employees. The
ability of PSO to meet planned and expected revenue levels is a function,
among other things, of PSO's ability to staff open positions with the
personnel required to satisfy its contractual backlog.
The areas of expertise provided by these services include: software
and system engineering; business decision support systems; analytical
modeling and simulation; database design and implementation; legacy
migration engineering; network design and integration; systems integration;
post deployment software support; operational support and management;
virtual manufacturing consulting; communications engineering; and test and
evaluation; among others.
1
These services are applied to such areas as: financial and personnel
management; automated acquisition systems; transportation planning and
analysis; manufacturing analysis; logistics planning; security clearance
processing; WAN/LAN analysis; training systems; as well as information
warfare systems relying on radar, optics, communication networks,
electronics, navigation and guidance, control, space, and surveillance
systems.
Telecommunications Division
Telecom Division consists of three business units: the OSU(R) business
unit, which developed and markets the OSU(R) Network Interface; the
NetworkVUE(TM) business unit, which offers network design services and is
completing its software suite product offering for automated network design
and optimization; and the Application Software Group, which develops custom
software for the telecommunications industry.
OSU(R): The OSU(R) Network Interface is a device that serves as an
intelligent demarcation where SONET (a synchronous optical network
transmission protocol) networks meet, either at a network-to-network
interface or at a user-to-network interface. The OSU device provides:
network isolation and security; SONET firewall protection; alarm
surveillance to simplify network maintenance and administration; SONET/SDH
conversion; equipment interoperability; non-intrusive test access; an
automatic protection switch; and quality monitoring.
Development of the OSU device was announced in November 1993; in
August 1994 Bell Atlantic purchased 15 units for its Advanced Technology
Demonstration Network for delivery in March 1995; a U.S. patent related to
overhead byte manipulation in SONET transmission was issued in October
1994; Bellcore confirmed that the OSU device complied with industry
standards in February 1996; and the Company delivered 58 units to MCI and
18 units to Stentor, the Canadian telecommunications consortium, in June
1996. In addition to the U.S. patent, the Company has an additional U.S.
patent application pending on the OSU, together with corresponding patent
applications pending in other countries.
It is anticipated that the OSU will be used by inter-exchange
carriers, regional Bell operating companies, and competitive access
providers. The widespread deployment of OSU devices is dependent, however,
upon the widespread implementation by telecommunication service providers
of SONET optical networks and ATM switching technology, the implementation
of which is beyond the Company's control.
NetworkVUE(TM): The NetworkVUE(TM) product is a suite of software
modules that automates the analysis, design, and planning of
telecommunications networks based on optimizing cost, performance, and
reliability. The NetworkVUE service offering uses the NetworkVUE product as
the basis for providing consulting services for the optimization of
networks.
The NetworkVUE product consists of six software modules: (1) an
importer, which imports data regarding a network's characteristics; (2) a
designer, which is a flexible network design tool; (3) a simulator, which
is based on discrete-event simulation; (4) an optimizer, which is a rules-
based expert system; (5) a searcher, which is a database of
2
hardware options and domestic and international rates and tariffs; and (6)
a reporter, which is a standard and custom report generator. Development of
NetworkVUE began in the second half of fiscal year 1995. The Company
expects to complete the development, integration, and testing of the
NetworkVUE product during the second half of calendar year 1996. The
completion of the NetworkVUE product, however, is subject to all the usual
risks with respect to the timely completion of a suite of integrated
software modules. The Company has filed a U.S. patent application with
respect to NetworkVUE as an automated network simulation and optimization
system, and corresponding patent applications in other countries.
Prior to the completion of the NetworkVUE product, the Company has
been able to offer network design services using parts of the NetworkVUE
suite. When the product is complete, the service offering will be
available based on the full suite.
The anticipated customers for the NetworkVUE product and services
include large corporate enterprises having internal network design
problems, domestic and international telecommunications service providers,
system and network integrators, and WAN hardware vendors.
Application Software Group: The Application Software Group ("ASG")
develops software and products for telecommunications equipment providers,
ranging from embedded communications software to graphical user interfaces
and resource managers. ASG was constituted during fiscal year 1996 and
ASG's primary customer to date is Lucent Technologies, Inc. ("Lucent").
The major task completed by ASG is the development of embedded software
applications and capabilities for the Lucent Digital Access Cross-Connect
Systems (DACS), particularly the development of software in support of
digital data services subrate applications for the DACS II Integral Shelf
Cross-connect product line and a graphical user interface and resource
manager for the DACS II.
Advanced Products Division
APD was formed from previously existing business units at the end of
the Company's 1996 fiscal year and consists of the business units for the
following businesses: materials testing; environmental, safety, and health
management software; security systems; and system development and
integration.
In materials testing, GRC Instruments(TM), designs, manufactures,
markets and sells electronically instrumented impact testing equipment for
dynamic materials testing under the Dynatup(R) label. The Commercial
Information Systems (CIS) business unit develops and markets the FLOW
GEMINI(TM) line of environmental, health and occupational safety software
products, which facilitate compliance with federal and state recordkeeping.
In security and law enforcement, the Vindicator(R) product line provides
physical security and access control systems for critical resource
protection requirements. Finally, the Advanced Technology Services Group
provides specialized software and systems development and integration for
government contract work.
3
See Note 11 to the Consolidated Financial Statements for a tabular
presentation of the revenues, operating profit or loss, and identifiable
assets attributable to each of the Company's industry segments.
Patents, Trademarks, Licenses, Copyrights
-----------------------------------------
The Company has a U.S. patent and patent application pending regarding
the OSU(R) Network Interface and a U.S. patent application pending for the
NetworkVUE(TM) software system, together with corresponding patent
applications pending in other countries on these products. OSU(R) is a
registered trademark of the Company, and NetworkVUE(TM) is a trademark of
the Company. In addition, the Company has a variety of other U.S. and
foreign patents, patent applications, and trademarks with respect to its
other products. The only patent issued to the Company to date which has a
material impact upon the Company's business is the OSU patent, which
expires in 2013.
Contracts
---------
Government contract revenues from professional and technical services,
either as prime contractor or subcontractor, represented approximately 93%,
96%, and 94% of the Company's total revenues from the fiscal years ended
June 30, 1996, 1995, and 1994, respectively. The Company's government
contracts generally fall into one of three categories: (1) cost
reimbursable, (2) fixed price, or (3) time and materials. Under a cost
reimbursable contract, the government reimburses the Company for its
allowable costs and expenses, and pays a fee which is either negotiated and
fixed or awarded based on performance. Under a fixed price contract, the
government pays an agreed upon price for the Company's services or
products, and the Company bears the risk that increased or unexpected costs
may reduce its profits or cause it to incur a loss. Conversely, to the
extent the Company incurs actual costs below anticipated costs on these
contracts, the Company could realize greater profits. Under a time and
materials contract, the government pays the Company a fixed hourly rate
intended to cover salary costs and related indirect expenses plus a certain
profit margin. For fiscal years 1996, 1995, and 1994, approximately 62%,
62%, and 61% of the Company's professional and technical services revenues
were from cost reimbursable contracts, while approximately 38%, 38%, and
39% were fixed price or time and materials type contracts, respectively.
PSO contracts are performed for a number of program offices within
various defense agencies, including each of the armed services. Customers
outside the field of defense and national security include other agencies
of the federal government, agencies of state and local governments, and
private industry. Any or all of the contracts with agencies of the United
States government may be subject to termination for the convenience of the
government. If a contract were to be terminated, the Company would be
reimbursed for its allowable costs up to the date of the termination, and
would be paid a proportionate amount of the fees attributable to the work
actually performed. In addition to the normal risks found in any business,
companies conducting research and analysis services for the United States
government are subject to changes in the defense budget, terminations of
contracts for cause or government convenience, and significant changes in
contract scheduling and funding.
4
At June 30, 1996, PSO had a maximum contract backlog amounting to
$326.8 million, compared to $235.3 million and $266.8 million for 1995 and
1994, respectively. For this purpose, maximum contract backlog assumes
that all government contract options for services in succeeding years will
be exercised and funded. Only a portion of the maximum contract backlog
would relate to the upcoming year. In contrast, funded contract backlog at
June 30, 1996, amounted to $48.5 million, compared to $38.7 million and
$29.8 million for 1995 and 1994, respectively. Funded contract backlog
represents the expected contract revenues for which contract awards have
been made and funded, and, thus, primarily represent the year-end backlog
of firm orders for which revenues may be expected in the current year.
Competition
-----------
With respect to PSO, the Company encounters substantial competition in
the professional and technical services area from a large number of
entities, some of which are significantly larger than the Company in size
and financial resources. The management of the Company believes that it
has a relatively small percentage of the total market. Competition comes
principally from other companies and certain non-profit organizations
engaged in similar aspects of research and analysis. Competitors include
BDM, CACI, Computer Sciences Corporation, SAIC, and others.
With respect to Telecom Division, the Company will encounter
substantial competition from established participants in the Division's
respective markets. With respect to the OSU(R) Network Interface, the
Company may either compete with or partner with established
telecommunications equipment suppliers, such as Lucent, Fujitsu, Alcatel,
Siemens, Northern Telecom, and others, which provide multiplexers or other
equipment having directly competitive or substitute functionality. With
respect to the NetworkVUE product suite, the Company may compete with
companies having network optimization products, such as CACI, Make Systems,
Mil 3, Wandl, NEC, and others. With respect to the NetworkVUE service
offering, the Company may either compete with or partner with information
technology consulting companies such as EDS, Andersen Consulting, and
others. With respect to ASG, the Company may have competition both from
the internal software development teams of telecommunications companies and
from other third party software developers for the telecommunications
industry.
With respect to APD, the markets in which the Company competes are
well developed with both larger and smaller competitors for testing
machines, environmental, health and safety management software, and
security systems. GRC Instruments(TM), the materials testing business unit,
competes with Instron and Ceast (an Italian company). CIS, the
environmental, health and safety software business unit, competes with
Oracle and Versar. The Vindicator(TM) security business unit competes with
Evantor and Checkpoint.
Research and Development and Capitalized Software Costs
-------------------------------------------------------
The Company performs R&D on its own behalf and on behalf of the U.S.
government under various government contracts. The Company's Strategy,
where feasible and permissible, is to expand upon the government R&D work
so as to exploit it
5
commercially. The Company's own research and development efforts have been
directed primarily at its Telecom Division. Total research and development
expenditures, excluding amounts paid under government contracts, but
including amounts capitalized, were approximately $18.6 million, $8.5
million, and $1.6 million, for 1996, 1995, and 1994, respectively. This
represented 15%, 6%, and 1% of revenues, respectively. The significant
increase in research and development spending in 1996 related to the
development of its OSU(R) Network Interface and NetworkVUE products. See
"Management's Discussion and Analysis", below, and Note 1 to the
Consolidated Financial Statements for a discussion of Statement of
Financial Accounting Standard ("SFAS") No. 86 related generally to Deferred
Software Costs and Research and Development, and specifically to a $15.4
million write-down of previously capitalized software and related costs in
1996.
Employees
---------
As of June 30, 1996, the Company employed 1,225 full-time and 110
part-time people, for a total of 1,335 people, an increase of 45 people, or
3%, over the 1,290 people employed at June 30, 1995, comprised of 1,197
full-time and 93 part-time people. At June 30, 1996, the Company had
approximately 245 openings for full-time employees, 209 of which were for
PSO. The filling of all open positions would represent a 20% increase in
the number of its full-time employees. At June 30, 1995, the Company did
not have a substantial number of PSO openings.
ITEM 2. PROPERTIES
----------
All of the Company's operations are conducted in leased facilities.
The Company has approximately 30 leased facilities within the United States
comprising approximately 449 thousand square feet. The minimum annual
rentals for fiscal year 1997 under non-cancelable operating leases are
approximately $6.8 million. The terms of Company leases range from monthly
tenancies to multi-year leases, and many of these leases may be renewed for
additional periods at the option of the Company. Major leased facilities
are at locations in California and Virginia. The Company owns no real
property and has no plans to purchase any in the foreseeable future. The
Company believes that its facilities are adequate for its purposes.
ITEM 3. LEGAL PROCEEDINGS
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The Company is involved in a number of legal proceedings arising out
of the normal course of its business, none of which, individually or in
aggregate, are, in the opinion of management, material to the operations of
the Company or are likely to have a material adverse impact on the
Company's liquidity or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
No matter was submitted to a vote of holders of the Company's
stock in the fourth quarter of fiscal year 1996.
6
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
------------------------------------------------------------
MATTERS
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Stock Prices and Dividends
--------------------------
The Company's common stock is traded on the New York and Pacific Stock
Exchanges. As of July 31, 1996, there were 1,441 holders of record of the
Company's common stock. Stock price information by quarter is presented in
the following table:
Fiscal Year
Market -----------------------------------
Price 1996 1995
------- ------------------- --------------
High Low High Low
------ ----------- ------ ------
1st Quarter 26 3/8 15 7/8 14 1/2 11 1/8
2nd Quarter 39 5/8 21 7/8 16 1/2 10 3/4
3rd Quarter 38 1/2 30 3/8 17 3/4 11 3/8
4th Quarter 44 5/8 31 1/4 17 1/8 13 1/8
On September 18, 1996, the closing price of the Company's common stock
was $19.
The Company did not declare or pay any dividend with respect to its
common stock during any of the years included in the financial data, and
the Board of Directors does not presently intend to commence the payment of
such dividends. See Note 10 to the Consolidated Financial Statements for a
discussion of the Company's Shareholder Rights Plan under which a dividend
of one common stock purchase right is automatically issued for each share
of the Company's common stock.
7
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
GRC International, Inc. and Subsidiaries
FOR THE YEAR 1996 1995 1994 1993 1992
----------- -------- -------- -------- --------
(in thousands, except for per share data)
Revenue $ 124,523 $137,808 $129,922 $130,644 $114,107
========== ======== ======== ======== ========
Operating income (loss) ($ 17,119) $ 4,760 $ 6,093 $ 5,683 $ 4,092
========== ======== ======== ======== ========
Income (loss) from operations before cumulative
effect of accounting change ($17,637) $ 5,030 $ 6,113 $ 5,509 $ 3,805
Income from cumulative effect of accounting change --- --- 1,000 --- ---
---------- -------- -------- -------- --------
Net income (loss) ($17,637) $ 5,030 $ 7,113 $ 5,509 $ 3,805
========== ======== ======== ======== ========
Income (loss) per common share:
Operations before cumulative effect of accounting
change ($1.92) $ .54 $ .65 $ .60 $.43
From cumulative effect of accounting change --- --- .11 --- ---
---------- -------- -------- -------- --------
($1.92) $ .54 $ .76 $ .60 $.43
========== ======== ======== ======== ========
Weighted average number of common and
common equivalent shares 9,172 9,393 9,426 9,211 8,893
Year-end data
Working capital $ 15,594 $ 20,378 $ 25,061 $ 26,286 $ 24,055
Total assets 74,101 73,709 69,080 65,082 55,670
Long-term debt (less current maturities) 17,770 --- --- 3,051 4,098
Stockholders' equity 28,675 48,268 45,040 39,310 33,889
* The operating loss for 1996 includes a write-off of $15.4 million in
deferred software and related costs, and the operating income for 1995
includes write-off of $0.5 million for deferred software and a gain of
approximately $0.9 million from the sale of a facility.
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
-----------------------------------------------------------------
FINANCIAL CONDITION
-------------------
Summary
The following table sets forth for the years indicated the percentage
of total revenues for each item in the Consolidated Statements of Income
and the percentage change of those items as compared to the prior year:
Relationship to Period to
Total Revenues Period Change
------------------------- ----------------------------
1996 1995 1994 96 vs. 95 95 vs. 94
------ -------- ------- --------------- -----------
Revenues 100% 100% 100% (10)% 6%
Cost of revenues 83 81 80 (8) 8
---- ---- ----
Gross Margin 17 19 20 (19) ---
Costs and expenses:
------------------
Research & Development 1 1 --- (32) 144
Sales & Marketing 5 2 2 135 4
General & Administrative 13 13 13 (10) 5
Write down of deferred software
and related costs 12 --- --- NM NM
Gain on sale of asset --- (1) --- NM NM
---- ---- ---- ---- ----
Total operating expenses 31 15 15 83 6
Operating income (loss) (14) 4 5 (460) (22)
Interest expense, net --- --- --- (292) (15)
Income (loss) before income taxes
and cumulative effect of accounting
change (14) 4 5 (451) (22)
Provision for income taxes --- --- --- NM (100)
Income (loss) before cumulative
effect of accounting change (14) 4 5 (451) (18)
Cumulative effect of accounting change --- --- 1 NM NM
---- ---- ---- ---- ----
Net income (loss) (14%) 4% 5% (451%) (29%)
---- ---- ---- ---- ----
"NM" indicates the percentage change is not meaningful.
9
Fiscal Year 1996 Compared to Fiscal Year 1995
---------------------------------------------
Revenues
--------
Fiscal year 1996 revenues of $124.5 million were $13.3 million, or
10%, lower than fiscal year 1995 revenues of $137.8 million. The decline
is attributable to a $15.5 million decline in revenues from PSO, an
increase in revenues of $1.8 million from Telecom Division, and an increase
of $425 thousand in revenues from APD. For 1996 and 1995, one PSO contract
accounted for 9% and 17%, respectively, of the Company's revenues.
For 1996, PSO revenues were $117.7 million, consisting of $110.4
million from PSO services revenues, $2.8 million from PSO product sales,
and $4.5 million in revenues from the minority-interest portion of a
majority-owned joint venture, which was accounted for on a consolidated
basis through the first quarter of 1996.
For 1995, PSO revenues were $133.2 million, consisting of $117.1
million from PSO service revenues, $1.5 million from PSO product sales, and
$14.6 million from the minority-interest portion of the majority-owned
joint venture.
Thus, the $15.5 million, or 12%, decline in PSO revenues from 1995 to
1996 arose from a decline of $6.7 million, or 6%, in PSO service revenues,
an increase of $1.3 million, or 85%, in PSO product sales, and a decline of
$10.2 million, or 70%, in revenues from the minority-interest portion of
the majority-owned joint venture. The decline in PSO service revenues of
$6.7 million was the net effect attributable primarily to the shift in
focus of a significant DoD contract requiring less effort by the Company,
offset by revenues earned from other DoD contracts.
For 1996, PSO service revenues of $110 million were derived from
approximately $87 million in revenues from direct labor fees, approximately
$11 million from subcontract revenues, and approximately $12 million from
revenues from other direct costs. Thus, approximately 79% of 1996 PSO
service revenues were derived from direct labor related fees and 10% from
subcontract revenues.
For 1995, PSO service revenues of $117 million were derived from
approximately $95 million in revenues from direct labor fees, approximately
$9 million from subcontract revenues, and approximately $13 million from
other direct costs. Thus, approximately 81% of 1995 PSO service revenues
were derived from direct labor related fees and 8% from subcontract
revenues.
The trend in PSO service revenues between 1995 and 1996, thus, shows a
decline in direct labor content and an increase in subcontract revenues.
The trend over the 3-year period from 1994 to 1996 shows a more marked
decline in direct labor revenues, from 86% in 1994 to 79% in 1996, and an
increase in subcontracting revenues from 3% in 1994 to 10% in 1996. This
trend is due, in part, to the growing "teaming" of companies on government
contracts, giving rise to more pass through of subcontract work by each
prime contractor on any particular contract.
As discussed in the next section, Cost of Revenues and Gross Profit,
the decline in the comparative percentages of PSO service revenue derived
from direct labor fees and the increase in subcontract revenues is a mix
shift from a relatively higher gross profit "direct labor" business to a
lower gross profit "subcontract revenue" business.
10
For 1996, Telecom Division's revenues were $2 million. These revenues
arose primarily from the OSU(R) Network Interface business unit, which sold
$1.5 million of commercial units in 1996. For the NetworkVUE business
unit, 1996 service revenues were $460 thousand. The Application Software
Group unit within Telecom has not yet recognized revenues, although, it
expects to do so in the first quarter of fiscal year 1997.
As a forward-looking statement where actual results may differ
materially from those planned or expected, the rate at which the Telecom
Division's revenues will grow in the future is a function of a variety of
factors, some of which are beyond the Company's control, including the
following:
. With respect to the OSU business unit, the growth of fiber optic
telecommunications transmission services; the growth in the use of
the SONET (synchronous optical network) transport protocol; the
growth in the use of ATM (asynchronous transfer mode) switching
technology; the lead times and procedures used by telecommunications
service providers and large, private corporate users in accepting
equipment based on these new technologies; whether the Company's OSU
product offering matches the industry demand as it develops in the
future; the propensity of large potential buyers to buy network
critical equipment from a new vendor in that market segment; and
other factors.
. With respect to the NetworkVUE business unit, the successful
completion of the product, and the matching of that product's
features and functions with the demand as it develops for such a
product.
. With respect to ASG business unit, the ability to attract software
engineers and programmers having the talent and skill required, and
the ability of the unit to expand its customer base beyond Lucent,
its primary customer at present.
See "Risk Factors", below, for a discussion of these and other risk
factors which may cause actual results to materially differ from those
planned or expected.
For 1996, APD revenues of $4.8 million were $425 thousand, or 10%,
greater than 1995 revenues of $4.4 million. The increase in APD revenues
was adversely impacted by the continuing updating and development of the
software modules which constitute the product offering for the
environmental, health, and safety management software business unit of APD
which began in 1995.
Cost of Revenues and Gross Profit
---------------------------------
Cost of revenues for 1996 amounted to $103.9 million, or 83% of
revenues, compared to $112.4 million, or 81% of revenues for 1995. Gross
profit for 1996 amounted to $20.7 million, or 17% of revenues, compared to
$25.4 million, or 19% of revenues for 1995. The $4.8 million decline in
gross profit for the Company is due primarily to a $3.7 million decline in
gross profit from the PSO service business.
Excluding the revenue and cost impact of the minority portion of the
majority-owned joint venture, for 1996 PSO had a cost of services of $92.1
million, or 83% of service revenues, compared to $95.1 million, or 81% of
service revenues in 1995. Consequently, the gross profit from PSO services
declined from $22 million in 1995 to $18.3 million in 1996, and gross
margin declined from 19% of service revenues in 1995 to 17% of service
revenues in 1996.
11
The decline in PSO service gross margins is, in part, attributable
to the reduced percentage of direct labor in cost of service revenues from
1995 to 1996, with an offsetting increase in subcontract costs. For 1996,
direct labor costs were 41% of cost of service, and subcontract costs were
12%. For 1995, direct labor costs were 44% of cost of service, and
subcontract costs were 9%. In addition, the decline in PSO service gross
margins is attributable to a decline in the gross margins achieved on the
direct-labor portion of its service business, due to increasing competitive
pressure in pricing government contracts.
Thus, the decline in gross margins for the Company from 1995 to 1996
is in large part due to the decline in PSO service gross margins, which, in
turn is, in large part, due to the mix shift from direct labor revenues to
subcontract revenues, accompanied also by a decline in the gross margins
derived from direct labor.
For 1996, given the start-up nature of its business, the OSU(R)
Network Interface business unit had gross margins of 25% on sales of $1.5
million and a gross profit of $380 thousand. Given the start-up nature of
its business for 1996, the NetworkVUE business units had a negative gross
margin of $330 thousand on revenues of $460 thousand. The Application
Software Group has not yet generated a gross profit, since it has not yet
recognized revenues. As a forward-looking statement where actual results
may differ materially from those planned or expected, the Company does not
consider these gross margins as indicative of the long-term range of gross
margins from these business units.
Operating Expenses and Operating Income
---------------------------------------
Fiscal year 1996 total operating expenses of $37.8 million, or 30% of
revenues, were $17.1 million greater than the $20.7 million, or 15% of
revenues, in operating expenses for 1995. Operating results for 1996 were
a loss of $17.1 million, compared to an operating profit for 1995 of $4.8
million.
Excluding a write-off of deferred software and related costs for 1996,
operating expenses would have been $22.3 million. Operating income for
1995 included a gain of approximately $900 thousand from the sale of the
Company's California facility, and a write-down of deferred software costs
of $500 thousand. Excluding these impacts, operating expenses for 1995
would have been $21.1 million.
Sales and marketing expenses increased by $3.4 million from $2.5
million, or 2% of revenues, in 1995, to $5.8 million, or 5% of revenues, in
1996. General and administrative expenses declined by $1.7 million from
$17.5 million, or 13% of revenues, for 1995 to $15.8 million, or 13% of
1996 revenues. The increase in sales and marketing expense is attributable
to Telecom Division.
In addition to the R&D efforts carried on by the Company on behalf of
the U.S. government under various government contracts and reported in cost
of revenues, the Company also carried on R&D efforts on its own behalf.
For 1996, research and development expense of $737 thousand when added to
the $17.8 million of capitalized software development costs for the year
(before the year-end write-off discussed below) amounted to a total effort
of $18.6 million. For 1995, research and development expense of $1.1
million together with capitalized software development costs for the year
of $7.4 million amounted to a total effort of $8.5 million. Thus, the
total R&D and capitalized software effort increased by $10.1 million from
$8.5 million, or 6% of revenues, in 1995 to $18.6 million, or 15% of
revenues, in 1996.
12
Total operating expenses plus capitalized software costs for the year,
before the year-end write-offs, increased by $11.7 million, from $28.5
million in 1995 to $40.2 million in 1996.
For 1996, allocating the $15.4 million write-off to the appropriate
divisions, PSO services business generated an operating profit of $5.7
million, PSO products business generated a loss of $4.2 million, yielding a
net profit for PSO of $1.6 million. Telecom Division had an operating loss
of $16.3 million, $13.3 million for the OSU business unit and $3.0 million
for the NetworkVUE business unit. APD had an operating loss of $1.8
million. And, unallocated corporate expenses (excluding net interest
expense) amounted to $550 thousand.
A portion of the 1996 write-down of deferred software and related
costs related to the PSO products business. As a forward-looking statement
where actual results may differ materially from those planned or expected,
the Company does not expect losses in the PSO products business unit to
continue in the future.
For 1995, the $4.8 million operating profit was comprised of a PSO
services operating profit of $6.8 million, a PSO products loss of $200
thousand, a Telecom Division loss of $824 thousand, and an APD loss of $1.3
million.
Write-down of Deferred Software and Related Costs
-------------------------------------------------
In 1996, the Company recorded a write-down of $15.4 million for
software development and related costs, compared to a write-down of $500
thousand for 1995. The $14.4 million write-down was comprised of $14.2
million in deferred software costs (including $10.3 million related to OSU)
and $1.0 million in other related costs.
In the fourth quarter of 1996, the Company completed and made
available to the marketplace its GOLD 2 OSU(R) product. The GOLD 2 product
contains more flexibility and functionality than earlier OSU products. In
the fourth quarter, the Company reviewed the expected completion costs and
recoverability of earlier OSU products and determined that the GOLD 2
product would be the only current OSU product to be marketed actively.
Accordingly, the Company wrote-off the costs incurred to develop the
earlier OSU products.
Net Interest Income or Expense
------------------------------
Net interest expense of $518 thousand for 1996, compared to net
interest income of $270 thousand for 1995, reflects the significant
increase in debt incurred during 1996 in order to fund the development of
the OSU(R) Network Interface and NetworkVUE(TM) product offerings.
Net Income or Loss
------------------
Net income for 1996 amounted to a loss of $17.6 million, compared to a
profit of $5 million for 1995.
13
Fiscal Year 1995 Compared to Fiscal Year 1994
---------------------------------------------
Revenues
--------
Fiscal year 1995 revenues of $137.8 million were $7.9 million, or 6%,
higher than fiscal year 1994 revenues of $129.9 million. The increase is
primarily attributable to a $9.2 million increase in revenues from PSO and
a decrease of $2.7 million in revenues from APD. For 1995 and 1994, one PSO
contract accounted for 17% and 15%, respectively, of the Company's
revenues.
For 1995, PSO revenues were $133.2 million, consisting of $117.1
million from PSO service revenues, $1.5 million from PSO product sales, and
$14.6 million from the minority-interest portion of the majority-owned
joint venture.
For 1994, PSO revenues were $124.0 million, consisting of $113.2
million from PSO service revenues, $993 thousand from PSO product sales,
and $9.8 million from the minority-interest portion of the majority-owned
joint venture.
Thus, the $9.2 million, or 7%, increase in PSO revenues from 1994 to
1995 arose from an increase of $3.9 million, or 3%, in PSO service
revenues, an increase of $546 thousand, or 55%, in PSO product sales, and
an increase of $4.8 million, or 49%, in revenues from the minority-interest
portion of the majority-owned joint venture.
For 1995, PSO service revenues of $117 million were derived from
approximately $95 million in revenues from direct labor fees, approximately
$9 million from subcontract revenues, and approximately $13 million from
other direct costs. Thus 81% of 1995 PSO service revenues were derived
from direct labor related fees and 8% from subcontract revenues.
For 1994, PSO service revenues of $113 million were derived from
approximately $97 million in revenues from direct labor fees, approximately
$4 million from subcontract revenues, and approximately $12 million from
revenues from other direct costs. Thus, 86% of 1994 PSO service revenues
were derived from direct labor related fees and 3% from subcontract
revenues.
The trend in PSO service revenues between 1994 and 1995, thus, shows a
decline in direct labor content and an increase in subcontract revenues.
As discussed in the next section, Cost of Revenues and Gross Profit, the
decline in the comparative percentages of PSO service revenue derived from
direct labor fees and the increase in subcontract revenues is a mix shift
from a relatively higher gross profit "direct labor" business to a lower
gross profit "subcontract revenue" business.
Telecom Division's revenues were negligible for 1995 and nil for 1994.
This reflects the fact that the Telecom products were not developed and
available for commercial sale during fiscal year 1994, and were still
substantially under development during fiscal year 1995.
For 1995, APD revenues of $4.4 million were $1.5 million lower than
the $5.9 million in revenues recognized for 1994. The decline in revenues
from 1994 to 1995 was attributable primarily to the need to rewrite the
software modules which constitute the product offering for the
environmental, health, and safety management software business unit of APD
beginning during 1995.
14
Cost of Revenues and Gross Profit
---------------------------------
Cost of revenues for 1995 amounted to $112.4 million, or 81% of
revenues, compared to $104.4 million, or 80% of revenues, for 1994. Gross
profit for 1995 amounted to $25.4 million, or 19% of revenues, compared to
$25.5 million, or 20% of revenues for 1994.
Excluding the revenue and cost impact of the minority portion of the
majority-owned joint venture, for 1995, PSO had a cost of services of $95.1
million, or 81% of revenues, compared to $91.1 million, or 81% of revenues
in 1994. Consequently, the gross profit from PSO services was essentially
unchanged at $22.1 million in 1994 and $22.0 million in 1995, although
gross margin declined slightly from 20% of revenues in 1994 to 19% of
revenues in 1995.
The slight decline in PSO service gross margins was, in part,
attributable to the increased percentage of subcontract costs in cost of
service revenues from 1994 to 1995. For 1995, direct labor costs were 44%
of cost of service and subcontract costs were 9%. For 1994, direct labor
costs were 48% of cost of service, and subcontract costs were 4%. The
shift in the mix of revenues and costs components for the PSO service
business from direct labor related costs and fees to subcontract related
costs is a mix shift which tends to reduce the gross profit derived from
the PSO service business.
Operating Expenses and Operating Income
---------------------------------------
Fiscal year 1995 total operating expenses of $20.7 million, or 15% of
revenues, were $1.3 million greater than the $19.4 million, or 15% of
revenues, in operating expenses for 1994. Operating profit of $4.8
million for 1995 was lower by $1.3 million for the $6.1 million operating
profit for 1994.
Operating income for 1995 included a gain of approximately $900
thousand from the sale of the Company's California facility, and a write-
down of deferred software costs of $500 thousand. Excluding these impacts,
operating expenses for 1995 would have been $21.1 million.
Sales and marketing expenses increased by $91 thousand from $2.4
million for 1994 to $2.5 million in 1995. General and administrative
expenses increased by $905 thousand from $16.6 million, or 13% of revenues,
for 1994 to $17.5 million, or 13% of revenues, for 1995.
In addition to the R&D efforts carried on by the Company on behalf of
the U.S. government under various government contracts and reported in cost
of revenues, the Company also carried on R&D efforts on its own behalf.
For 1995, research and development expense of $1.1 million when added to
the $7.4 million of capitalized software development costs amounted to a
total effort of $8.5 million. For 1994, research and development expense
of $445 thousand together with capitalized software development costs for
the year of $1.2 million amounted to a total effort of $1.6 million. Thus,
the total R&D and capitalized software effort increased by $6.9 million
from $1.6 million, or 1% of revenues, in 1994 to $8.5 million, or 6% of
revenues, in 1995.
Total operating expenses plus capitalized software costs for the year
increased from $20.6 million in 1994 to $28.5 million in 1995.
15
For 1995, PSO services had an operating profit of $6.8 million, PSO
products lost $200 thousand, Telecom Division lost $800 thousand, and APD
lost $1.3 million. For 1994, PSO services had an operating profit of $7.4
million, PSO products had a loss of $303 thousand, Telecom Division had a
loss of $148 thousand, and APD had a loss of $368 thousand.
Net Interest Income or Expense
------------------------------
Net interest income of $270 thousand for 1995, compared to net
interest income of $319 thousand for 1994.
Net Income or Loss
------------------
Net income for 1995 of $5 million, compared to net income of $7.1
million for 1994. Net income for 1994 included a net benefit of $1 million
attributable to recording a net deferred tax asset in accordance with SFAS
109.
Liquidity and Capital Resources
-------------------------------
The Company had $2.8 million in cash and cash equivalents at June 30,
1996, compared to $2.7 million at June 30, 1995. Net cash provided from
operations amounted to $3.7 million for 1996, compared to $10.1 million for
1995. Net cash used in investing activities for 1996 amounted to $21.2
million, compared to $8.5 million for 1995. Net cash provided by financing
activities amounted to $17.6 million for 1996, compared to $2.6 million
used in 1995.
The increased use of cash in investing activities for 1996 of $12.7
million over 1995 was due primarily to the increased level of software
development costs between the two years. For 1996, investments in software
development costs amounted to $17.8 million, compared to $7.4 million for
1995. This was financed in 1996 by the $19.6 million in new debt,
primarily the increase of $17.8 million in bank and equipment financing
described below.
Cash flows from operations, adjusted for cash used in developing
software, was a negative $14.1 million and a positive $2.7 million in 1996
and 1995, respectively.
As a summary of consolidated sources and uses of cash for 1996,
positive operating cash flows from the PSO service business funded losses
from the PSO product business and corporate expenses. The increase in debt
during the year funded operating losses in Telecom Division and APD.
As a result of the large increase in debt during 1996, the Company's
ratio of debt to total capitalization amounted to 41%, compared to zero for
1995.
During fiscal years 1994, 1995 and 1996, the Company invested
approximately $28 million in operating losses, capital equipment, and
deferred software production costs for Telecom Division. This was funded
primarily by a combination of internally generated cash flows from PSO and
from increased bank debt. As a forward-looking statement where actual
results may differ materially from those planned or expected, the Company
does not anticipate investing similar amounts in new technologies in the
future, unless operating cash flows become significantly positive or
additional sources of external capital are established.
16
At June 30, 1996, the Company had $19.6 million of debt, $1.8 million
of which was classified as short term, and $17.8 million of which was
classified as long term. Of these amounts, $17.8 million was bank debt
and $1.8 million was a note payable related to the 1996 acquisition of
assets from Quintessential Solutions, Inc. The Company had no bank debt at
June 30, 1995.
The credit facilities with the Company's bank consist of a fully used
$5 million term loan, a $22 million revolving line of credit, of which $5.4
million was used at June 30, 1996, and a $7.3 million debt arising from the
equipment financing arranged with the bank's equipment leasing subsidiary.
The term loan is due on September 1, 1998, and bears interest at the bank's
floating prime rate, currently 8.25% per annum. The revolving line of
credit is due on January 15, 1998, and, if the Company is not in default,
is automatically renewable for one-year renewal terms unless the bank, at
its option, delivers written notice of non-renewal to the Company at least
15 months prior to the end of the initial term or any renewal term. The
revolving line of credit bears interest at the bank's floating prime rate,
currently 8.25% per annum. The equipment financing is for a term of 60
months.
The Amended and Restated Revolving Credit and Term Loan Agreement
containing the term loan and the revolving line of credit was amended as of
March 31, 1996, and again as of June 30, 1996, to reduce various financial
ratio covenant levels so as to bring the Company into compliance with those
covenants as of those dates.
Given the relatively high levels of debt already incurred by the
Company, maintaining the Company's future liquidity and the availability
of needed capital resources requires that either the Telecom business units
begin generating positive operating cash flows, or the Company raise
additional equity, or the Company enter into strategic financial and
marketing relationships with appropriate participants in the
telecommunications industry segment, or a combination of these corporate
finance strategies. There can be no assurances, however, that any or all
of these strategies will be feasible, effective, or sufficient to satisfy
the Company's liquidity requirements.
Nonetheless, as a forward-looking statement where actual results may
differ materially from those planned or expected, the Company believes that
a combination of PSO positive cash flow from operations, reduced negative
operating cash flows from Telecom Division and APD, continued reliance on
available credit facilities, and availing itself of various opportunities
for additional capital will provide sufficient liquidity and capital
resources to fund the Company's requirements for the next fiscal year. See
"Risk Factors", below, for factors which may have a material adverse impact
on the Company's plans and expectations.
Outlook
-------
As forward-looking statements where actual results may differ
materially from those planned or expected, the Company believes that the
following are the current outlooks for its various Divisions:
For PSO, given the increase in its various measures of U.S. government
contract backlog, its high win rates on new bids, and its enhanced focus on
marketing its information technology services both within the government
and in commercial areas, the Company believes that PSO should be able to
sustain average long-term growth rates greater than it has been able to
achieve in recent years. PSO, for the next fiscal year, should continue to
achieve positive operating results and positive cash flows.
17
For Telecom Division's OSU and NetworkVUE business units, the Company
is optimistic regarding the future long-term trends and prospects for both
its optical network equipment business, beginning with the OSU(R) Network
Interface and derivative products now being marketed, and its NetworkVUE
suite of network design and optimization modules now nearing completion and
related services. However, given the early stage of these business units'
commercial sales efforts, these units are expected to continue to sustain
losses from operations and negative cash flows for the next fiscal year.
The Company, however, expects both the OSU and the NetworkVUE business
units to increase their unit sales and revenues during the next fiscal
year.
For Telecom Division's Application Software Group, the Company is
optimistic regarding the Group's current and future prospects to engage in
highly sophisticated and leading-edge software development for the
telecommunications industry. However, given the early stage of this
business unit's operating history, ASG is expected to have essentially a
small loss to break-even cash flows for the next fiscal year. The Company,
however, expects a growth in revenues recognized by the Group and an
operating profit for the next fiscal year.
For APD, the Company is optimistic regarding the Division's ability to
bring focused management leadership to its four business units. Given the
maturity of the materials testing business unit, the recent redevelopment
of the environmental, safety, and health management software business unit,
and growth prospects for the security and systems integration business
units, the Company expects a growth in revenues and gross margins for the
Division, but, essentially, a break-even result of operations and a
slightly negative cash flow for the next fiscal year.
Given the level of debt being carried by the Company, and its expected
increase during the next fiscal year, and the expected negative cash flows
for the next fiscal year, the Company expects net interest expense to
increase for the next fiscal year.
See "Risk Factors", below, for factors which could cause actual
results to differ materially from those outlined in this Outlook section.
Risk Factors
------------
The Private Securities Litigation Reform Act of 1995 (the "Reform
Act") provides a "safe harbor" for forward-looking statements to encourage
companies to provide prospective information about their companies, so long
as those statements are identified as forward-looking and are accompanied
by meaningful cautionary statements identifying important factors that
could cause actual results to differ materially from those discussed in the
statement. Except for the historical information contained herein, the
matters discussed in this Form 10-K Annual Report which relate to present
or future events or trends are intended to be forward-looking statements
which involve risks and uncertainties. Although the Company believes that
the expectations reflected in such forward-looking statements are based
upon reasonable assumptions, it can give no assurance that its expectations
will be achieved. Important factors that could cause actual results to
differ materially from the Company's expectations are disclosed in
conjunction with the forward-looking statements and again below.
PSO derives substantially all of its business from service contracts
with the Department of Defense of the United States government. This
business is subject to the uncertainties of the U.S. budget, funding for
the DoD, terminations of contracts for cause or government convenience, the
type of contracts which may be awarded to the Company,
18
and the ability of the Company to fill the required staff positions to
service those contracts. These open positions require operations research
and software engineers, computer programmers, and other skilled scientists
and engineers, employees for whom there is a general shortage and a high
degree of competitive pressure. During fiscal year 1996, the Company had a
net gain of 45 full-time and part-time employees, and at June 30, 1996, had
openings for approximately 245 employees of which 209 related to positions
for PSO. The number of openings was significantly lower at June 30, 1995.
An inability to fill a substantial portion of these current openings could
have a materially adverse impact on PSO's revenue growth and profitability.
Although PSO contracts at year-end 1996, 1995 and 1994 have numbered 149,
175 and 189, respectively, the loss of one or more may have a substantial
adverse impact on PSO's revenues and profitability, if the particular
contract is large in relation to the rest.
Telecom Division is a new business division for the Company, competing
in a new industry segment, not related to government contracting. The
OSU(R) Network Interface business unit sells hardware having a critical
software component to the telecommunications industry and large private
corporate users. The NetworkVUE business unit sells software and provides
related services to the telecommunications industry, large corporate users,
and to intermediary software and service providers to these end users. The
Application Software Group provides software engineering and computer
programming to the telecommunications industry. Actual results may differ
materially from those planned or expected for these business units within
Telecom Division, depending on the adverse impact of the following risk
factors:
. In all cases, the Company must attract, hire, and retain employees
with the requisite training and experience in these industry
segments, and the Company's business units must compete successfully
with large well established companies already having product and
service offerings which are familiar to the end users in the
relevant segments.
. The Company's OSU product offering is dependent upon the growth and
development of fiber optic transmission services, the SONET
(synchronous optical network) transmission protocol, and ATM
switching technology (asynchronous transfer mode), and the matching
of the features and functions of the Company's product offerings
with the industry's requirements, as well as the buying procedures
and lead times of established telecommunications service and
equipment providers, which are not yet accustomed to buying this
product offering from the Company.
. The Company's NetworkVUE product and service offering is dependent
upon the successful completion of the product, the matching of the
features and functions of this product and service offering with the
needs of the telecommunications industry, large corporate end users,
and intermediate service and product providers.
. The Company's Application Software Group is, at present, a new
business unit having one primary customer, Lucent, and is dependent
upon attracting new clients.
. The Company in general and Telecom Division business units in
particular have not yet established sustained and continuing
successes with its sales and marketing strategies and, thus, do not
yet have the operating history which can serve as the basis for
forecasting the future results of plans and budgets with small
variability in expected results. Thus, the risk inherent in these
businesses at this time is high.
19
-- Given the Company's increased reliance upon debt financing, the
financial risk arising from increased leverage is higher than it
has been in recent years and will probably grow higher during the
next fiscal year.
New Accounting Pronouncements
-----------------------------
The Financial Accounting Standards Board has released Statement of
Financial Accounting ("SFAS") Nos. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" and 123
"Accounting for Stock-Based Compensation". The Company plans to adopt the
provisions of these statements in fiscal year 1997, when required. The
Company has not completed the process of evaluating the impact that might
result from the adoption of these statements. The Company does not plan to
adopt the recognition provision of SFAS No. 123, but rather continue to
follow its current accounting practice.
ITEM 8. FINANCIAL STATEMENTS
--------------------
INDEX TO FINANCIAL STATEMENTS
-----------------------------
Page
----
Independent Auditors' Report 21
Report of Management 22
Consolidated Statements of Income for the years ended
June 30, 1996, 1995 and 1994 23
Consolidated Balance Sheets as of June 30, 1996 and 1995 24
Consolidated Statements of Cash Flows for the years ended
June 30, 1996, 1995 and 1994 26
Consolidated Statements of Stockholders' Equity
for the years ended June 30, 1996, 1995 and 1994 27
Notes to Consolidated Financial Statements 28
20
INDEPENDENT AUDITORS' REPORT
To the Stockholders of GRC International, Inc.:
Vienna, Virginia
We have audited the accompanying consolidated balance sheets of GRC
International, Inc. and subsidiaries as of June 30, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended June 30, 1996. Our
audits also included the financial statement schedule listed in the Index
at Item 14. These financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is
to express an opinion on the financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of GRC International, Inc.
and subsidiaries as of June 30, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period
ended June 30, 1996 in conformity with generally accepted accounting
principles. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly in all material respects the information set
forth therein.
DELOITTE & TOUCHE LLP
McLean, Virginia
August 20, 1996
21
REPORT OF MANAGEMENT
The management of GRC International, Inc. is responsible for all
information and representations contained in the annual report. The
consolidated financial statements, which include amounts based on estimates
and judgments of management, have been prepared in conformity with
generally accepted accounting principles. Other financial information in
the annual report is consistent with the consolidated financial statements.
The Company maintains a system of internal financial controls which
provides management with reasonable assurance that transactions are
recorded and executed in accordance with its authorizations, that assets
are properly safeguarded and accounted for, and that records are maintained
so as to permit preparation of financial statements in accordance with
generally accepted accounting principles. This system includes written
policies and an organizational structure that segregates duties. The
Company also has instituted policies and guidelines which require all
employees to conduct business according to the highest standards of
integrity.
In addition, the Audit Committee of the Board of Directors, consisting
solely of outside directors, meets periodically with management and the
independent public accountants to discuss auditing, internal accounting
controls and financial reporting matters and to ensure that each is
properly discharging its responsibilities. The independent public
accountants periodically meet alone with the Audit Committee and have full
and unrestricted access to the Committee at any time.
GRC INTERNATIONAL, INC.
/s/ Jim Roth /s/ Ronald B. Alexander
Jim Roth Ronald B. Alexander
President and Chief Executive Officer Senior Vice President-Finance,
Treasurer and Chief Financial Officer
22
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
FOR THE YEARS ENDED JUNE 30,
----------------------------
1996 1995 1994
-------------- ------------- -------------
(in thousands, except for per share data)
Revenues $124,523 $137,808 $129,922
Cost of revenues 103,861 112,376 104,391
-------- -------- --------
Gross margin 20,662 25,432 25,531
Operating Expenses:
------------------
Research and Development 737 1,086 445
Sales and Marketing 5,842 2,482 2,391
General and Administrative 15,767 17,507 16,602
Write-down of deferred software
and related costs 15,435 500 ---
Gain on sale of asset --- (903) ---
-------- -------- --------
Total operating expenses 37,781 20,672 19,438
Operating income (loss) (17,119) 4,760 6,093
Interest expense (income), net 518 (270) (319)
Income (loss) before income taxes and
cumulative effect of accounting change (17,637) 5,030 6,412
Provision for income taxes --- --- 299
-------- -------- --------
Income (loss) before cumulative effect of
accounting change (17,637) 5,030 6,113
Cumulative effect of accounting change --- --- 1,000
-------- -------- --------
Net income (loss) $(17,637) $ 5,030 $ 7,113
======== ======== ========
INCOME (LOSS) PER COMMON AND
COMMON EQUIVALENT SHARE:
Before cumulative effect of accounting
change $ (1.92) $ .54 $ .65
From cumulative effect of accounting change --- --- .11
-------- -------- --------
$ (1.92) $ .54 $ .76
======== ======== ========
The accompanying notes are an integral part of these statements.
23
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
AS OF JUNE 30,
--------------
ASSETS
------
1996 1995
--------- ---------
(in thousands)
CURRENT ASSETS:
Cash and cash equivalents $ 2,790 $ 2,679
Accounts receivable 29,966 32,419
Unbilled reimbursable costs and fees 4,033 5,662
Inventories, at the lower of cost
or market 2,635 1,600
Other receivables 1,018 1,160
Prepaid expenses 1,462 918
------- -------
Total current assets 41,904 44,438
------- -------
PROPERTY AND EQUIPMENT, at cost:
Land, buildings and leasehold
improvements 4,528 4,275
Equipment, furniture and fixtures 17,204 13,830
Less - Accumulated depreciation and
amortization (9,465) (7,773)
------- -------
12,267 10,332
------- -------
OTHER ASSETS:
Goodwill and other intangible
assets, net 2,311 2,555
Software development costs, net 11,216 8,344
Deferred income taxes 2,625 2,561
Deposits and other 3,778 5,479
------- -------
19,930 18,939
------- -------
$74,101 $73,709
======= =======
The accompanying notes are an integral part of these balance sheets.
24
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
AS OF JUNE 30,
--------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
1996 1995
--------- ---------
(in thousands)
CURRENT LIABILITIES:
Current maturities of long-term debt $ 1,823 ---
Accounts payable 6,382 7,774
Accrued compensation and benefits 13,125 11,960
Income taxes payable 270 446
Deferred income taxes 1,625 1,561
Accrued expenses 2,095 2,118
Other current liabilities 990 201
-------- --------
Total current liabilities 26,310 24,060
-------- --------
LONG-TERM LIABILITIES
Long-term debt 17,770 ---
Other long-term liabilities 1,346 1,381
-------- --------
Total long-term liabilities 19,116 1,381
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.10 par value -
Authorized - 30,000,000 shares,
issued - 9,586,000 shares in 1996
and 9,325,000 shares in 1995 958 932
Paid-in capital 74,830 76,812
Accumulated deficit (43,268) (25,631)
-------- --------
32,520 52,113
Less: Treasury stock, at cost; 300,000 shares
in 1996 and 1995 (3,845) (3,845)
-------- --------
Total stockholders' equity 28,675 48,268
-------- --------
$ 74,101 $ 73,709
======== ========
The accompanying notes are an integral part of these balance sheets.
25
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE YEARS ENDED JUNE 30,
----------------------------
1996 1995 1994
--------- -------- --------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(17,637) $ 5,030 $ 7,113
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 3,988 3,185 2,613
Provision for losses on accounts receivable,
unbilled reimbursable costs and fees 956 857 791
Write-down of deferred software and related costs 15,435 500 ---
Gain on sale of assets --- (903) ---
Cumulative effect of accounting change --- --- (1,000)
Changes in assets and liabilities:
Accounts receivable and unbilled reimbursable
costs and fees 3,126 (1,169) (4,257)
Inventory (1,652) (415) (275)
Prepaid expenses (544) 652 (786)
Accounts payable, accruals, income taxes and other
current liabilities 34 2,510 (744)
Other, net 21 (156) (194)
-------- ------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,727 10,091 3,261
-------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net proceeds from notes receivables 1,440 2,750 ---
Capital expenditures (5,024) (3,731) (3,610)
Software development costs (17,839) (7,401) (1,171)
Other, net 176 (85) (1,064)
-------- ------- -------
NET CASH USED BY INVESTING ACTIVITIES (21,247) (8,467) (5,845)
-------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on debt and capital lease obligations --- --- (3,245)
Proceeds from bank borrowings 19,622 --- ---
Purchase of treasury stock --- (3,071) (774)
Taxes related to exercise of employee stock options (1,956) --- ---
Other, net (35) 466 194
-------- ------- -------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES 17,631 (2,605) (3,825)
-------- ------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 111 (981) (6,409)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,679 3,660 10,069
-------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,790 $ 2,679 $ 3,660
======== ======= =======
Supplemental disclosures:
Cash payments:
Interest $ 754 $ 371 $ 214
Income taxes 84 111 411
The accompanying notes are an integral part of these statements.
26
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
FOR THE YEARS ENDED JUNE 30,
----------------------------
Preferred Stock Common Stock Paid-in Accumulated Treasury
Shares Amount Shares Amount Capital Deficit Stock
------ ------ ------ ------ ------- ------- -------
(in thousands)
Balances as of June 30, 1993 21 $ 21 8,998 $900 $76,146 $(37,757) $ ---
Proceeds from stock options
exercised -- --- 90 9 202 --- ---
Preferred stock dividends -- --- --- --- --- (17) ---
Conversion of Preferred Stock (21) (21) 64 6 15 --- ---
Net Income -- --- --- --- --- 7,113 ---
Purchase of 142,500 shares of
Treasury stock -- --- --- --- --- --- (1,577)
--- ----- ----- ---- ------- -------- -------
Balances as of June 30, 1994 -- --- 9,152 915 76,363 (30,661) (1,577)
Proceeds from stock options
exercised -- --- 173 17 449 --- ---
Net Income -- --- --- --- --- 5,030 ---
Purchase of 157,500 shares of
Treasury Stock -- --- --- --- --- --- (2,268)
--- ----- ----- ---- ------- -------- -------
Balances as of June 30, 1995 -- --- 9,325 932 76,812 (25,631) (3,845)
Stock options exercised net of
shares retained for exercise
price and taxes -- --- 261 26 (1,869) --- ---
Compensation on officers' stock
options -- --- --- --- 88 --- ---
Discount on Employee Stock
Purchase Plan -- --- --- --- (201) --- ---
Net loss -- --- --- --- --- (17,637) ---
--- ----- ----- ---- ------- -------- -------
Balances as of June 30, 1996 -- $ --- 9,586 $958 $74,830 $(43,268) $(3,845)
=== ===== ===== ==== ======= ======== =======
27
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
June 30, 1996, 1995 and 1994
----------------------------
(1) ACCOUNTING POLICIES
Principles of consolidation - The consolidated financial statements
---------------------------
include the accounts of GRC International, Inc. and all subsidiaries (the
Company). All significant intercompany balances and transactions have been
eliminated.
Major customer - 91%, 92% and 89% of the Company's revenues were
--------------
derived from contracts with the U.S. Department of Defense (DoD) and 9%,
17% and 15% of revenues were derived from one contract for fiscal
years 1996, 1995 and 1994, respectively.
Cash and cash equivalents - Cash and cash equivalents include cash on
-------------------------
hand, cash in banks and temporary investments purchased with a maturity of
three months or less.
The Company has a policy of investing all available cash, on a daily
basis, in either overnight master note agreements or overnight time
deposits issued by banks. Since these transactions are recorded daily in a
book entry format, the Company does not take possession of any securities.
At June 30, 1996 and 1995, the Company had approximately $27,000 and $2.6
million, respectively, invested in overnight time deposits issued by Fuji
Bank of Japan.
Inventories - Inventory costs include materials, labor and
-----------
manufacturing overhead. Inventories are priced using the average unit cost
method.
1996 1995
------ -----
(in thousands)
Raw materials and supplies $1,961 $ 693
Work-in-process 158 179
Finished goods 516 728
------ -----
$2,635 $1,600
====== ======
Approximately $940 thousand of the $2.6 million net inventory at June
30, 1996, was attributable to the OSU(R) business unit within Telecom
Division.
Property and equipment - Expenditures for betterments and major
----------------------
renewals are capitalized and ordinary maintenance and repairs are charged
to operations as incurred.
Depreciation is computed using the straight-line method based on the
estimated useful lives of assets, which range from 3 to 10 years.
Amortization of leasehold improvements is computed using the straight-line
method based on the remaining term of the related lease.
Upon sale or retirement of property and equipment, the difference
between the proceeds and the net book value of the assets is charged or
credited to income.
28
Intangible assets - Goodwill, representing the cost in excess of the
-----------------
fair value of the net assets of businesses acquired, is being amortized to
operations on a straight-line basis over periods of up to 40 years. Other
intangible assets are being amortized to operations on a straight-line
basis over periods of up to 15 years. The Company periodically evaluates
the goodwill and other intangible assets in relation to the operating
performance and future contribution to the underlying businesses and makes
adjustments, if necessary, for any impairment of these assets. Accumulated
amortization as of June 30, 1996 and 1995, of goodwill was $1,160,000 and
$1,083,000, respectively, and of other intangible assets was $1,089,000 and
$975,000, respectively.
Software development costs - Software development costs incurred for
--------------------------
products to be sold are capitalized only after establishing technological
feasibility. Capitalized software is amortized over the greater of
straight-line method over the estimated economic life of the product,
ranging between three and five years, or the ratio that current revenues
bear to the total of current and estimated future revenue stream on an
individual product basis. At the end of each quarter, the Company re-
evaluates the estimates of future revenues and remaining economic life of
products for which software costs have been capitalized, and, if required
under SFAS 86, writes-down the carrying values to net realizable value. At
June 30, 1996, deferred software costs on the Company's balance sheet were
carried at $11.2 million. Changes in estimates regarding the
recoverability of this asset could have a significant adverse impact on the
Company's future results of operations.
The amount of software costs capitalized was $17,839,000, $7,401,000
and $1,171,000 and the related amortization expense was $734,000, $771,000
and $162,000 in 1996, 1995 and 1994, respectively. In the fourth quarter
of fiscal year 1996, pursuant to the re-evaluation of software development
costs discussed above, the Company wrote off $15.4 million of deferred
software and related costs, comprised of $10.3 million in OSU related
software costs, $1.2 million in commercial environmental related software
costs, $2.9 million in other software costs, $617 thousand in related
inventory costs, and $385 thousand in other related costs. During fiscal
1995, the Company wrote down the deferred software costs for prior
development efforts associated with its commercial environmental software
products to its estimated net realizable value by $500,000, after
reassessing current trends in the marketplace.
Revenue recognition - Service revenues result from contracts with
-------------------
various government agencies and private industry. Revenues on cost plus
fee and fixed price contracts are recognized using the percentage of
completion method generally determined on the basis of cost incurred to
date as a percentage of estimated total cost. Revenues on time and
materials contracts are recognized at contractual rates as labor hours and
materials are expended. Losses are recognized in the period in which they
become determinable.
Costs incurred in excess of current contract funding are deferred when
management believes they are realizable through subsequent additional
funding. No revenues are recognized related to such costs which are
included in unbilled reimbursable costs and fees in the accompanying
consolidated balance sheets.
Revenue on software sales are recognized upon the signing of a
contract or receipt of a firm purchase order and the delivery and
acceptance of the software.
29
Retirement plans - The Company has a deferred income plan covering
----------------
substantially all of its employees. The plan provides that the Company may
make pension and employee deferred matching contributions for the benefit
of employees. The amount of any such contributions is at the discretion of
the Board of Directors. The total expense under the deferred income plan
was approximately $3,842,000, $3,694,000 and $3,911,000 in 1996, 1995 and
1994, respectively.
The Company has an unfunded defined benefit pension plan for directors
who are not employees of the Company. After termination as a director for
any reason, a director will receive the then-current directors' retainer
fee for the lesser of 15 years or life. Directors may also elect to
receive a lump sum or other actuarial equivalent of the foregoing benefit.
Directors achieve 50% vesting after five years of service, with annual
increases of 10%, until full vesting is achieved after 10 years of service.
However, in the event of a change in control, directors immediately become
fully vested. The total expense charged under the defined benefit pension
plan was approximately $50,000, $50,000 and $73,800 in 1996, 1995 and 1994,
respectively. The present value of the projected benefit obligation is
approximately $191,800 and $185,400 at June 30, 1996 and 1995,
respectively.
Income taxes - The provision for income taxes for fiscal years 1996
------------
and 1995 have been computed under the requirements of SFAS No. 109,
"Accounting for Income Taxes". The adoption of SFAS No. 109, effective
July 1, 1993, resulted in a cumulative effect adjustment to increase income
by $1 million for fiscal year 1994. SFAS No. 109 supersedes the Company's
previous accounting practice of accounting for income taxes under SFAS No.
96. Both statements require the use of the liability method of accounting
for income taxes, but the recognition of deferred tax assets was limited
under SFAS No. 96. Under SFAS No. 109, deferred tax assets and liabilities
are determined based on the difference between the financial statement and
the tax basis of assets and liabilities, using enacted tax rates in effect
for the year in which the differences are expected to reverse.
Earnings per share - Earnings per common share in 1995 and 1994 are
------------------
computed based upon the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Earnings per
common share in 1996 do not include common equivalent shares, as the effect
would be anti-dilutive. Dilutive common equivalent shares consist of stock
options calculated using the treasury stock method. Primary and fully
dilutive per share data, based on 9,172,000 shares in 1996, 9,393,000
shares in 1995 and 9,426,000 shares in 1994, respectively, is the same in
each year.
Use of estimates - The preparation of financial statements in
----------------
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amount
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
New accounting pronouncements - The Financial Accounting Standards
-----------------------------
Board has released SFAS Nos. 121 "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed of" and 123
"Accounting for Stock-Based Compensation". The Company plans to adopt the
provisions of these statements in fiscal year 1997, when required. The
Company has not completed the process of evaluating the impact that might
result from the adoption of these statements. The Company does not
30
plan to adopt the recognition provision of SFAS No. 123, but rather
continue to follow its current accounting practice.
Changes in presentation - Certain amounts in the 1995 and 1994
-----------------------
Consolidated Financial Statements have been reclassified to conform to the
1996 presentation.
(2) SALE OF REAL PROPERTY
In June 1995, the Company sold approximately 13.1 acres, including all
buildings, structures, parking areas and other improvements, located in
Santa Barbara, California for $4,300,000. The Company received 20% of the
proceeds in cash at closing and took back a promissory note, secured by a
Deed of Trust, for the remaining balance of approximately $3,400,000. The
note has a maturity of not more than 5 years, accrues interest at the rate
of 7% per annum, provides for the annual payment of both interest and
principal, and has a remaining balance of $2.0 million at June 30, 1996.
The Company has included the note in deposits and other. The transaction
resulted in the Company recognizing a gain of approximately $900,000 in
1995 from the sale.
In addition to the sale of the property, the Company entered into a 15
year lease for a portion of a new building that is scheduled to be built on
the existing property site.
(3) DEBT
Long -term debt at June 30, 1996 consists of the following (the
Company had no long-term debt at June 30, 1995):
1996
(in thousands)
Revolving credit agreement $ 5,425
Term loans 5,000
Equipment financing 7,346
Other 1,822
-------
Total long-term debt $19,593
Less current portion 1,823
-------
$ 17,770
========
Equipment Financing - In June 1996, the Company completed a $7.5
-------------------
million financing of substantially all of its furniture and equipment. The
loan is being amortized over a five year period at an interest rate of 9%.
At June 30, 1996, the Company had a revolving credit agreement with
its bank that provides for secured borrowings up to $22 million. The
agreement extends to January 1998, with the bank required to provide 15
months prior written notice to terminate the facility (absent any defaults
under the agreement). The bank has provided an additional $5 million
financing under term notes due September 1, 1998. Advances under the
agreement and the notes accrue interest at the bank's prime rate which was
8.25% as of June 30,
31
1996. The collateral under the Amended and Restated Revolving Credit and
Term Loan Agreement includes all of the Company's assets, except for
property and equipment.
The revolving credit agreement contains certain covenants, including a
material adverse change clause, which require the Company to maintain
certain minimums for earnings, tangible net worth working capital and debt
ratios. The Amended and Restated Revolving Credit and Term Loan Agreement
containing the term loan and the revolving line of credit was amended as of
March 31, 1996, and again as of June 30, 1996, to reduce various financial
ratio covenant levels so as to bring the Company into compliance with those
covenants as of those dates.
Other debt consists of the net present value of the Company's
obligation to Quintessential Solutions Inc. (QSI) incurred with the
acquisition of the rights to QSI's operating software. Payments of
$600,000 and $1,400,000 are due in November, 1996 and November, 1997
respectively.
Annual maturities for all long-term debt for the next five years are
as follows: 1997, $1,823,000; 1998, $8,028,000; 1999, $6,488,000; 2000,
$1,628,000; 2001, $1,626,000.
(4) INCOME TAXES
The differences between the tax provision calculated at the statutory
federal income tax rate and the actual tax provision for each year are as
follows:
1996 1995 1994
-------- -------- --------
(in thousands)
Tax (benefit) at statutory federal rate (5,997) $ 1,710 $ 2,180
State income taxes (698) --- 335
Utilization of loss carryforwards --- (1,100) (1,100)
Change in valuation reserve 6,659 (642) (1,150)
Other 36 32 34
------- ------- -------
Provision for income taxes $ --- $ --- $ 299
======= ======= =======
The primary components of temporary differences which give rise to the
Company's net deferred tax asset are as follows:
As of June 30,
-------------------------
1996 1995
-------- -------
(in thousands)
Deferred tax assets:
Reserves and other contingencies $ 1,887 $ 1,942
Compensation not currently deductible 2,159 2,061
Net operating loss 20,231 9,699
AMT and general business credits 1,178 1,178
Other 141 35
Valuation reserve (15,443) (5,796)
-------- -------
Total deferred tax assets 10,153 9,119
-------- -------
32
Deferred tax liabilities:
Reimbursable costs and fees (2,985) (3,600)
Prepaid expenses and rent (500) (406)
Depreciation (tax over book) (1,410) (982)
Internally developed software (4,258) (3,131)
-------
Total deferred tax liabilities (9,153) (8,119)
-------- -------
Net deferred tax asset $ 1,000 $ 1,000
======== =======
At June 30, 1996, the Company had net operating loss carryforwards of
approximately $53 million to reduce future federal tax liabilities of which
$23 million expire in 2006 and $30 million expire in 2011.
(5) COMMITMENTS AND CONTINGENCIES
Commitments - The Company leases all of its facilities and rents
-----------
certain equipment under lease agreements, some with inflation escalator
clauses. The minimum annual rentals due under non-cancelable leases during
each of the next five years and in total thereafter, are presented in the
table below.
Operating Leases
(in thousands)
1997 $ 6,789
1998 6,261
1999 6,042
2000 5,558
2001 5,018
2002 and thereafter 36,793
-------
$66,461
=======
Rent expense under operating leases was $6,643,000, $6,181,000 and
$6,716,000 net of sublease income of $477,000, $395,000 and $457,000, in
1996, 1995 and 1994, respectively.
The Company has employment agreements with 18 employees which provide
for severance payments, in the event of a change of control situation,
totaling approximately $2,810,000.
33
(6) ACCOUNTS RECEIVABLE AND UNBILLED REIMBURSABLE COSTS AND FEES
A summary of U.S. government and non-U.S. government accounts
receivable and unbilled reimbursable costs and fees is as follows:
1996 1995
-------- --------
(in thousands)
Accounts receivable, net of reserves of
$5 in 1996 and $16 in 1995 -
U.S. government $24,057 $30,252
Non-U.S. government 5,909 2,167
------- -------
$29,966 $32,419
======= =======
Unbilled reimbursable costs and fees,
net of reserves of $3,691 in 1996
and $3,821 in 1995 -
U.S. government $ 3,805 $ 5,615
Non-U.S. government 228 47
------- -------
$ 4,033 $ 5,662
======= =======
Invoices released in July that relate to June activity were $
9,863,000 and $11,536,000 for 1996 and 1995, respectively, and are
reflected in accounts receivable in the accompanying financial statements.
The components of unbilled reimbursable costs and fees are as follows:
1996 1995
------- -------
(in thousands)
Retainages billable upon completion of contract $1,989 $3,113
Indirect costs incurred in excess of provisional billing rates 146 273
Costs incurred in excess of contractual authorization,
billable upon execution of a contract or contractual
amendment to increase funding 1,898 2,276
------ ------
$4,033 $5,662
====== ======
At June 30, 1996, unbilled reimbursable costs and fees expected to be
collected after one year were approximately $ 1,882,000.
Costs incurred by the Company in the performance of U.S. government
contracts are subject to audit by the Defense Contract Audit Agency (DCAA).
In the opinion of management, the final settlement of these costs will not
result in significant adjustments to recorded amounts.
34
(7) RELATED PARTY TRANSACTIONS
Through December 31, 1995, one of the Company's directors was of
counsel to a law firm which serves as counsel for the Company. As of June
30, 1996, this director owns 21,356 shares and options to purchase 2,489
shares. In addition, the wife of this director holds 6,000 shares as
trustee of various trusts. Fees for legal services rendered by the law
firm to the Company aggregated $52,000, $83,000 and $25,000, in 1996, 1995
and 1994, respectively.
A former director who served until November 4, 1993 was a partner in a
law firm which served as counsel for the Company. Fees for legal services
rendered by this law firm to the Company aggregated $4,000 in 1994.
The chairman and chief executive officer of Mercantile Bankshares
Corporation (Mercantile) is a member of the Company's Board of Directors.
Mercantile has entered into a revolving credit agreement with the Company
(see Note 3 for discussion).
(8) STOCK OPTIONS
As of June 30, 1996, there are 251,378 shares of authorized but
unissued common stock reserved for issuance under the Company's 1985
Employee Stock Option Plan. The number of shares subject to option at that
date is 251,378. An option entitles the holder to purchase shares of the
Company's stock at the market price on the date of grant. As of June 30,
1996, options for 77,615 shares are exercisable. The following table
summarizes the option activity:
1985 Employee Stock Option
Shares Under Option
-------------------
Option Price
Number of Shares Per Share
---------------- -------------
Balance, June 30, 1993 694,691 2.75 6.50
Granted 164,500 6.50 - 11.25
Exercised (112,378) 2.75 5.88
Expired/Canceled (45,125) 3.13 7.31
--------
Balance, June 30, 1994 701,688 2.75 - 11.25
Granted 111,888 12.38 - 16.00
Exercised (161,795) 2.75 6.06
Expired/Canceled (17,188) 3.13 - 15.44
--------
Balance, June 30, 1995 634,593 3.00 - 16.00
Granted ---- ---
Exercised (373,215) 3.00 - 10.81
Expired/Canceled (10,000) 3.63 - 15.44
--------
Balance, June 30, 1996 251,378 3.13 - 16.00
========
35
As of June 30, 1996, there are 699,620 shares authorized but unissued
common stock reserved for issuance under the Company's 1994 Employee Stock
Option Plan. The number of shares subject to option at that date is
604,283. An option entitles the holder to purchase shares of the Company's
stock at the market price on the date of grant. As of June 30, 1996, there
are 88,671 options that are exercisable. The following table summarizes
the option activity:
1994 Employee Stock Option
Shares Under Option
-------------------
Option Price
Number of Shares Per Share
---------------- ----------------
Balance, June 30, 1994 0 N.A.
Granted 200,152 14.00 - 16.06
Exercised --- ---
Canceled (5,000) 15.44
-------
Balance, June 30, 1995 195,152 14.00 - 16.06
Granted 415,011 19.06 - 41.06
Exercised (380) 16.06 - 24.63
Canceled (5,500) 16.00 - 25.50
-------
Balance, June 30, 1996 604,283 14.00 - 41.06
=======
As of June 30, 1996, there are 89,349 shares of authorized but
unissued common stock reserved for issuance under the Company's Directors
Fee Replacement Plan. The number of shares subject to option at that date
is 29,623. Outside directors may elect to receive stock and/or non-
qualified options in lieu of annual fees and/or other compensation.
Options are immediately exercisable. Options remain exercisable for three
years after a participant ceases to be a director. As of June 30, 1996,
options for 29,623 shares are exercisable. A separate plan permits outside
directors to receive their fees in the form of phantom stock, but to date,
no phantom stock has been awarded. The table below summarizes the option
activity.
As of June 30, 1996, there are 430,433 shares of authorized but
unissued common stock reserved for issuance under the Company's Cash
Compensation Replacement Plan. The number of shares subject to option at
that date is 30,301. Participation in the Plan is limited to officers of
the Company. Under the Plan, participating officers forego cash
compensation (up to 25% of salary and up to 100% of bonus) to purchase non-
qualified options at a 20% discount. The options are immediately
exercisable as to 80% of the shares, with the remainder becoming
exercisable in increments over a four year period. Options remain
exercisable for three years after an officer's termination as an employee.
As of June 30, 1996, options for 24,491 shares are exercisable. The table
below summarizes the option activity.
36
Number of Shares Under Option
-----------------------------
Directors Option Cash Option
Fee Price Compensation Price
Replacement Per Replacement Per
Plan Share Plan Share
----------- ----------- ------------ -----------
Balance, June 30, 1993 35,438 .10 - 1.00 2,737 1.00
Granted 5,899 1.00 8,104 1.00
Exercised (4,452) .10 --- ---
------- ----------- ------ -----------
Balance, June 30, 1994 36,885 .10 - 1.00 10,841 1.00
Granted 7,649 3.05 - 3.77 11,283 3.05 - 3.77
Exercised (20,149) .10 - 1.00 (5,006) 1.00 - 3.77
------- ----------- ------ -----------
Balance, June 30, 1995 24,385 .10 - 3.77 17,118 1.00 - 3.77
Granted 5,238 5.67 - 9.43 17,744 5.67 - 9.43
Exercised --- --- (4,561) 1.00 - 8.57
------- ----------- ------ -----------
Balance, June 30, 1996 29,623 .10 - 9.43 30,301 1.00 - 9.43
======= =========== ====== ===========
In December 1994, the Company announced that it had completed the
previously authorized repurchase of 300,000 shares of its common stock, at
a cost of $3,845,000, and that its Board of directors authorized the
repurchase of up to 200,000 additional shares of its common stock in the
open market or in private transactions.
The timing and number of shares of the repurchase of the additional
200,000 shares of common stock will depend greatly on market conditions and
other factors. The shares will be purchased with existing cash, short-term
borrowings, future cash flows, or a combination of these factors, and may
be retired or used for general corporate purposes. As of June 30, 1995,
the Company has not purchased any additional shares under its repurchase
program.
The Company's current policy allows for the acceptance of mature
shares of the Company's stock at market value in lieu of cash for the
proceeds due upon exercise of the stock options and for tax withholdings
due from the employee. Furthermore, the Company accepts shares issuable
upon exercise at their fair market value in lieu of cash for the tax
withholdings. The shares received are retired and are reflected as
reductions in common stock and paid-in capital.
(9) ACQUISITION
In the second quarter of fiscal 1996, the Company acquired
substantially all of the assets of Quintessential Solutions, Inc. (QSI) for
a purchase price of approximately $3.9 million. The purchase price
consists of the initial cash payments of $2,190,000 and the net present
value of the deferred payments of $600,000 due November 1996 and $1,400,000
due November 1997. The purchase price was allocated primarily to software
development
37
cost. If the purchase had occurred at the beginning of fiscal 1996 or
fiscal 1995, there would have been no material impact on the Company's
results of operations.
(10) COMMON STOCK PURCHASE RIGHTS
The Company has a Shareholder Rights Plan under which a dividend of
one common stock purchase right (right) is automatically issued for each
share of the Company's common stock. The rights are not exercisable or
transferable apart from the common stock until ten business days after a
person has acquired beneficial ownership of 25% or more of the common
stock, or commences, or announces an intention to commence, a tender offer
for 25% or more of the common stock. Separate certificates for the rights
will be mailed to holders of the common stock as of such date, and each
right will entitle the holder thereof to buy one share of common stock at
an exercise price of $100. However, if any person or group becomes the
beneficial owner of 25% or more of the stock other than pursuant to an
offer for all shares which the independent Directors of the Company
determine is fair to and otherwise in the best interest of the Company and
its shareholders, each right not owned by such person or group will entitle
the holder to purchase, at the exercise price of the rights, that number of
shares of common stock of the Company (or other consideration) which would
have a market value of two times the exercise price of the right.
Similarly, in the event that the Company is a party to a merger or other
business combination transaction, each right will entitle the holder to
purchase, at the exercise price of the rights, that number of shares of
common stock of the acquiring company which would have a market value of
two times the exercise price of the right. The rights are redeemable at
$.05 per right prior to the tenth business day following the public
announcement that a person has acquired beneficial ownership of 25% of the
common stock. Upon redemption, the right to exercise the rights will
terminate. The rights expire on December 31, 2005.
(11) SEGMENT INFORMATION
The Company currently classifies its operations into three business
segments: (i) professional services, primarily providing support to the
U.S. government's Department of Defense; (ii) telecommunications products
and software comprising of the OSU, NetworkVUE, and custom software for the
telecommunications industry; and (iii) advanced products, which includes
manufacturing test products, security products and services, and
environmental software products. Information concerning the Company's
business segments in fiscal 1996, 1995, and 1994 is as follows:
Professional Telecommunications Advanced
Services Products & Services Products Corporate Consolidated
------------ -------------------- --------- ---------- -------------
Revenues
1996 $117,697 $ 2,009 $ 4,817 $ --- $124,523
1995 133,218 198 4,392 --- 137,808
1994 124,039 --- 5,883 --- 129,922
Operating income (loss)
1996 1,553 (16,329) (1,793) (550) (17,119)
1995 6,566 (824) (1,255) 273 4,760
1994 7,074 (148) (368) (465) 6,093
Identifiable assets
1996 44,204 17,155 3,062 9,680 74,101
38
1995 51,668 6,357 3,976 11,708 73,709
1994 52,183 989 3,875 12,033 69,080
Depreciation & amortization
1996 2,893 641 307 147 3,988
1995 2.521 125 396 143 3,185
1994 2,279 50 220 64 2,613
Capital expenditures and
software development costs
1996 3,266 18,076 1,233 288 22,863
1995 4,526 6,347 122 137 11,132
1994 3,013 989 608 171 4,781
SUPPLEMENTARY DATA
------------------
Quarterly Results of Operations
(Unaudited)
The following is a summary of the quarterly results of operations for
the years ended June 30, 1996 and 1995 (in thousands, except for per share
data):
1996
-----------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
-------- --------- --------- --------- ----------
Revenues $32,686 $28,268 $28,981 $ 34,588 $124,523
Operating income (loss) * 568 (235) (1,105) (16,347) (17,119)
Net Income (loss) 631 (318) (1,300) (16,650) (17,637)
------- ------- ------- -------- --------
Income (loss) per share $ 0.07 $( 0.03) $ (0.14) $ (1.80) $ (1,92)
======= ======= ======= ======== ========
1995
----------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
-------- -------- -------- -------- ---------
Revenues $31,494 $29,813 $35,688 $ 40,813 $137,808
Operating income ** 1,352 903 1,013 1,492 4,760
Net Income 1,507 930 1,107 1,486 5,030
------- ------- ------- -------- --------
Income per share $ .16 $ .10 $ .12 $ .16 $.54
======= ======= ======= ======== ========
* NOTE: Operating income for the fourth quarter of 1996 includes the
write-down of $15.4 million of software development and related costs.
** NOTE: Operating income for the fourth quarter of 1995 includes the gain
of approximately $.9 million from the sale of the Company's
California facility, as well as the write down of approximately $.5
million of software development costs.
39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
The information required by this item is hereby incorporated by
reference to the Proxy Statement (to be filed).
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The information required by this item is hereby incorporated by
reference to the Proxy Statement (to be filed).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information required by this item is hereby incorporated by
reference to the Proxy Statement (to be filed).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information required by this item is hereby incorporated by
reference to the Proxy Statement (to be filed).
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
----------------------------------------------------------------
(a) EXHIBITS
See "Index to Exhibits" hereinafter contained and
incorporated herein by reference.
(b) SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULE
The following financial information is filed herewith on the
pages indicated:
Schedule II - Valuation and Qualifying Accounts (Page 44)
(c) REPORTS ON FORM 8-K
None.
40
SIGNATURES
----------
Pursuant to the requirements of section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
GRC INTERNATIONAL INC.
Date: September 26, 1996 By: /s/ Jim Roth
------------------ -----------------------------
Jim Roth
President and Chief Executive
Office, and Director
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Ronald B. Alexander his attorney-in-
fact, with the power of substitution, for him in any and all capacities, to
sign any amendments to this Report, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities
and Exchange Commission, hereby ratifying and confirming all that said
attorney-in-fact, or his substitute or substitutes, may do or cause to be
done by virtue hereof.
Pursuant to the Securities and Exchange Act of 1934, this Report has
been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated:
Date: September 26, 1996 By: /s/ Jim Roth
------------------ -------------------------------
Jim Roth
President and Chief Executive
Officer, and Director
Date: September 26, 1996 By: /s/ Ronald B. Alexander
------------------ -------------------------------
Ronald B. Alexander
Senior Vice President-Finance,
Chief Financial Officer and
Treasurer
Date: September 26, 1996 By: /s/ H. Furlong Baldwin
------------------ -------------------------------
H. Furlong Baldwin, Director
Date: September 26, 1996 By: /s/ Leslie B. Disharoon
------------------ -------------------------------
Leslie B. Disharoon, Director
41
Date: September 26, 1996 By: /s/ Charles H.P. Duell
------------------ -------------------------------
Charles H.P. Duell, Director
Date: September 26, 1996 By: /s/ Edward C. Meyer
------------------ -------------------------------
Edward C. Meyer, Chairman
of the Board
Date: September 26, 1996 By: /s/ George R. Packard
------------------ -------------------------------
George R. Packard, Director
Date: September 26, 1996 By: /s/ Herbert Rabin
------------------ -------------------------------
Herbert Rabin, Director
Date: September 26, 1996 By: /s/ Harris W. Seed
------------------ -------------------------------
Harris W. Seed, Director
and Assistant Secretary
Date: September 26, 1996 By: /s/ E. Kirby Warren
------------------ -------------------------------
E. Kirby Warren, Director
Date: September 26, 1996 By: /s/Joseph R. Wright, Jr.
------------------ -------------------------------
Joseph R. Wright, Jr., Director
42
INDEPENDENT AUDITORS' CONSENT
-----------------------------
We consent to the incorporation by reference in Registration
Statements No's. 33-1046, 33-39512, 33-39513, 33-52536, 33-52538, 33-87981
and 33-87982 of GRC International, Inc. on Form S-8 of our report dated
August 20, 1996, appearing in this Annual Report on Form 10-K of GRC
International, Inc. for the year ended June 30, 1996.
DELOITTE & TOUCHE LLP
McLean, Virginia
September 27, 1996
43
GRC INTERNATIONAL, INC. AND SUBSIDIARIES
----------------------------------------
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
-----------------------------------------------
(in thousands)
Additions
--------------------------
Balance at Charged to Charged Deductions Balance
Beginning Costs and to Other from at End of
Description of Period Expenses Accounts /(A)/ Reserves /(B)/ Period
- - ----------- ---------- ---------- --------------- --------------- ---------
Year ended June 30, 1996
Reserves for uncollectible receivables -
Deducted from accounts receivable $ 16 $ 5 $ --- $ (16) $ 5
Deducted from unbilled reimbursable
costs and fees 3,821 496 455 (1,018) 3,691
------ ------ ----- ------- ------
$3,837 $ 501 $ 455 $(1,097) $3,696
====== ====== ===== ======= ======
Year ended June 30, 1995
Reserves for uncollectible receivables -
Deducted from accounts receivable $ 64 $ 3 $ --- $ (51) $ 16
Deducted from unbilled reimbursable
costs and fees 3,606 1,051 (197) (639) 3,821
------ ------ ----- ------- ------
$3,670 $1,054 $(197) $ (690) $3,837
====== ====== ===== ======= ======
Year ended June 30, 1994
Reserves for uncollectible receivables -
Deducted from accounts receivable $ 75 $ 3 $ --- (14) $ 64
Deducted from unbilled reimbursable
costs and fees 4,509 794 (6) (1,691) 3,606
------ ------ ----- ------- ------
$4,584 $ 797 $ (6) $(1,705) $3,670
====== ====== ===== ======= ======
/(A)/ Reductions of revenue for potentially nonrecoverable costs.
/(B)/ Write off of uncollectible accounts and cost against reserves,
net of recoveries.
44
INDEX TO EXHIBITS
(Exhibit Numbers correspond to Exhibit Table,
Regulation S-K, Item 601)
Exhibit
Number
- - ------
3.1 Restated Certificate of Incorporation (incorporated by reference to
Exhibit 3.1 to the 1994 Form 10-K)
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the 1995 Form
10-K)
10.1* 1985 Employee Stock Option Plan
10.2* 1994 Employee Option Plan
10.3* Officers Stock Option Plan
10.4* Cash Compensation Replacement Plan
10.5* Incentive Compensation Plan (incorporated by reference to Exhibit 10.7
to the 1995 Form 10-K)
10.6* Directors Fee Replacement Plan
10.7* Directors Phantom Stock Plan
10.8* Directors Retirement Plan
10.9 Amended and Restated Revolving Credit and Term Loan Agreement, with
Exhibits, with Mercantile-Safe Deposit & Trust Company, dated as of
February 12, 1996, First Confirmation and Amendment thereto dated May
15, 1996, Second Confirmation and Amendment thereto dated July 18,
1996, and Third Confirmation and Amendment thereto dated September 24,
1996
10.10 Lease Agreement dated as of June 30, 1989, with Exhibits, between the
Company and Centennial III Limited Partnership (incorporated by
reference to Exhibit 10.17 to the 1989 Form 10-K)
10.11 Lease Amendment No. 1, with Exhibits, to Lease between the Company and
Centennial III Limited Partnership (incorporated by reference to
Exhibit 10.6 to the 1990 Form 10-K)
10.12 Lease Amendments Nos. 2, 3, 4 and 5 to Lease between the Company and
Richmond Land Corporation (as successor to Centennial III Limited
Partnership) (incorporated by referenced to Exhibit 10.12 to the 1994
Form 10-K)
10.13 Lease Amendment No. 6 to Lease between the Company and Richmond Land
Corporation (as successor to Centennial III Limited Partnership)
(incorporated by referenced to Exhibit 10.13 to the 1995 Form 10-K)
10.14 Amended and Restated Rights Agreement dated June 30, 1995 between the
Company and the American Stock Transfer & Trust Company (incorporated
by referenced to Exhibit 10.14 to the 1995 Form 10-K)
10.15* Employment Agreement between the Company and Jim Roth
10.16* Note dated July 9, 1992, and Deed of Trust dated as of August 11,
1993, by and between the Company and Jim Roth (incorporated by
reference to Exhibit 10.15 to the 1994 Form 10-K)
10.17* Employment Agreement between the Company and Gary L. Denman
10.18* Employment Agreement between the Company and James P. McCoy
10.19* Employment Agreement between the Company and Thomas E. McCabe
10.20* Employment Agreement between the Company and Clifford C. Bream
10.21* Employment Agreement between the Company and Ronald B. Alexander
10.22 Purchase and Sale Agreement and Joint Escrow Instructions between
General Research Corporation and Bermant Development Company
(incorporated by reference to Exhibit 10.19 to the 1995 Form 10-K)
10.23 First Amendment to Purchase and Sale Agreement and Joint Escrow
Instructions between General Research Corporation and Bermant
Development Company (incorporated by reference to Exhibit 10.20 to the
1995 Form 10-K)
10.24 Building Lease between the Company and Bermant Development Company
(incorporated by reference to Exhibit 10.21 to the 1995 Form 10-K)
10.25 Interim Lease between the Company and Bermant Development Company
(incorporated by reference to Exhibit 10.22 to the 1995 Form 10-K)
10.26 Patent Application Assignment and Royalty Agreement dated as of
October 15, 1993, by and among the Company (as successor to SWL Inc.),
Robert E. Pfister and William D. Kight
11 Statement of Computation of Earnings Per Share
21 Subsidiaries of the Registrant
23 Consent of Deloitte & Touche LLP (included on Page 43 of Form 10-K)
24 Powers of Attorney (included as a part of signature pages)
27 Financial Data Schedule
*Indicates management contract or compensatory plan.