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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ________
Commission File No. 0-24015
STEELCLOUD, INC
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(Exact name of Registrant as specified in its charter)
VIRGINIA
--------------------------------------------------------------
(State or other jurisdiction of incorporation or organization)
54-1890464
------------------------------------
(I.R.S. Employer Identification No.)
1306 Squire Court, Dulles, VA. 20166
----------------------------------------- ----------
(Address of principal executive offices) (zip code)
(703) 450-0400
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(Registrant's telephone number, including area code)
(Former name or former address, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
------ ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
------
As of March 1, 2004 there were 12,953,570 shares of the registrant's common
stock outstanding.
SteelCloud, Inc.
Form 10-Q Index
For the Quarterly period ended January 31, 2004
DESCRIPITION PAGE
Part I. Financial Information 3
Item 1. Financial Statements
Consolidated Balance Sheets as of October 31, 2003 and
January 31, 2004 3
Consolidated Statements of Operations for the three month
periods ended January 31, 2003 and 2004 4
Consolidated Statements of Cash Flows for the three month
periods ended January 31, 2003 and 2004 5
Notes to the Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risks 13
Item 4. Controls and Procedures 13
Part II. Other Information 15
Item 1. Legal Proceedings 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 15
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STEELCLOUD, INC.
CONSOLIDATED BALANCE SHEET
OCTOBER 31, JANUARY 31,
2003 2004
------------ -----------
ASSETS (UNAUDITED)
Current assets
Cash and cash equivalents $ 8,098,221 $ 7,855,830
Accounts receivable, net of allowance for doubtful accounts of
$293,000 and $11,743 as of October 31, 2003 and January 31, 2004,
respectively 5,332,549 3,488,162
Inventory, net 2,880,944 3,350,463
Deferred tax asset 400,000 --
Income tax receivable 55,392 55,392
Prepaid expenses and other current assets 184,420 206,469
Deferred contract cost 7,053 721,546
------------ ------------
Total current assets 16,958,579 15,677,862
Property and equipment, net 477,111 422,546
Equipment on lease, net 335,935 278,482
Goodwill and other intangible assets, net 1,778,059 1,758,060
Deferred tax asset -- 400,000
Other assets 211,155 196,603
------------ ------------
Total assets $ 19,760,839 $ 18,733,553
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 3,202,195 $ 1,299,279
Accrued expenses 1,369,145 1,506,155
Notes payable, current 96,133 14,637
Unearned revenue 293,363 1,813,666
------------ ------------
Total current liabilities 4,960,836 4,633,737
Note payable, long-term 59,952 56,269
Other 6,415 --
------------ ------------
Total long-term liabilities 66,367 56,269
Stockholders' equity
Common stock, $.001 par value: 50,000,000 shares authorized,
13,008,553 and 13,353,570 shares issued and outstanding at October
31, 2003 and January 31, 2004 13,009 13,354
Additional paid in capital 47,307,036 48,222,699
Treasury stock, 400,000 shares at October 31, 2003 and January 31,
2004, respectively (3,432,500) (3,432,500)
Accumulated deficit (29,153,909) (30,760,006)
------------ ------------
Total stockholders' equity 14,733,636 14,043,547
------------ ------------
Total liabilities and stockholders' equity $ 19,760,839 $ 18,733,553
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
3
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
JANUARY 31,
2003 2004
------------ ------------
Revenues
Products $ 6,880,390 $ 3,295,312
Services 753,778 868,385
------------ ------------
Total revenues 7,634,168 4,163,697
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Cost of revenues
Products 5,523,403 2,802,087
Services 568,428 569,116
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Total cost of revenue 6,091,831 3,371,203
------------ ------------
Gross profit 1,542,337 792,494
Selling and marketing 298,724 470,285
General and administrative 1,128,728 1,791,106
Research and product development -- 150,444
------------ ------------
Income (loss) from continuing operations 114,885 (1,619,341)
Interest expense (income), net 5,840 (13,242)
------------ ------------
Net income (loss) from continuing operations 109,045 (1,606,099)
Loss from discontinued operations (29,501) --
------------ ------------
Net income (loss) $ 79,544 $ (1,606,099)
============ ============
Earnings (loss) per share (basic and diluted):
Earnings (loss) from continuing operations $ 0.01 $ (0.12)
Discontinued operations -- --
------------ ------------
Net earnings (loss) per share $ 0.01 $ (0.12)
============ ============
Weighted-average shares outstanding, basic 10,046,556 12,865,977
Weighted-average shares outstanding, diluted 10,412,839 12,865,977
The accompanying notes are an integral part of these consolidated statements.
4
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
JANUARY 31,
2003 2004
----------- -----------
OPERATING ACTIVITIES
Net income (loss) $ 79,544 $(1,606,099)
Loss from discontinued operations, net 29,501 --
----------- -----------
Net income (loss) from continuing operations 109,045 (1,606,099)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 93,986 176,691
Changes in operating assets and liabilities:
Accounts receivable 1,917,583 1,834,795
Inventory 708,574 (469,519)
Prepaid expenses and other assets (37,422) (24,322)
Deferred contract costs 90,016 (714,493)
Accounts payable (1,253,284) (1,876,493)
Accrued expenses 12,681 130,595
Unearned revenue and other liabilities (1,552,591) 1,520,303
----------- -----------
Net cash provided by (used in) operating activities 88,588 (1,028,542)
INVESTING ACTIVITIES
Purchase of property and equipment (23,372) (44,673)
FINANCING ACTIVITIES
Proceeds from exercise of warrants, net of expenses -- 718,714
Proceeds from exercise of common stock options 1,513 197,294
Payments on notes payable (158,421) (85,184)
----------- -----------
Net cash (used in) provided by financing activities (156,908) 830,824
Net (decrease) in cash and cash equivalents of continuing operations
(91,692) (242,391)
Net cash provided by operating activities of discontinued operations
233,256 --
Cash and cash equivalents at beginning of period 751,323 8,098,221
----------- -----------
Cash and cash equivalents at end of period $ 892,887 $ 7,855,830
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 8,073 $ 2,852
Income taxes paid $ -- $ --
The accompanying notes are an integral part of these consolidated financial
statements.
5
STEELCLOUD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Founded in 1987, SteelCloud, Inc, based in Dulles, Virginia, designs, develops
and manufactures customized computer servers and network appliances. The
Company's custom computer servers are designed to meet the precise needs of
volume customers to reduce the customer's investments in logistics, integration
capacity and support. SteelCloud's consulting services organization provides
clients with tchnical services, including network analysis, security, design,
troubleshooting and implementation. The Company is also a value-added reseller
for the software products of its strategic partners and certain other software
providers.
The consolidated financial statements for the three month periods ended January
31, 2004 and 2003 are unaudited and include all adjustments which, in the
opinion of management, are necessary to present fairly the results of operations
for the periods then ended. All such adjustments are of a normal and recurring
nature. These consolidated financial statements should be read in conjunction
with the Annual Report on Form 10-K of SteelCloud, Inc. (the "Company") which
includes consolidated financial statements and notes thereto for the years ended
October 31, 2003 and 2002.
2. DISCONTINUED OPERATIONS
The Company continually evaluates its operating facilities with regard to its
long-term strategic goals established by management and the Board of Directors.
Operating facilities, which are not expected to contribute to the Company's
future operations are either closed or sold. In fiscal 2002, management, with
the approval of the Board of Directors, adopted a plan to dispose of the Puerto
Rico Industrial Manufacturing Operation Acquisition, Corp ("PRIMOA"). The plan
was completed in fiscal 2003 whereby the remaining assets were sold and
remaining warranty liabilities and obligations were contracted to a local
service provider. The Company believes that there will be no additional costs
incurred related to this operation.
The loss associated with the discontinued operation for the three months ending
January 31, 2003 and 2004 was approximately $29,500 and $0, respectively.
Revenues amounted to $920 and $0 in the three months ended January 31, 2003 and
2004, respectively.
3. SUBSEQUENT EVENTS
On February 17, 2004, the Company purchased the assets of Asgard Holding, LLC
(Asgard), an internet security product and service company. In exchange for the
assets of Asgard Holding, LLC, which include intellectual property and
patent-pending technology, the Company paid approximately $630,000 and issued
575,000 shares of SteelCloud common stock valued at approximately $2.3 million.
In addition, the Company assumed approximately $170,000 of Asgard's debt. This
acquisition will be accounted for as a purchase and as such, operations of the
acquired business will be included in the Company's financial statements
prospectively from the acquisition date. The Company is in the process of
completing its purchase price allocation and expects to complete its analysis in
the second quarter of fiscal 2004.
4. DEBT
On January 22, 2004, the Company amended its bank line of credit that allows the
Company to borrow an amount to the lesser of its collateralized cash on hand or
$3.5 million. The line of credit bears interest at the LIBOR Market Index rate
plus 1.25%. The line of credit is secured by all assets of the Company and
expires on March 31, 2005. There were no outstanding borrowings on the line of
credit at October 31, 2003 and January 31, 2004.
6
On April 1, 2002, the Company executed a two-year promissory note in conjunction
with a litigation settlement for approximately $240,000. The promissory note
bears interest at the prime rate and matures in May 2004. The Company makes
monthly payments of $10,000 plus accrued interest. In December 2003, the Company
paid the debt thereby extinguishing its obligations under this note. The
outstanding balance on the note at October 31, 2003 and January 31, 2004 was
approximately $60,000 and $0, respectively.
5. CONTRACT REVENUE
For the three months ended January 31, 2004, the Company's deferred contract
revenue of approximately $1.6 million related to Lockheed Martin server
appliance contracts which were awarded in February of 2003. The deferred revenue
represents payments received for milestones achieved. This revenue will be
recognized over the remaining life of the contracts as units are shipped under
the contracts, which are scheduled for completion in December of 2004.
6. EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period and is calculated by dividing the net
earnings (loss) available to common shareholders by the weighted average number
of common shares outstanding. Diluted earnings per share is based on the
weighted average number of common shares outstanding plus common stock
equivalents associated with stock options and warrants and is calculated by
dividing net earnings (loss) available to common shareholders by the weighted
average number of common shares outstanding used in the basic earnings per share
calculation plus the common stock equivalent of stock options and warrants. For
the three months ended January 31, 2004, the Company's common stock equivalent
shares outstanding from stock options and warrants of 1,130,800 have been
excluded from the diluted earnings per share calculation as their effect is
antidilutive.
7. EMPLOYEE STOCK OPTIONS
The Company accounts for employee stock option grants using the intrinsic method
in accordance with Accounting Principles Board (APB) Opinion No. 25 "Accounting
for Stock Issued to Employees" and accordingly associated compensation expense,
if any, is measured as the excess of the underlying stock price over the
exercise price on the date of grant. The Company complies with the disclosure
option of Statement of Financial Accounting Standards (SFAS) No. 123 "Accounting
for Stock Based Compensation", as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation--Transition and Disclosure" which requires pro-forma
disclosure of compensation expense associated with stock options under the fair
value method.
The Company's pro forma information follows:
THREE MONTHS ENDED
JANUARY 31,
2003 2004
------------- --------------
Net earnings (loss), as reported .................... $ 79,544 $ (1,606,099)
Less: Total stock based employee compensation expense
determined under the fair-value based method ........ 121,641 87,662
------------- --------------
Pro-Forma net (loss) ................................ (42,097) (1,693,761)
============= ==============
Basic earnings (loss) per share as reported ......... 0.01 (0.13)
============= ==============
Basic pro-forma net (loss) per share .............. (0.01) (0.13)
============= ==============
Diluted earnings (loss) per share as reported ....... 0.01 (0.13)
============= ==============
Diluted pro-forma net (loss) per share .............. (0.01) (0.13)
============= ==============
7
8. SEGMENT REPORTING
FASB Statement No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, establishes standards for reporting information about operating
segments. Operating segments are defined as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The Company's chief operating
decision maker is the Company's Chief Operating Officer. While the Chief
Operating Officer is apprised of a variety of financial metrics and information,
the Chief Operating Officer makes decisions regarding how to allocate resources
and assess performance based on a single Operating Unit.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained herein may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Because such statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, risks associated with the integration of
businesses following an acquisition, competitors with broader product lines and
greater resources, emergence into new markets, the termination of any of the
Company's significant contracts, the Company's inability to maintain working
capital requirements to fund future operations or the Company's inability to
attract and retain highly qualified management, technical and sales personnel.
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto included in Item 1 in this Quarterly
Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 filed by the Company with the Securities and Exchange
Commission.
OVERVIEW
Founded in 1987, SteelCloud, Inc, based in Dulles, Virginia, designs, develops
and manufactures customized computer servers and network appliances. The
Company's custom computer servers are designed to meet the precise needs of
volume customers to reduce the customer's investments in logistics, integration
capacity and support. The Company's network security appliances are developed in
collaboration with some of the world's premiere software companies. In addition,
the Company develops proprietary software to optimize the performance of its
security appliances. The Company's appliances are specially designed and
optimized to deliver a dedicated network service such as antivirus gateway
protection, intrusion detection and secure content management.
In fiscal 2003, SteelCloud began focusing its efforts on the network security
marketplace and on the creation of additional SteelCloud intellectual property.
The Company has created its own family of hardened (highly secured) appliances
to be delivered as co-branded appliances with its software partners. With its
strategic partners, SteelCloud creates and uniquely brands ready-to-use turnkey
network server appliance solutions combining both hardware and software. The
Company integrates its own, its partner's, or other third-party software, into a
custom designed server platform. The Company manufactures the resulting product
either under a co-branded name or its partner's brand name allowing the partner
to deliver a complete turnkey solution. The Company enhances its product
development and manufacturing capability by providing custom supply chain and
logistics support services to its partners.
To extend its network security offerings, the Company acquired the assets of
Asgard Holding, LLC in February 2004 through the payment of $630,000 in cash,
the issuance of 575,000 shares of common stock and assumption of debt totaling
approximately $170,000. Management believes that with the addition of Asgard,
the Company will be in a position to define and control proprietary product
features, services and positioning resulting from its own intellectual property.
With this purchase, the Company has also acquired the technical knowledgebase
and resources to design and develop proprietary products. The Company
anticipates that its new product offerings will be available mid to late
calendar year 2004.
SteelCloud's consulting services organization provides clients with a seamless
extension of their own IT organizations. Expert technical services include
network analysis, security, design, troubleshooting and implementation. The
Company provides Information Technology (IT) support services to the public
sector as well as commercial customers. The Company is also a value-added
reseller for the software products of its strategic partners and certain other
software providers.
9
The following summarizes significant activity for the three-month period ended
January 31, 2004.
CRITICAL ACCOUNTING POLICIES
The Company believes the following represent its critical accounting policies:
SIGNIFICANT CUSTOMER CONTRACT
In February 2003, the Company was awarded several contracts by Lockheed Martin
valued at more than $2.7 million for customized servers. The Company commenced
work under the contracts in February 2003, and is expected to complete the
contracts by December 2004. During the three months ended January 31, 2004, the
Company recognized revenue of approximately $749,000 (or approximately 18% of
total net revenues) from the contract awards and has deferred contract revenue
and deferred contract costs of approximately $1.6 million and $701,000,
respectively that will be recognized over the life of the contracts as units are
shipped. Given the nature of the products manufactured by the Company as well as
the delivery schedules established by its partners, revenue and accounts
receivable concentration by any single customer will fluctuate from quarter to
quarter. The Company anticipates that concentration in this specific customer
will begin to decrease as the Company expands its customer base as a result of
sales of its security appliances. Future revenues and results of operations
could be adversely affected should this customer reduce its purchases, eliminate
product lines or choose not to continue to buy products and services from
SteelCloud.
REVENUE RECOGNITION
The Company recognizes revenue in accordance with Staff Accounting Bulletin No,
101, "Revenue Recognition in Financial Statements" (SAB101) as amended by SAB
101A and 101B. SAB 101 requires that four basic criteria be met before revenue
can be recognized: (1) persuasive evidence of an arrangement exists; (2)
delivery has occurred or services rendered; (3) the fee is fixed and
determinable; and (4) collectibility is reasonably assured.
The Company derives its revenue from the following sources: Product revenue,
information technology support services, software license as a reseller and
support revenue and software training and customization revenue assoicated with
software license reselling activity.
For product sales the Company generally recognizes revenue at the time of
shipment when both title and risk of loss transfers to the customer. For
technology support services under time and material contracts, the Company
recognizes revenue as services are provided. Revenue from hardware leased to
customers under operating lease arrangements is recognized over the contract
term. When product and installation services that are not essential to the
functionality of the product are sold as part of a bundled agreement, the fair
value of the installation services, based on the price charged for the services
when sold separately, is deferred and recognized when the services are
performed. The products sold are generally covered by a warranty for periods
ranging from one to three years. The Company accrues an estimated warranty
reserve in the period of sale to provide for estimated costs to provide warranty
services.
The Company is a value-added reseller for certain software products. When resold
software licenses, and related maintenance, customization and training services
are all provided together to an individual customer, the Company recognizes
revenue for the arrangement after the Company has delivered the software license
and the customer has approved all customization and training services provided.
In instances were the Company only resells the software license and maintenance
to the customer, the Company recognizes revenue after the customer has
acknowledged and accepted delivery of the software. The software manufacturer is
responsible for providing software maintenance. Accordingly, revenue from
maintenance contracts is recognized upon delivery or acceptance, as the Company
has no future obligation to provide the maintenance services and no right of
return exists.
The Company incurs shipping and handling costs, which are recorded in cost of
revenues.
10
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JANUARY 31, 2004 COMPARED TO THE THREE MONTHS ENDED
JANUARY 31, 2003
Product revenues decreased to $3,295,312 for the three months ended January 31,
2004 from $6,880,390 for the same period in fiscal 2003, a decrease of
approximately 52%. The decrease is primarily attributable to delays in the
availability of software for the Company's security appliances, lower than
expected distribution sales through newly acquired channel partners, and delays
in the issuance of a contract from a major integrator. As a result, the Company
has approximately $1.8 million in deferred revenue as of January 31, 2004 which
will be recognized in future periods as units are shipped. Service revenues
increased to $868,385 for the three months ended January 31, 2004 from $753,778
for the same period in fiscal 2003, an increase of approximately 15%. The
increase is attributable to growth in demand for the Company's consulting
services. The increase in revenue and demand for the Company's consulting
services is the result of continuing efforts to leverage existing customer
relationships, bundle our product lines with complementary services and invest
in additional resources.
Gross margin, as a percentage of net revenues, decreased to 19.0% for the three
months ended January 31, 2004 from 20.2% for the same period in fiscal 2003.
This was primarily the result of product gross margins, which decreased to 14.9%
from 19.7%, or approximately 4.8%, from the same period in the prior fiscal
year. The product revenue shortfall significantly contributed to the overall
decline in gross margins as reseller revenue represented a higher percentage of
total product revenues. Gross margin realized on reseller revenue is lower
relative to the Company's other product offerings. The Company anticipates gross
margins will increase in future periods as its appliance products are released
to market. Although product margins declined, consulting services gross margins,
as a percentage of service revenues increased to 34.5% from 24.6%, or
approximately 9.9% from the same period during fiscal 2003. The increase in
gross margin from service revenue is principally the result of improved
utilization of the Company's consulting service resources. Growth in consulting
service demand and backlog has enhanced management's ability to match consulting
demand with consulting resources immediately following resource availability.
Sales and marketing expenses increased to $470,285 for the three months ended
January 31, 2004 from $298,724 for the same period in fiscal 2003. The $171,561
or 57% increase is primarily attributable to an increase in sales and marketing
efforts for the Company's new security appliances as well as its services.
General and administrative expenses increased to $1,791,106 for the three months
ended January 31, 2004 from $1,128,728 for the same period in fiscal 2003, an
increase of approximately $662,000 or 59%. Approximately $340,000 of the
increase relates to personnel cost increases in operations, customer service,
administration, and contractor services. While the Company continues to manage
its costs relative to its revenues and gross margins, increases in personnel
costs and contractor services were necessary to support the Company's ongoing
efforts to acquire intellectual property and to develop and manufacture its
security appliances. The Company incurred increased professional services,
insurance and depreciation costs of approximately $185,000. In addition, the
Company incurred approximately $85,000 in non-recurring professional services
related to analysis associated with amending the Company's Net Operating Loss
carryforward.
Research and product development expenses increased to $150,444 for the three
months ended January 31, 2004 from $0 for the same period in fiscal 2003. The
increase is attributable to the Company's ongoing efforts to develop
intellectual property and its own network security products. Research and
product development efforts commenced in the second quarter of fiscal 2003 and
the Company anticipates the costs will continue in future quarters as new
products are brought to market.
Interest expense decreased to $2,809 for the three months ended January 31, 2004
from $6,587 for the same period in fiscal 2003. Interest income increased to
$16,094 for the three months ended January 31, 2004 from $748 for the the same
period in fiscal 2003. The increase in interest income, net of interest expense,
is the direct result of the Company's reduction in its outstanding debt and
increase in cash during the three months ended January 31, 2004 as compared to
the same period in fiscal 2003.
11
The Company reported a net loss of $1,606,099 for the three months ended January
31, 2004, as compared to net income of $79,544 for the same period in fiscal
2003. The decrease of $1,685,643 is primarily the result of the Company's
increased costs associated with its efforts to acquire and develop intellectual
property and to produce, manufacture, and market its network security products.
Anticipated product revenue associated with the Company's efforts to produce,
manufacture, and market its network security appliances was not realized due to
delays in the availability of software for the Company's co-branded security
appliances. The decrease in net income is also related to product revenue
shortfalls attributable to lower than expected distribution sales through newly
acquired channel partners and a contract from a major integrator which was
delayed.
LIQUIDITY AND CAPITAL RESOURCES
As of January 31, 2004, the Company had cash and cash equivalents of $7,855,830
and working capital of $11,044,125. The Company believes cash on hand together
with cash generated from operations will provide sufficient financial resources
to finance current operations of the Company through fiscal 2004.
For the three months ended January 31, 2004, the Company used $1,028,542 in cash
flow from continuing operations. The Company generated cash from the collection
of its accounts receivables of $1,834,795, and an increase in unearned revenue
and other liabilities of $1,520,303. The cash generated was primarily used to
pay down accounts payable of $1,876,493. In addition, the Company experienced an
increase in deferred contract costs of $714,493.
For the three months ended January 31, 2004, the Company's investing activities
consisted of the purchase of $44,673 for property and equipment. Cash provided
by the Company's financing activities resulted primarily from proceeds received
in connection with the exercise of warrants and options to purchase the
Company's common stock. Proceeds from the exercise of warrants and common stock
options generated approximately $916,008. The Company did not rely on its bank
line of credit for the three months ended January 31, 2004.
On January 22, 2004, the Company modified its bank line of credit that allows
the Company to borrow an amount to the lesser of its collateralized cash on hand
or $3.5 million. The line of credit bears interest at the LIBOR Market Index
rate plus 1.25%. The line of credit is secured by all assets of the Company. As
of January 31, 2004, there were no outstanding borrowings on the line of credit.
The line of credit expires on March 31, 2005.
From time to time, the Company may pursue strategic acquisitions or mergers,
which may require significant additional capital, and additional capital may be
required to satisfy unusual or infrequent expenses. In such event, the Company
may seek additional financing of debt and/or equity.
Contractual Obligations and Commercial Commitments:
The Company's significant contractual obligations as of January 31, 2004 are for
debt and operating leases. Debt by year of maturity and future rental payments
under operating lease agreements are presented below. The Company does not have
any purchase obligations as of January 31, 2004. The Company has not engaged in
off-balance sheet financing, commodity contract trading or significant related
party transactions.
- ----------------------------------- --------------------------------------------------------------------
Contractual Obligations Payments Due by Period
- ----------------------------------- --------------------------------------------------------------------
Less than 1 After 5
Total year 1-3 years 4-5 years years
- ----------------------------------- --------------- -------------- -------------- ----------- ----------
Notes Payable - Current $ 14,637 $ 14,637 -- -- --
- ----------------------------------- --------------- -------------- -------------- ----------- ----------
Long Term Debt $ 56,269 -- 45,418 10,851 --
- ----------------------------------- --------------- -------------- -------------- ----------- ----------
Operating Lease $ 366,216 $ 366,216 -- -- --
- ----------------------------------- --------------- -------------- -------------- ----------- ----------
Management believes that these commitments will be satisfied with current
operating cash flow.
12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk related to fluctuations in interest rates
on its debt. Increase in prevailing interest rates could increase the Company's
interest payment obligations relating to variable rate debt. For example, a 100
basis point increase in interest rates would increase annual interest expense by
$35,000.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of SteelCloud's Disclosure Controls and Internal Controls
SteelCloud evaluated the effectiveness of the design and operation of its
disclosure controls and procedures, or "Disclosure Controls," as of the end of
the period covered by this quarterly report on Form 10-Q. This evaluation, or
"Controls Evaluation" was performed under the supervision and with the
participation of management, including our Chairman of the Board, Chief
Executive Officer and Director ("CEO") and our Chief Financial Officer ("CFO").
CEO and CFO Certifications
The certifications of the CEO and the CFO required by Rule 13a-15(e) of the
Securities Exchange Act of 1934, or the "Rule 13a-15(e) Certifications" are
filed as Exhibit 31 of this quarterly report on Form 10-Q. This Controls and
Procedures section of the quarterly report includes the information concerning
the Controls Evaluation referred to in the Rule 13a-15(e) Certifications and it
should be read in conjunction with the Rule 13a-15(e) Certifications for a more
complete understanding of the topics presented.
Disclosure Controls and Internal Control over Financial Reporting
Disclosure Controls are controls and other procedures designed to ensure that
information required to be disclosed in our reports filed under the Exchange
Act, such as this quarterly report, is recorded, processed, summarized and
reported within the time periods specified in the U.S. Securities and Exchange
Commission's rules and forms. Disclosure Controls include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Exchange Act is accumulated and
communicated to our management, including our CEO and CFO, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure.
Internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles and includes those policies and
procedures that (1) pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect the transactions and dispositions of our
assets; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that our receipts and expenditures
are being made only in accordance with authorizations of our management and
directors; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the financial statements.
Limitations on the Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our Disclosure
Controls or our internal controls will prevent all error and all fraud. A
control system, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that the control system's objectives will be
met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within SteelCloud have been
detected. These inherent limitations include the realities that judgments in
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decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions or deterioration in the degree of compliance with associated
policies or procedures. Because of the inherent limitations in a cost-effective
control system, misstatements due to error or fraud may occur and not be
detected.
Conclusions
Based upon the Controls Evaluation, our CEO and CFO have concluded that, subject
to the limitations noted above, our Disclosure Controls are effective to ensure
that material information relating to SteelCloud is made known to management,
including the CEO and CFO, particularly during the period when our periodic
reports are being prepared.
During the period covered by this quarterly report on Form 10-Q, there were no
changes in our internal control over financial reporting that have materially
affected or are reasonably likely to materially affect our internal control over
financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are routine legal claims pending against the Company, that occur in the
ordinary course of business but in the opinion of management, liabilities, if
any, arising from such claims will not have a material adverse effect on the
financial condition and results of operation of the Company.
Other than the items previously disclosed, we are not a party in any other
material legal proceedings.
ITEM 5. OTHER INFORMATION
On February 17, 2004, the Company acquired all of the assets of Asgard Holding,
LLC. In exchange for all of the assets of Asgard, which include intellectual
property and patent-pending technology, the Company paid approximately $630,000
in cash, issued 575,000 shares of its common stock and assumed approximately
$170,000 in debt. In connection with the acquisition of Asgard's assets, the
Company acquired Asgard's proprietary SecureNet(TM) products and associated
managed services that are already installed and operational with multiple
customers in both domestic and international market places.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1: Statement of computation of earnings per share.
Exhibit 31. Rule 13a-14(a)/15d-14(a) Certifications.
Exhibit 32.1 Certification by the Chief Executive Officer Relating to a Periodic
Report Containing Financial Statements.* Exhibit 32.2 Certification by the Chief
Financial Officer Relating to a Periodic Report Containing Financial
Statements.*
(b) Reports on Form 8-K
On January 22, 2004, the Company filed a report on Form 8-K pursuant to Item 7
"Financial Statements and Exhibits", Item 9 "Regulation FD Disclosure" and Item
12 "Results of Operations and Financial Condition".
* The Exhibit attached to this Form 10-Q shall not be deemed "filed" for
purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange
Act") or otherwise subject to liability under that section, nor shall it be
deemed incorporated by reference in any filing under the Securities Act of 1933,
as amended, or the Exchange Act, except as expressly set forth by specific
reference in such filing.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
March 12, 2004 STEELCLOUD, INC.
By: /S/ THOMAS P. DUNNE
-------------------------------
Name: Thomas P. Dunne
Title: Chief Executive Officer
By: /S/ KEVIN MURPHY
-------------------------------
Name: Kevin Murphy
Title: Chief Financial Officer
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