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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, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ________
Commission File No. 0-24015
STEELCLOUD, INC
(Exact name of registrant as specified in its charter)
VIRGINIA_ 54-1890464
(State or other jurisdiction of incorporation or
(I.R.S. Employer Identification No.)
organization)
1306 Squire Court, Dulles, VA 20166
(Address of principal executive offices) (Zip code)
(703) 450-0400
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- --
Indicate 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 9, 2005 there were 13,854,139 shares of the registrant's common
stock outstanding.
SteelCloud, Inc.
Form 10-Q Index
For the Quarterly period ended January 31, 2005
Description Page
- ----------- ----
Part I. Financial Information
Item 1. Financial Statements 3
Consolidated Balance Sheets as of October 31, 2004 and
January 31, 2005 3
Consolidated Statements of Operations for the three month
periods ended January 31, 2004 and 2005 4
Consolidated Statements of Cash Flows for the three
month periods ended January 31, 2004 and 2005 5
Consolidated Statements of Stockholders' Equity for the three
month periods ended January 31, 2004 and 2005 6
Notes to the Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risks 16
Item 4. Controls and Procedures 16
Part II. Other Information_ 18
Item 1. Legal Proceedings_ 18
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 19
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STEELCLOUD, INC.
CONSOLIDATED BALANCE SHEET
OCTOBER 31, JANUARY 31,
2004 2005
----------------- -----------------
ASSETS (UNAUDITED)
Current assets
Cash and cash equivalents $3,108,941 $5,314,979
Accounts receivable, net of allowance for doubtful accounts of
$86,027 and $16,754 as of October 31, 2004 and January 31, 2005,
respectively 9,532,770 5,756,067
Inventory, net 3,629,685 5,236,597
Prepaid expenses and other current assets 307,427 230,119
Deferred contract cost 40,085 633,752
----------------- -----------------
Total current assets 16,618,908 17,171,514
Property and equipment, net 454,928 502,708
Equipment on lease, net 373,590 311,765
Goodwill and other intangible assets, net 4,687,105 4,658,327
Deferred tax asset 400,000 400,000
Other assets 196,244 237,203
----------------- -----------------
Total assets $22,730,775 $23,281,517
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $4,866,079 $3,769,307
Accrued expenses 1,441,350 1,691,485
Notes payable, current 71,176 70,879
Unearned revenue 373,017 1,348,583
----------------- -----------------
Total current liabilities 6,751,622 6,880,254
Notes payable, long-term 120,660 102,752
Other 20,083 19,550
----------------- -----------------
Total long-term liabilities 140,743 122,302
Stockholders' equity
Preferred stock, $.001 par value: 2,000,000 shares authorized, 0
shares issued and outstanding at October 31, 2004 and January 31,
2005 - -
Common stock, $.001 par value: 50,000,000 shares authorized,
14,213,514 and 14,244,514 shares issued at October 31, 2004 and
January 31, 2005, respectively 14,214 14,245
Additional paid in capital 50,934,453 50,960,180
Treasury stock, 400,000 shares at October 31, 2004 and January 31,
2005, respectively (3,432,500) (3,432,500)
Accumulated deficit (31,677,757) (31,262,964)
----------------- -----------------
Total stockholders' equity 15,838,410 16,278,961
----------------- -----------------
Total liabilities and stockholders' equity $22,730,775 $23,281,517
================= =================
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,
2004 2005
--------------------- ------------------
Revenues
Products $3,295,312 $8,223,458
Services 868,385 840,135
--------------------- ------------------
Total revenues 4,163,697 9,063,593
--------------------- ------------------
Cost of revenues
Products 2,802,087 5,934,618
Services 569,116 591,302
--------------------- ------------------
Total cost of revenue 3,371,203 6,525,920
--------------------- ------------------
Gross profit 792,494 2,537,673
Selling and marketing 470,285 441,985
General and administrative 1,791,106 1,446,344
Research and product development 150,444 213,482
Amortization of other intangible assets - 28,778
--------------------- ------------------
Income (loss) from operations (1,619,341) 407,084
Interest income (expense), net 13,242 7,709
--------------------- ------------------
Net income (loss) $(1,606,099) $414,793
===================== ==================
Earnings (loss) per share (basic and diluted):
Net basic and diluted (loss) earnings per share $ (0.12) $ 0.03
Weighted-average shares outstanding, basic 12,865,977 13,835,870
Weighted-average shares outstanding, diluted 12,865,977 14,389,234
The accompanying notes are an integral part of these consolidated financial
statements.
4
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
JANUARY 31,
2004 2005
---------------------------------------
OPERATING ACTIVITIES
Net income (loss) $(1,606,099) $414,793
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 176,691 197,612
Changes in operating assets and liabilities:
Accounts receivable 1,834,795 3,776,703
Inventory (469,519) (1,606,912)
Prepaid expenses and other assets (24,322) 36,350
Deferred contract costs (714,493) (593,667)
Accounts payable (1,876,493) (1,096,772)
Accrued expenses 130,595 243,669
Unearned revenue and other liabilities 1,520,303 981,499
---------------------------------------
Net cash (used in) provided by operating activities (1,028,542) 2,353,275
INVESTING ACTIVITIES
Purchase of property and equipment (44,673) (154,789)
FINANCING ACTIVITIES
Proceeds from exercise of warrants, net of expenses 718,714 -
Proceeds from exercise of common stock options 197,294 25,757
Payments on notes payable (85,184) (18,205)
-------- --------
Net cash provided by financing activities 830,824 7,552
Net (decrease) increase in cash and cash equivalents (242,391) 2,206,038
Cash and cash equivalents at beginning of period 8,098,221 3,108,941
---------------------------------------
Cash and cash equivalents at end of period $7,855,830 $5,314,979
=======================================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $2,852 $1,557
Income taxes paid $- $-
The accompanying notes are an integral part of these consolidated financial
statements.
5
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ADDITIONAL RETAINED
PREFERRED STOCK COMMON STOCK PAID-IN TREASURY EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK (ACCUMULATED TOTAL
DEFICIT)
-------------------------------------------------------------------------------------------
BALANCE AT NOVEMBER 1, 2003 - - 13,008,553 $13,009 $47,307,036 $(3,432,500)$(29,153,909) $14,733,636
-------------------------------------------------------------------------------------------
Issuance of common stock
in connection with
exercise of employee
incentive stock option
plan...................... - - 344,250 344 915,663 - - 916,007
Net loss.................. - - - - - - (1,606,099) (1,606,099)
-------------------------------------------------------------------------------------------
BALANCE AT JANUARY 31, 2004 13,352,803 $13,353 $48,622,699 $(3,432,500)$(30,760,008) $14,043,544
===========================================================================================
-------------------------------------------------------------------------------------------
BALANCE AT NOVEMBER 1, 2004 - - 14,213,514 $14,214 $50,934,453 $(3,432,500)$(31,677,757) 15,838,410
-------------------------------------------------------------------------------------------
Issuance of common stock
in connection with
exercise of employee
incentive stock option
plan....................... - - 31,000 31 25,727 - - 25,758
Net income................. - - - - - - 414,793 414,793
-------------------------------------------------------------------------------------------
BALANCE AT JANUARY 31, - - 14,244,514 $14,245 $50,960,180 $(3,432,500)$(31,262,964) $16,278,961
2005
===========================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
6
STEELCLOUD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Founded in 1987, SteelCloud, Inc, ("the Company") 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 technical 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, 2005 and 2004 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 the Company, which includes consolidated
financial statements and notes thereto for the years ended October 31, 2004 and
2003.
2. 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", and 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,
2004 2005
--------------- --------------
Net earnings (loss) earnings, as reported................ $ (1,606,099) $ 414,793
Less: Total stock based employee compensation expense
determined under the fair-value based method.. 87,662 349,651
--------------- --------------
Pro-Forma net (loss) income.............................. (1,693,761) 65,142
=============== ==============
Basic earnings (loss) earnings per share as
reported................................................. (0.12) 0.03
=============== ==============
Basic pro-forma net (loss) income per share (0.12) 0.01
=============== ==============
Diluted earnings (loss) earnings per share as
reported................................................. (0.12) 0.03
=============== ==============
Diluted pro-forma net (loss) earnings per (0.12) 0.01
share....................................................
=============== ==============
7
3. ACQUISITION
On February 17, 2004, the Company completed its acquisition of the assets of
Asgard Holding LLC ("Asgard"), an internet security product and service company.
In exchange for the assets of Asgard, which included intellectual property and
patent-pending technology, the Company paid cash of $630,015, issued 575,000
shares of common stock valued at $2,283,900 and incurred approximately $50,000
of direct costs associated with the transaction. The value of the Company's
common stock issued was determined in accordance with SFAS No. 141 by taking the
average market price over the 2-day period before and after the terms of the
acquisition were agreed to and announced.
4. DEBT
On February 17, 2004, the Company executed two three-year promissory notes in
conjunction with the purchase of the assets of Asgard for an aggregate amount of
$170,138. The promissory notes bear interest at 4% and mature in February 2007.
The Company makes monthly aggregate payments of $4,726 plus accrued interest.
The outstanding balance on the two notes at January 31, 2005 was $118,151.
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, 2004 and January 31, 2005. The Company anticipates that
this line of credit will be renewed.
5. DEFERRED CONTRACT REVENUE
As of January 31, 2005, the Company had deferred contract revenue of
approximately $728,000 related to Lockheed Martin contracts, which were awarded
in fiscal year 2005. The deferred revenue represents payments received for
milestones achieved prior to recognition of revenue. This revenue will be
recognized over the remaining life of the contracts as products are shipped
under the contracts, which are scheduled for completion in August of 2005. Other
deferred revenue consists of warranties, OEM releases and consulting services.
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) 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) 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.
7. 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
8. SIGNIFICANT CUSTOMER
For the three ending January 31, 2005, the Company had one significant third
party customer, Lockheed Martin. Lockheed revenues were approximately 75% of
total net revenues for the three months ended January 31, 2005. Accounts
receivable balances at January 31, 2005 included amounts due from Lockheed of
approximately $3.7 million or 71% of total net accounts receivable.
9. SIGNIFICANT ACCOUNTING POLICY
In December 2004, the FASB issued SFAS No.123 (revised 2004), "Share-Based
Payment". Statement 123(R) will provide investors and other users of financial
statements with more complete and neutral financial information by requiring
that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. Statement 123(R) covers a
wide range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123, as originally issued in
1995, established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in Opinion 25,
as long as the footnotes to financial statements disclosed what net income would
have been had the preferable fair-value-based method been used. Public entities
(other than those filing as small business issuers) will be required to apply
Statement 123(R) as of the first interim or annual reporting period that begins
after June 15, 2005. The Company is currently evaluating the financial statement
impact of the adoption of SFAS 123(R).
10. RECLASSIFICATION
Certain prior year's amounts have been reclassified to conform to current year
presentation.
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. The
words or phrases "would be," "will allow," "intends to," "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project," or
similar expressions are intended to identify "forward-looking statements".
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.
Statements made herein are as of the date of the filing of this Form 10-Q with
the Securities and Exchange Commission and should not be relied upon as of any
subsequent date. Unless otherwise required by applicable law, the Company does
not undertake, and the Company specifically disclaims, any obligation to update
any forward-looking statements to reflect occurrences, developments,
unanticipated events or circumstances after the date of such statement.
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, 2004 filed by the Company with the Securities and Exchange
Commission.
9
OVERVIEW
SteelCloud, Inc. is primarily engaged in the design, development and
manufacturing of custom appliance servers; delivering network security solutions
in the form of security appliances, software and professional services; and
developing proprietary software products.
CUSTOM APPLIANCES AND SERVERS
The Company designs and manufactures specialized servers and infrastructure
solutions for large commercial and government integrators as well as for certain
governmental agencies. The Company's specialized servers are designed to meet
the precise needs of volume customers and reduce the customer's investments in
logistics, integration capacity and support. The Company enhances its
custom-design and manufacturing capability by providing custom supply chain and
logistics support services to its partners.
In addition, the Company integrates either its partner's or other third-party
software into a custom-designed server platform or appliance and manufactures
the product under a co-branded name or its partner's brand name. This allows the
partner to deliver a complete turnkey solution.
NETWORK SECURITY
The Company is also focused on the network security marketplace with a suite of
network security software products from its strategic partners. The company
resells the software to end users along with consulting, installation and
integration services.
SteelCloud's professional consulting services organization provides clients with
a seamless extension of their Information Technology ("IT") organizations.
Expert technical services include network analysis, network security audits and
appraisals, system design, troubleshooting and implementation. SteelCloud
provides these professional services to public sector organizations as well as
to commercial customers.
ADVANCED TECHNOLOGY
The company has established an advanced technology organization which designs
and develops SteelCloud intellectual property in the form of proprietary
SteelCloud software products. The company expects to market these
SteelCloud-brand software and/or appliance products directly to select end user
organizations and through channel partners who will buy and resell the products
to their end user customers.
10
CRITICAL ACCOUNTING POLICIES
The Company believes the following represent its critical accounting policies:
SIGNIFICANT CUSTOMER CONTRACT
In May 2004, the Company was awarded a contract by Lockheed Martin valued at
more than $12 million for customized servers. The contract included options for
the government integrator to purchase a substantial number of additional
appliances. Additional contract options were exercised early in fiscal year 2005
and the total contract value currently exceeds $18 million. The Company began
making shipments under the initial contract in fiscal year 2004. The estimated
completion date for deliveries under this contract is February 2005. In
addition, contract options have been exercised and deliveries under those
options will begin after February 2005. For the first quarter of fiscal year
2005, the Company recognized revenue associated with this contract of
approximately $3.8 million. 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. 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.
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 completed the contracts in fiscal
year 2004. The Company did not recognize any revenue associated with these
contracts in fiscal year 2005.
REVENUE RECOGNITION
The Company recognizes revenue in accordance with Staff Accounting Bulletin No,
104, "Revenue Recognition in Financial Statements" (SAB104). SAB 104 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 have
been rendered; (3) the seller's price to the buyer is fixed or determinable; and
(4) collectibility is reasonably assured.
For product sales to commercial customers, the Company recognizes revenue at the
time of shipment (shipping FOB shipping point) when both title and risk of loss
transfers to the customer. For product sales to government customers, the
Company recognizes revenue when customer receipt of goods is confirmed (shipping
FOB destination) 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 for 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.
11
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. FASB Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information, also
establishes a quantitative threshold, whereby an enterprise should report
separately information about an operating segment if its reported revenue is 10%
or more of the combined revenue of all reported operating segments. The Company
is organized on the basis of products and services. However, the Company does
not evaluate the performance of its segments based on earnings. 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.
DEFERRED TAX ASSETS
Deferred tax assets and liabilities are recorded to reflect the tax consequences
on future years of temporary differences of revenue and expense items for
financial statement and income tax purposes. A valuation allowance is provided
to reduce related assets to an amount that is more likely than not realizable.
The Company determines its valuation allowance pursuant to the provisions of
Financial Accounting Standards Board Statement of Financial Accounting Standards
Number 109, Accounting for Income Taxes, which requires the Company to weigh all
positive and negative evidence including past operating results and forecasts of
future taxable income. If forecasts of taxable income change in the future, the
Company may be required to adjust the valuation allowance against deferred tax
assets, which would result in additional tax expense or benefit.
12
RESULTS OF OPERATIONS
FOR THE THREE ENDED JANUARY 31, 2005 COMPARED TO THE THREE MONTHS ENDED
JANUARY 31, 2004
Product revenues increased to $8,223,458 for the three months ended January 31,
2005 from $3,295,312 for the same period in fiscal 2004, an increase of
$4,928,146 or 149.6%. The increase is primarily attributable to deliveries
associated with several significant contracts with Lockheed Martin during the
first quarter of fiscal year 2005. These contracts are currently valued at
approximately $22 million. The Company generated revenue of approximately $5.9
million during the first quarter of fiscal year 2005 and approximately $7.6
million during fiscal year 2004 under these contracts. The Company will complete
deliveries under these contracts in May 2005. These deliveries resulted in an
increase in revenues of approximately $5.7 million for the three month period
ended January 31, 2005 as compared to the same periods in fiscal 2004. This
increase was offset by a decrease in reselling revenues of approximately $1.1
million for the three month period ended January 31, 2005 as compared to the
same periods in fiscal 2004. This decrease is attributable to certain
organizational and restructuring changes within one of the Company's reselling
partners during fiscal 2004 which significantly impacted the Company's reselling
activities and associated consulting services. Accordingly, the Company is
engaging new reselling partners in an effort to enhance its product offerings
and expand its revenue base. Establishing these new business relationships has
impacted revenue activities as time and resources have been required to develop
these relationships.
Service revenues decreased to $840,135 for the three months ended January 31,
2005 from $868,385 for the same period in fiscal 2004, a decrease of $28,250 or
3.3%. The decrease in service revenues for the first quarter of fiscal year 2005
as compared to the same period in fiscal 2004 is primarily the result of the
aforementioned changes in the Company's reselling partner relationships.
Reselling service revenues in the first quarter of fiscal year 2005 were
adversely affected as the Company worked to improve its reselling partner
relationships to better address its future goals. Partially offsetting this
decrease, service revenue associated with the acquisition of Asgard in February
2004 was approximately $144,000 in the first quarter of fiscal year 2005. No
revenues associated with the Asgard acquisition were recognized in the first
quarter of fiscal year 2004.
Product gross margin, as a percentage of net revenues, increased to 27.8% for
the three months ended January 31, 2005 from 15.0% for the same period in fiscal
2004. The increase in gross margin for the three months ended January 31, 2005
is due to lower product costs realized, with the significant product backlog, as
the Company utilized its cash on hand and purchasing power to take advantage of
product discounts, incentives and rebates available in the marketplace. In
addition, start up costs associated with the Company's contracts from fiscal
year 2004 were primarily incurred during the initial delivery phase. As the
Company anticipated, gross margins have increased since these initial
deliveries. The gross margin for services, as a percentage of net revenues,
decreased to 29.6% for the three months ended January 31, 2005 from 31.0% for
the same period in fiscal 2004. The minor decrease in gross margin from services
is principally the result of lower reselling service revenue in fiscal year 2005
as compared to the similar period in fiscal year 2004. The Company expects gross
margin as a percentage of net revenues to fluctuate from quarter to quarter as
product lines expand, new products are brought to market, start up costs are
incurred and new discounts, incentives and rebates become available.
13
Sales and marketing expenses decreased to $441,985 for the three months ended
January 31, 2005 from $470,285 for the same period in fiscal 2004, a decrease of
$28,300 or 6.0%. The decrease is primarily attributable to increased sales and
marketing expenses incurred in early fiscal year 2004 for anticipated growth. As
a result, the Company received significant contract awards at the end of fiscal
year 2004 which corresponded to increased revenue in the first quarter of fiscal
year 2005. Additionally, we increased our sales and marketing efforts associated
with our server appliance relationships in 2004 which did not generate the
business results anticipated. As a result, the Company has realigned its
resources in fiscal 2005 to better support its more successful product lines.
Research and product development expenses increased to $213,482 for the three
months ended January 31, 2005 from $150,444 for the same period in fiscal 2004,
an increase of $63,038 or 41.9%. The increase is primarily the result of the
Company intensifying its research and product development work in an effort to
release new products in mid to late fiscal year 2005. The Company expects to
continue to incur additional research and product development costs in future
quarters as new products are brought to market.
General and administrative expenses decreased to $1,446,344 for the three months
ended January 31, 2005 from $1,791,106 for the same period in fiscal 2004, a
decrease of $344,762 or 19.3%. As a percentage of revenue, general and
administrative expenses decreased to 16% from 43% for the same period in fiscal
2004 as a result of the significant revenue growth in 2005. The decrease is
largely attributable to non-recurring costs such as professional services of
approximately $85,000, accrued severance pay of approximately $140,000 and
accrued regulatory costs of $45,000 that were incurred in the first quarter of
fiscal year 2004. Although the Company continues to manage its costs relative to
its revenues and gross margins, additional resources will be required in order
to support its new product lines and successfully transition the Company into a
network security company. In addition, the Company expects to incur additional
general and administrative expenses associated with Sarbanes-Oxley compliance.
However, at present, it is difficult to predict the timing and extent of such
costs to be incurred in fiscal 2005 due to the recently announced delay in the
implementation date for certain provisions related to internal control
reporting. Management is currently assessing the impact of this deferral on its
compliance plans.
Interest income, net decreased to $7,709 for the three months ended January 31,
2005 from $13,242 for the same period in fiscal 2004, a decrease of $5,533 or
41.8%. The decrease in interest income is the result of the Company's
utilization of its cash balance for its purchasing efforts undertaken to take
advantage of available vendor discounts, incentives and rebates. As a result,
the Company's average cash balance, and corresponding interest income, for the
period ending January 31, 2005 was lower than the comparable period in fiscal
year 2004.
The Company reported net income of $414,793 from continuing operations for the
three months ended January 31, 2005, as compared to a net loss of $(1,606,099)
from continuing operations for the same period in fiscal 2004. The increase in
net income for the three months ended January 31, 2005 as compared to the same
periods in fiscal 2004 is primarily attributable to the Company's increased
revenues associated with deliveries of products associated with significant
contract awards. Additionally, the Company experienced significantly higher
gross margins. The Company has also realigned its resources and streamlined
operating costs to better position itself in its significant markets.
14
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended January 31, 2005, the Company generated $2,353,275 in
cash flow from continuing operations. The Company generated cash from the
collection of its accounts receivables of $3,776,703, and experienced an
increase in accrued expenses of $243,699 and deferred contract revenues of
$981,499. The cash generated was primarily used to pay accounts payable of
$1,096,772 and purchase inventory of $1,606,912.
For the three months ended January 31, 2005, the Company invested $154,789 in
property and equipment.
For the three months ended January 31, 2005, the Company generated $7,552 from
financing activities. The Company did not rely on its bank line of credit for
the three months ended January 31, 2005.
As of January 31, 2005, the Company had working capital of $10,291,260. 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 2005.
In addition, the Company assumed $170,138 of Asgard's debt by executing two
three-year promissory notes. The promissory notes bear interest at 4% and mature
in February 2007. The Company makes monthly aggregate payments of $4,726 plus
accrued interest. The outstanding balance on the two notes at January 31, 2005
was $118,151.
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, 2005, there were no outstanding borrowings on the line of credit.
The line of credit expires on March 31, 2005. The Company anticipates that this
line of credit will be renewed.
From time to time, the Company may pursue strategic acquisitions or mergers,
which may require significant additional capital 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, 2005 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, capital lease obligations or any material commitments
for capital expenditures as of January 31, 2005. 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 More than 5
Total year 1-3 years 3-5 years years
- ------------------------------ ---------------- ------------- -------------- --------------- -------------
Notes Payable - Current $ 70,879 $ 70,879 - - -
- ------------------------------ ---------------- ------------- -------------- --------------- -------------
Long Term Debt $ 102,752 - $ 91,957 $ 10,795 -
- ------------------------------ ---------------- ------------- -------------- --------------- -------------
Operating Lease $ 2,683,697 $ 626,079 $ 1,157,858 $ 899,760 -
- ------------------------------ ---------------- ------------- -------------- --------------- -------------
Management believes that these commitments will be satisfied with current
operating cash flow.
15
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 if the Company fully utilized its existing line of credit.
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"), our Chief Operating Officer ("COO"), and
our Chief Financial Officer ("CFO").
CEO, COO AND CFO CERTIFICATIONS
The certifications of the CEO, COO, and the CFO required by Rule 13a-15(e) of
the Securities Exchange Act of 1934, as amended, 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, COO, 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.
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LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Our management, including our CEO, COO, 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
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, COO, 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, COO, 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.
17
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 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1 Statement of computation of earnings per share.
Exhibit 31.1 Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.*
Exhibit 31.2 Certification of Chief Operating Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.*
Exhibit 31.3 Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.*
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002.*
Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002.*
Exhibit 32.3 Certification Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002.*
* 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.
(b) Reports on Form 8-K
On January 27, 2005, the Company filed a report on Form 8-K pursuant to Item
8.01 "Other Events" and Item 9.01 "Financial Statements and Exhibits".
On January 14, 2005, the Company filed a report on Form 8-K pursuant to Item
2.02 "Results of Operations and Financial Condition" and Item 9.01 "Financial
Statements and Exhibits".
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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 10, 2005 STEELCLOUD, INC.
By: /S/ THOMAS P. DUNNE
-----------------------
Name: Thomas P. Dunne
Title: Chief Executive Officer
By: /S/ BRIAN HAJOST
--------------------
Name: Brian Hajost
Title: Chief Operating Officer
By: /S/ KEVIN MURPHY
----------------------
Name: Kevin Murphy
Title: Chief Financial Officer
20