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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 June 30, 2002 or
[ ] Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from ________ to ________
Commission file number 0-18603
INTEGRAL SYSTEMS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1267968
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5000 Philadelphia Way, Lanham, MD 20706
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (301) 731-4233
- --------------------------------------------------------------------------------
(Former name, address and fiscal year, if changed since last report)
Indicate by checkmark 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 ___
Registrant had 9,257,083 shares of common stock outstanding as of July 31, 2002
INTEGRAL SYSTEMS, INC.
TABLE OF CONTENTS
Page No.
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PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Balance Sheets - June 30, 2002 (unaudited) and September 30, 2001.................1
Unaudited Statements of Operations - Three and Nine Months Ended
June 30, 2002 and June 30, 2001..................................................3
Unaudited Statement of Stockholders' Equity - Nine Months
Ended June 30, 2002..............................................................4
Unaudited Statements of Cash Flow - Nine Months Ended
June 30, 2002 and June 30, 2001..................................................5
Notes to Financial Statements.....................................................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................................8
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................18
PART II. OTHER INFORMATION:
Item 4. Submission of Matters to a Vote of Security Holders.........................18
Item 6. Exhibits and Reports on Form 8-K............................................19
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 (UNAUDITED) AND SEPTEMBER 30, 2001
ASSETS
June 30, September 30,
2002 2001
(Unaudited)
--------------- ---------------
CURRENT ASSETS
Cash $ 9,608,447 $ 2,379,503
Marketable Securities 45,421,000 57,890,170
Accounts Receivable 18,454,087 18,384,883
Notes Receivable 116,767 112,495
Prepaid Expenses 768,101 340,677
Deferred Income Tax - Current Portion 447,078 611,395
Income Taxes Receivable 368,852 1,940,573
--------------- ---------------
TOTAL CURRENT ASSETS 75,184,332 81,659,696
FIXED ASSETS
Electronic Equipment 4,026,885 3,318,309
Furniture & Fixtures 610,128 523,324
Leasehold Improvements 373,224 237,133
Software Purchases 631,449 396,107
Equip. Under Capital Lease 579,496 1,378,461
--------------- ---------------
SUBTOTAL - FIXED ASSETS 6,221,182 5,853,334
Less: Accum. Depreciation 2,707,576 2,659,644
--------------- ---------------
TOTAL FIXED ASSETS 3,513,606 3,193,690
OTHER ASSETS
Marketable Securities - Available for Sale 5,382,500 0
Notes Receivable - Non-Current 318,610 406,727
Intangible Assets, net 468,750 0
Goodwill 2,366,062 0
Software Development Costs 6,327,920 5,080,629
Deposits and Deferred Charges 109,177 72,702
--------------- ---------------
TOTAL OTHER ASSETS 14,973,019 5,560,058
TOTAL ASSETS $ 93,670,957 $ 90,413,444
=============== ===============
-1-
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 (UNAUDITED) AND SEPTEMBER 30, 2001
LIABILITIES & STOCKHOLDERS' EQUITY
June 30, September 30,
2002 2001
(Unaudited)
--------------- ---------------
CURRENT LIABILITIES
Accounts Payable $ 4,464,808 $ 5,131,229
Accrued Expenses 3,300,372 2,926,443
Capital Leases Payable 41,790 137,791
Billings in Excess of Cost 2,718,949 2,036,795
--------------- ---------------
TOTAL CURRENT LIABILITIES 10,525,919 10,232,258
--------------- ---------------
LONG TERM LIABILITIES
Capital Leases Payable 100,158 122,161
Deferred Income Taxes 1,882,384 1,882,384
--------------- ---------------
TOTAL LONG TERM LIABILITIES 1,982,542 2,004,545
STOCKHOLDERS' EQUITY
Common Stock, $.01 par value,
40,000,000 shares authorized, and
9,246,113 and 9,071,113 shares issued and
outstanding at June 30, 2002
and September 30, 2001, respectively 92,461 90,711
Additional Paid-in Capital 64,032,440 63,246,985
Retained Earnings 17,037,595 15,095,953
Accumulated other comprehensive income 0 (257,008)
--------------- ---------------
TOTAL STOCKHOLDERS' EQUITY 81,162,496 78,176,641
--------------- ---------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 93,670,957 $ 90,413,444
=============== ===============
-2-
INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
June 30, June 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue $ 14,439,583 $ 10,392,318 $ 35,254,569 $ 28,405,590
Cost of Revenue
Direct Labor 3,664,434 2,834,597 9,416,789 7,740,146
Overhead Costs 2,545,065 1,916,358 6,780,030 5,659,833
Travel and Other Direct Costs 594,329 287,479 1,378,251 1,071,749
Direct Equipment & Subcontracts 3,999,978 2,677,446 7,879,070 5,637,838
------------ ------------ ------------ ------------
Total Cost of Revenue 10,803,806 7,715,880 25,454,140 20,109,566
------------ ------------ ------------ ------------
Gross Margin 3,635,777 2,676,438 9,800,429 8,296,024
Selling, General & Administrative 2,701,789 1,370,399 6,961,834 5,167,322
Product Amortization 547,276 342,500 1,641,802 1,027,500
------------ ------------ ------------ ------------
Income From Operations 386,712 963,539 1,196,793 2,101,202
Other Income (Expense)
Interest Income 223,692 602,134 694,959 2,044,561
Interest Expense (3,554) (9,662) (12,238) (41,193)
Gain on sale of marketable securities 730,932 0 1,117,531 0
Miscellaneous, net (12,952) (32,184) (95,898) (170,670)
------------ ------------ ------------ ------------
Total Other Income 938,118 560,288 1,704,354 1,832,698
Income Before Income Taxes 1,324,830 1,523,827 2,901,147 3,933,900
Provision for Income Taxes 365,122 518,339 891,735 1,088,139
------------ ------------ ------------ ------------
Net Income $ 959,708 $ 1,005,488 $ 2,009,412 $ 2,845,761
============ ============ ============ ============
Weighted Avg. Number of Common
Shares Outstanding During Period 9,225,046 9,464,818 9,139,669 9,452,751
Earnings per Share - Basic $ 0.10 $ 0.11 $ 0.22 $ 0.30
============ ============ ============ ============
Diluted Shares Outstanding 9,382,045 9,690,170 9,269,441 9,570,947
Earnings per Share - Diluted $ 0.10 $ 0.10 $ 0.22 $ 0.30
============ ============ ============ ============
-3-
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
COMMON ACCUMULATED
NUMBER STOCK ADDITIONAL OTHER
OF AT PAR PAID-IN RETAINED COMPREHENSIVE
SHARES VALUE CAPITAL EARNINGS INCOME TOTAL
Balance September 30, 2001 9,071,113 $ 90,711 $ 63,246,985 $ 15,095,953 $ (257,008) $ 78,176,641
Comprehensive income
Net income - - - 2,009,412 - 2,009,412
Unrealized gain on marketable
securities - - - - 257,008 257,008
--------------
Comprehensive Income 2,266,420
Repurchased Shares (6,000) (60) (41,820) (67,770) (109,650)
Stock Options Exercised 181,000 1,810 827,275 829,085
--------- -------------- -------------- -------------- -------------- --------------
Balance June 30, 2002 9,246,113 $ 92,461 $ 64,032,440 $ 17,037,595 - $ 81,162,496
========= ============== ============== ============== ============== ==============
-4-
INTEGRAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
For the Nine Months Ended
June 30,
2002 2001
--------------- ---------------
Cash flows from operating activities:
Net income $ 2,009,412 $ 2,845,761
--------------- ---------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,638,888 1,731,727
Gain on sale of marketable (1,117,531) 0
securities
Loss on disposal of fixed assets 0 2,229
Deferred income taxes, net 0 (24,747)
(Increase) decrease in operational assets and
liabilities net of effects from acquisition:
Accounts receivable and other receivables 529,704 (2,845,675)
Prepaid expenses and deposits (337,167) (176,765)
Accounts payable (3,053,757) 1,520,581
Accrued expenses (21,648) 294,171
Billings in excess of cost 176,040 (855,583)
Income taxes payable, net 1,571,721 482,039
--------------- ---------------
Total adjustments 386,250 127,977
--------------- ---------------
Net cash provided by operating activities 2,395,662 2,973,738
--------------- ---------------
Cash flows from investing activities:
Sale of marketable securities, net 6,552,500 1,040,000
Sale of common stock investments, net 2,073,026 0
Notes receivable, net 83,845 53,517
Acquisition of fixed assets (1,021,346) (1,509,248)
Software development costs (2,889,093) (2,473,252)
Net advances to Newpoint Technologies (448,332) 0
Acquisition of Newpoint Technologies (118,749) 0
--------------- ---------------
Net cash provided by (used in) investing activities 4,231,851 (2,888,983)
--------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of common stock 829,085 226,517
Proceeds from line of credit 0 235,000
Payments on stock repurchase (109,650) 0
Payments on capital lease obligations (118,004) (369,287)
--------------- ---------------
Net cash provided by financing activities 601,431 92,230
--------------- ---------------
Net increase (decrease) in cash 7,228,944 176,985
Cash - beginning of year 2,379,503 17,558,331
--------------- ---------------
Cash - end of period $ 9,608,447 $ 17,735,316
=============== ===============
-5-
INTEGRAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The interim financial statements include the accounts of Integral
Systems, Inc. (ISI or the Company) and its wholly-owned subsidiaries,
SAT Corporation (SAT), Newpoint Technologies, Inc. (Newpoint),
Integral Systems Europe (ISI Europe), and InterSys, Inc. (INTSYS). All
significant intercompany accounts and transactions have been
eliminated in consolidation.
In the opinion of management, the financial statements reflect all
adjustments consisting only of normal recurring accruals necessary for
a fair presentation of results for such periods. The financial
statements, which are condensed and do not include all disclosures
included in the annual financial statements, should be read in
conjunction with the consolidated financial statements of the Company
for the fiscal year ended September 30, 2001. The results of
operations for any interim period are not necessarily indicative of
results for the full year.
Certain accounts in the prior period financial statements have been
reclassified for comparative purposes to conform with the presentation
in the current year financial statements.
2. Accounts Receivable
Accounts receivable at June 30, 2002 and September 30, 2001 consist of
the following:
June 30, 2002 Sept. 30, 2001
--------------- ---------------
Billed $ 9,325,428 $ 10,081,489
Unbilled 8,965,922 8,163,934
Other 162,737 139,460
--------------- ---------------
Total $ 18,454,087 $ 18,384,883
=============== ===============
The Company's accounts receivable consist of amounts due on prime
contracts and subcontracts with the U.S. Government and contracts with
various private organizations. Unbilled accounts receivable consist
principally of amounts that are billed in the month following the
incurrence of cost, amounts related to indirect cost variances on cost
reimbursable type contracts or amounts related to milestones that are
delivered under fixed price contracts. All unbilled receivables are
expected to be billed and collected within one year.
During the three months ended June 30, 2002, the Company reserved
$315,000 against a receivable due to SAT from SSP/Litronic, Inc. (SSP
Solutions), a publicly traded company located in Irvine, California.
SSP Solutions served as a prime contractor to SAT for delivery of SAT
terrestrial monitoring products to the Federal Communications
Commission in September 2001. The full value of SAT's purchase orders
from SSP Solutions amounted to $432,000. Although the Company believes
that SSP Solutions has been paid in full by the FCC for SAT's
deliveries, SSP Solutions to date has failed to pay SAT $315,000 due
under the FCC related purchase orders. During the quarter ended June
30, 2002 the Company determined that doubt existed regarding the
collection of this receivable due to lack of payments as per an agreed
upon payment plan and deterioration of negotiations with SSP
Solutions.
Accordingly, the Company has fully reserved the outstanding SSP
Solutions receivable at June 30, 2002.
-6-
3. Line of Credit
The Company has a line of credit agreement with a local bank for $10.0
million for general corporate purposes. Borrowings under the line are
due on demand with interest at the London Inter-Bank Offering Rate
(LIBOR), plus a spread of 1.5 to 2.4% based on the ratio of funded
debt to earnings before interest, taxes and depreciation (EBITDA). The
line of credit is secured by the Company's billed and unbilled
accounts receivable and has certain financial covenants, including
minimum net worth and liquidity ratios. The line expires February 29,
2004.
The Company had no balance outstanding at June 30, 2002, under the
line of credit.
4. Acquisition
On January 30, 2002, the Company completed its acquisition of Newpoint
Technologies, Inc. (Newpoint). As consideration for all of the shares
issued and outstanding of Newpoint the Company agreed to make future
contingent payments to the shareholders of Newpoint for the period
beginning February 1, 2002 through September 30, 2005. The contingent
payments are calculated every September 30 in the period from February
1, 2002 through September 30, 2005 based on a formula of net income
and excess revenues as defined in the acquisition agreement.
A total of $118,749 represents Integral Systems' direct transaction
costs relating to the acquisition. To retire debt and fund operations,
the Company made advances to Newpoint in the amounts of $490,000 and
$1,837,849 immediately prior to and immediately following consummation
of the acquisition. The operations of Newpoint are included in the
consolidated statement of operations as of February 1, 2002.
The acquisition was accounted for using the purchase method of
accounting under the guidance in FASB Statement 141, Business
Combinations. Accordingly, a portion of the purchase price has been
allocated to assets acquired and liabilities assumed and other
identified intangible assets based on estimated fair values on the
acquisition date. Approximately $2,747,313, $400,000 and $100,000 were
allocated to net liabilities assumed, technology, and customer base,
respectively. The excess of the net liabilities assumed and the direct
transaction costs over the identified intangible assets acquired was
allocated to goodwill. The Company's primary reason for acquiring
Newpoint was to gain entrance to new markets and increase exposure to
a certain class of customer. The technology and specific customers
acquired were incidental to the transaction. Accordingly, a
significant portion of the excess of net liabilities assumed and the
purchase price was allocated to goodwill. The net liabilities assumed
includes amounts previously advanced by the Company. The identified
intangible assets are being amortized on a straight-line basis over an
estimated useful life of four years for the technology and customer
base. Goodwill is not being amortized but is being reviewed annually
for impairment in accordance with FAS 142. The purchase price
allocation is based on preliminary estimates and is subject to change
as final valuations are made. During the quarter ended June 30, 2002,
the Company made adjustments to the purchase price allocation that
resulted in an immaterial addition to goodwill associated with the
acquisition.
5. Marketable Securities - Available for Sale
On June 3, 2002, the Company purchased Howard County Municipal Bond in
the amount of $5,382,500. These debt securities are carried at cost,
which approximates fair market value.
-7-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001
OVERVIEW
Integral Systems, Inc. builds satellite ground systems for command and control,
integration and test, data processing, and simulation. Since its inception in
1982, the Company has provided ground systems for over 120 different satellite
missions for communications, science, meteorology, and earth resource
applications. The Company has an established domestic and international customer
base that includes government and commercial satellite operators, spacecraft and
payload manufacturers, and aerospace systems integrators.
The Company has developed innovative software products that reduce the cost and
minimize the development risk associated with traditional custom-built systems.
The Company believes that it was the first to offer a comprehensive COTS
("Commercial-Off-the-Shelf") software product line for command and control. As a
systems integrator, the Company leverages these products to provide turnkey
satellite control facilities that can operate multiple satellites from any
manufacturer. These systems offer significant cost savings for customers that
have traditionally purchased a separate custom control center for each of their
satellites.
Through its wholly owned subsidiary SAT Corporation ("SAT"), acquired in August
2000, the Company also offers turnkey systems and software for satellite and
terrestrial communications signal monitoring.
In March 2001 the Company formed a wholly owned subsidiary, Integral Systems'
Europe S.A.S. ("ISI Europe") with headquarters in Toulouse, France. ISI Europe
serves as the focal point for the support of all of Integral's European
business.
On January 30, 2002, the Company completed the acquisition of Newpoint
Technologies, Inc. ("Newpoint") of Salem, New Hampshire. Newpoint provides
equipment monitoring and control software to satellite operators and the
telecommunications industry.
-8-
RESULTS OF OPERATIONS
The components of the Company's income statement as a percentage of revenue are
depicted in the following table for the three months ended June 30, 2002 and
June 30, 2001:
THREE MONTHS ENDED JUNE 30,
% OF % OF
2002 REVENUE 2001 REVENUE
-------------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
Revenue $ 14,440 100.0 $ 10,392 100.0
Cost of Revenue 10,804 74.8 7,716 74.2
-------------- -------------- -------------- --------------
Gross Margin 3,636 25.2 2,676 25.8
Operating Expenses
SG&A 2,702 18.7 1,370 13.2
Prod. Amortization 547 3.8 343 3.3
-------------- -------------- -------------- --------------
Income from Operations 387 2.7 963 9.3
Other Income (Expense) (net) 938 6.5 560 5.4
-------------- -------------- -------------- --------------
Income Before Income Taxes 1,325 9.2 1,523 14.7
Income Taxes 365 2.5 518 5.0
-------------- -------------- -------------- --------------
Net Income $ 960 6.7 $ 1,005 9.7
============== ============== ============== ==============
REVENUE
The Company earns revenue, both as a prime contractor and a subcontractor, from
sales of its products and services through contracts that are funded by the U.S.
Government, as well as commercial and international organizations.
Internally, the Company classifies revenues in two separate categories on the
basis of the contracts' procurement and development requirements: (i) contracts
which require compliance with Government procurement and development standards
("Government Services") are classified as government revenue, and (ii) contracts
conducted according to commercial practices ("Commercial Products and Services")
are classified as commercial revenue, regardless of whether the end customer is
a commercial or government entity. Sales of the Company's COTS products are
classified as Commercial Products and Services revenue. Revenues attributable to
SAT, Newpoint, and ISI Europe are also classified as Commercial Products and
Services revenue.
-9-
For the three months ended June 30, 2002 and 2001, the Company's revenues were
generated from the following sources:
THREE MONTHS ENDED JUNE 30,
REVENUE TYPE 2002 2001
------------ --------------- ---------------
COMMERCIAL PRODUCTS & SERVICES
Commercial Users 42% 40%
U.S. Government Users - 1
--------------- ---------------
Subtotal 42
41
GOVERNMENT SERVICES
NOAA 24 41
Air Force 28 14
Other U.S. Government Users 6 4
--------------- ---------------
Subtotal 58 59
Total 100% 100%
=============== ===============
Based on the Company's revenue categorization system, the Company classified 42%
of its revenue as Commercial Products and Services revenue with the remaining
58% classified as Government Services revenue for the three months ended June
30, 2002. For the three months ended June 30, 2001 the Company classified 41% of
its revenue as Commercial Products and Services revenue with the remaining 59%
classified as Government Services revenue. By way of comparison, if the revenues
were classified strictly according to end user (independent of the Company's
internal revenue categorization system), the U.S. Government would account for
58% and 60% of the total revenues for the three months ended June 30, 2002 and
2001, respectively.
On a consolidated basis, revenue increased 39%, or $4.0 million, to $14.4
million for the three months ended June 30, 2002, from $10.4 million for the
three months ended June 30, 2001. The increase was due to four factors as
follows:
1. Government Services revenue increased by approximately $1.8 million due
to revenues earned on new contracts with the U.S. Air Force
2. Commercial Products and Services revenues increased by approximately $1.2
million due to the acquisition of Newpoint. Newpoint revenues were not part
of the Company's consolidated revenues during the three months ended June
30, 2001.
3. SAT revenues increased by approximately $500,000. Revenues for SAT recorded
during the three months ended June 30, 2001 were atypically low when
compared to other quarters in fiscal year 2001 and fiscal year 2002.
4. The remaining $500,000 increase was due to higher license revenues and
higher Commercial Products and Services revenues due to increased sales in
the Company's core business.
COST OF REVENUE/GROSS MARGIN
The Company computes gross margin by subtracting cost of revenue from revenue.
Included in cost of revenue are direct labor expenses, overhead charges
associated with the Company's direct labor base and other costs that can be
directly related to specific contract cost objectives, such as travel,
consultants, equipment, subcontracts and other direct costs.
Gross margins on contract revenues vary depending on the type of product or
service provided. Generally, license revenues related to the sale of the
Company's COTS products have the greatest gross margins because of the minimal
associated marginal costs to produce. By contrast, gross margins rates for
equipment and subcontract pass-throughs seldom exceed 15%. Engineering service
gross margins typically range between 20% and 35%.
-10-
During the three months ended June 30, 2002, cost of revenue increased by 40%,
or $3.1 million, from $7.7 million during the three months ended June 30, 2001
to $10.8 million during the three months ended June 30, 2002. The increases in
cost of revenue proportionately track the increases in revenue described above.
Namely:
1) Government Services cost of revenue increased by approximately $1.4
million due to costs incurred on new contracts with the U.S. Air Force
2) Commercial Products and Services cost of revenue increased by approximately
$900,000 due to the acquisition of Newpoint. Newpoint costs of revenue were
not part of the Company's consolidated costs of revenue during the three
months ended June 30, 2001.
3) SAT costs of revenue increased by approximately $200,000. The increase
in SAT cost of revenue related to SAT's $500,000 revenue increase
described above.
4) The remaining $600,000 increase in cost of revenue was due to higher
Commercial Products and Services costs of revenue in the Company's core
business.
Overall cost of revenue expressed as a percentage of revenue increased to 74.8%
for the three months ended June 30, 2002 from 74.2% for the three months ended
June 30, 2001.
The Company's gross margin increased $960,000, or 35.8% to $3.6 million for the
three months ended June 30, 2002 from $2.7 million for the three months ended
June 30, 2001. The increase was principally due to the $4.0 million revenue
increase discussed above. Gross margin as a percentage of revenue was relatively
constant at 25.2% during the three months ended June 30, 2002 compared to 25.8%
for the three months ended June 30, 2001.
Included in the Company's revenue mix during the three months ended June 30,
2002 was approximately $3.8 million of low-margin equipment and subcontract
pass-through revenue compared to $2.8 million of such revenue recorded during
the three months ended June 30, 2001. The increase in low-margin equipment and
subcontract pass-through revenue contributed to a lower gross margin percentage
during the current three-month period.
Looking forward to fiscal year 2003 and beyond, the Company expects to see
increased low-margin equipment and subcontract pass-through revenues due to
relatively large subcontract efforts that are involved under its new U.S. Air
Force contracts.
OPERATING EXPENSES/INCOME FROM OPERATIONS
Selling, General & Administrative expenses (SG&A) were $2.7 million during the
three months ended June 30, 2002 compared to $1.4 million for the three months
ended June 30, 2001, a $1.3 million increase. Virtually all of the increase was
attributable to Newpoint and SAT. Approximately $400,000 of the increase was the
result of the inclusion of SG&A costs from Newpoint (which was acquired by the
Company in January 2002), which costs were not recorded by the Company during
the three months ended June 30, 2001. SG&A costs at SAT increased by almost
$800,000 between the periods being compared as result of the following:
1. Bad debt expense attributable to the Company's receivable with
SSP/Litronic, Inc. in the amount of $315,000 (see note 2 to the notes of
the consolidated financial statements included in this Form 10-Q).
2. Severance expense related to the termination of SAT's former President of
approximately $90,000.
3. Increased selling expenses incurred during the quarter.
4. Atypically low SG&A costs incurred during the three months ended
June 30, 2001 when compared with other quarters in fiscal year 2001 and
fiscal year 2002.
The remaining SG&A increase of approximately $100,000 was attributable to
increased selling expenses in the Company's core business.
-11-
Product amortization increased from $342,000 for the three months ended June 30,
2001 to $547,000 for the three months ended June 30, 2002 due to increases in
capitalized software development costs.
Income from operations decreased $580,000 to $390,000 for the three months ended
June 30, 2002 from $960,000 for the three months ended June 30, 2001. The
decrease is primarily due to increases in SG&A expenses and product amortization
expenses. Further, the Company experienced operating losses of approximately
$530,000 at SAT and $140,000 at Newpoint for the three months ended June 30,
2002.
As a percentage of revenue, income from operations decreased to 2.7% for the
three months ended June 30, 2002 from 9.3% for the prior year's third quarter.
The decrease is the result of a higher SG&A percentage against revenue coupled
with an increased percentage of product amortization expenses against revenue
during the three months ended June 30, 2002 compared to the three months ended
June 30, 2001. Operating losses at SAT and Newpoint also contributed to the
lower operating income percentage.
During the three months ended June 30, 2002, the Company recorded $220,000 of
interest income compared to $600,000 of interest income recorded for the three
months ended June 30, 2001. The decrease is due to the general decline in
interest rates in response to recent interest rate cuts by the Federal Reserve
Board and the Company's reduction in interest generating capital resulting from
the repurchase of approximately $8.0 million of Company stock in September and
October of 2001. During the current quarter, the Company also realized a gain of
approximately $730,000 resulting from the sale of marketable securities. No such
gain was recorded during the three months ended June 30, 2001.
Income before income taxes decreased by approximately $200,000 to $1.3 million,
from $1.5 million, between the two periods being compared principally due to the
increase in SG&A and product amortization expenses accompanied by the decrease
in interest income discussed above, offset by the gain on sale of marketable
securities.
As a result of the above, net income decreased to approximately $960,000 during
the three months ended June 30, 2002 from approximately $1.0 million during the
three months ended June 30, 2001.
-12-
COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001
The components of the Company's income statement as a percentage of revenue are
depicted in the following table for the nine months ended June 30, 2002 and June
30, 2001:
NINE MONTHS ENDED JUNE 30,
2002 2001
-------------- % OF -------------- % OF
(IN THOUSANDS) REVENUE (IN THOUSANDS) REVENUE
-------------- --------------
Revenue $ 35,254 100.0 $ 28,406 100.0
Cost of Revenue 25,454 72.2 20,110 70.8
-------------- -------------- -------------- --------------
Gross Margin 9,800 27.8 8,296 29.2
Operating Expenses
SG&A 6,961 19.7 5,167 18.2
Prod. Amortization 1,642 4.7 1,028 3.6
-------------- -------------- -------------- --------------
Income from Operations 1,197 3.4 2,101 7.4
Other Income (Expense)(net) 1,704 4.8 1,833 6.4
-------------- -------------- -------------- --------------
Income Before Income Taxes 2,901 8.2 3,934 13.8
Income Taxes 892 2.5 1,088 3.8
-------------- -------------- -------------- --------------
Net Income 2,009 5.7 2,846 10.0
REVENUE
For the nine months ended June 30, 2002 and 2001 the Company's revenues were
generated from the following sources:
NINE MONTHS ENDED JUNE 30,
REVENUE TYPE 2002 2001
------------
COMMERCIAL PRODUCTS AND SERVICES
Commercial Users 46% 44%
U.S. Government Users - 1
------------- -------------
Subtotal 46 45
GOVERNMENT SERVICES
NOAA 33 41
Air Force 15 9
Other U.S. Government Users 6 5
------------- -------------
Subtotal 54 55
Total 100% 100%
============= =============
Based on the Company's revenue categorization system, the Company classified 46%
and 45% of its revenue as Commercial Products and Services revenue with the
remaining 54% and 55% classified as Government Services revenue for the nine
months ended June 30, 2002 and 2001, respectively. By way of comparison, if the
revenues were classified strictly according to end user (independent of the
Company's internal revenue categorization system), the U.S. Government would
account for 54% of the total revenues for the nine months ended June 30, 2002
and 56% for the nine months ended June 30, 2001.
-13-
On a consolidated basis, revenue increased 24%, or $6.8 million, to $35.3
million for the nine months ended June 30, 2002 from $28.4 million for the nine
months ended June 30, 2001. All revenue functional components (i.e. licenses,
services, and pass throughs) were greater during the nine months ended June 30,
2002 compared to the nine months ended June 30, 2001 due to increased sales.
Further, during the current nine month period, approximately $1.8 million in
Commercial Products and Services revenue was recorded for Newpoint, which was
acquired by the Company in January 2002, whereas the Company recorded no
Newpoint revenues during the first nine months in fiscal year 2001.
COST OF REVENUE/GROSS MARGIN
During the nine months ended June 30, 2002, cost of revenue increased 26.6% or
$5.4 million to $25.5 million from $20.1 million during the nine months ended
June 30, 2001. The increase was due to increases in direct labor, related
overhead costs and equipment and subcontract pass-throughs necessary to support
the increase in revenue discussed above. Further, cost of sales amounts
attributed to Newpoint (approximately $1.4 million) were not included with the
Company's results from operations for the nine months ended June 30, 2001.
In addition, cost of revenue for SAT increased approximately $700,000 between
the periods being compared. The increased costs at SAT for the nine months ended
June 30, 2002 relate to overruns on two fixed price contracts that were recorded
during the three months ended March 31, 2002. Overall cost of revenue expressed
as a percentage of revenues increased to 72.2% for the nine months ended June
30, 2002 from 70.8% for the nine months ended June 30, 2001. The increase was
primarily due to a higher cost of revenue percentage at SAT for the nine months
ended June 30, 2002 compared to the nine months ended June 30, 2001.
The Company's gross margin increased approximately $1.5 million to $9.8 million
for the nine months ended June 30, 2002 from $8.3 million for the nine months
ended June 30, 2001. The increase was principally due to the $6.8 million
increase in revenue discussed above. Gross margin as a percentage of revenue was
27.8% during the nine months ended June 30, 2002 compared to 29.2% for the nine
months ended June 30, 2001. This decrease is primarily attributable to a
decrease in gross margin at SAT as a result of overruns on two contracts
discussed above. Further Newpoint's gross margin percentage was only 20% for the
nine months ended June 30, 2002, thereby reducing the Company's overall gross
margin percentage.
OPERATING EXPENSES/INCOME FROM OPERATIONS
SG&A increased approximately $1.8 million for the nine months ended June 30,
2002 when compared with the nine months ended June 30, 2001. Approximately
$600,000 of the increase was the result of the inclusion of SG&A costs for
Newpoint, which costs were not recorded by the Company during the nine months
ended June 30, 2001. SG&A costs at SAT increased by approximately $700,000
between the periods being compared as result of the following:
1. Bad debt expense attributable to the Company's receivable with
SSP/Litronic, Inc. in the amount of $315,000 (see note 2 to the notes of
the consolidated financial statements)
2. Severance expense related to the termination of SAT's former President of
approximately $90,000.
3. Increased selling expenses incurred during the period.
The remaining SG&A increase of approximately $500,000 was primarily attributable
to sales and marketing costs incurred in the Company's core business in pursuit
of new contract opportunities principally with the U.S. Air Force. As a
percentage of revenue, SG&A accounted for 19.7% of revenue for the nine months
ended June 30, 2002 compared to 18.2% for the nine months ended June 30, 2001.
The change in percentage of revenue was primarily due to the increases in SG&A
expenses at SAT discussed above.
-14-
Product amortization increased to $1.6 million for the nine months ended June
30, 2002 compared to $1.0 million for the nine months ended June 30, 2001 due to
increases in capitalized software development costs.
Income from operations decreased approximately $900,000, or 43.0%, to $1.2
million for the nine months ended June 30, 2002 from $2.1 million for the nine
months ended June 30, 2001, which decrease was primarily due to higher SG&A and
product amortization expenses. Further, the Company experienced an operating
loss of approximately $730,000 at SAT and an operating loss of approximately
$270,000 at Newpoint for the nine months ended June 30, 2002. As a percentage of
revenue, income from operations decreased to 3.4% for the nine months ended June
30, 2002 from 7.4% for the prior fiscal year's nine months. This decrease was
principally the result of a lower gross margin percentage coupled with a higher
percentage of SG&A and product amortization expense against revenue in the first
nine months of fiscal year 2002 compared to the first nine months of the last
fiscal year.
During the nine months ended June 30, 2002, the Company recorded $700,000 of
interest income compared to $2.0 million of interest income for the nine months
ended June 30, 2001. The decrease is due to the general decline in interest
rates in response to recent interest rate cuts by the Federal Reserve Board and
the Company's reduction in interest generating capital resulting from the
repurchase of approximately $8.0 million of Company stock in September and
October of 2001. During the current nine months, the Company also realized a
gain of approximately $1.1 million resulting from the sale of marketable
securities. No such gain was recorded during the nine months ended June 30,
2001.
Income before income taxes decreased by approximately $1.0 million to $2.9
million from $3.9 million between the two periods being compared principally due
to the increase in SG&A and product amortization expenses accompanied by the
decrease in interest income discussed above, offset by the gain on sale of
marketable securities.
The Company's effective tax rate increased from 27.7% for the nine months ended
June 30, 2001 to 30.7% for the nine months ended June 30, 2002. The increase was
primarily a result of a lower percentage of tax-free interest income compared to
operating income recorded in the current nine month period compared to the prior
year's first nine months.
As a result of the above, net income decreased to approximately $2.0 million
during the nine months ended June 30, 2002 from approximately $2.8 million
during the nine months ended June 30, 2001.
OUTLOOK
This outlook section contains forward-looking statements, including but not
necessarily limited to projections, all of which are based on current
expectations. There is no assurance that the Company's projections will in fact
be achieved and these projections do not reflect any acquisitions or
divestitures subsequent to the end of the quarterly reporting period covered by
this Form 10-Q. Reference should be made to the various important factors listed
under the heading "Forward Looking Statements" that could cause actual future
results to differ materially.
At this time, the Company has a backlog of work to be performed and it may
receive additional contract awards based on proposals in the pipeline.
Management believes that operating results for future periods will improve based
on the following assumptions:
. Demand for satellite technology and related products and services
will continue to expand; and
. Sales of its software products and engineering services will
continue to increase.
Looking forward to fiscal year 2002 in its entirety, the Company is anticipating
growth in revenue of at least 20% over results posted for fiscal year 2001 in
its entirety. Conversely (and consistent with previously
-15-
announced guidance), earnings per share may be as much as 20% to 25% lower than
results recorded for fiscal year 2001. The anticipated lower earnings would
result from:
. Lower first nine months results as discussed above
. Continued lower interest income
. Anticipated operating losses from Newpoint
. Anticipated operating losses from SAT
Based on recently announced contract awards (particularly with the U.S. Air
Force) and also consistent with previous guidance, management believes that
revenues for fiscal year 2003 should be at least 25% greater than revenues for
fiscal year 2002. Earnings per share should be at least 40% greater in fiscal
year 2003 compared to fiscal year 2002.
LIQUIDITY AND CAPITAL RESOURCES
Since the Company's inception in 1982, it has been profitable on an annual basis
and has generally financed its working capital needs through internally
generated funds, supplemented by borrowings under the Company's general line of
credit facility with a commercial bank and the proceeds from the Company's
initial public offering in 1988. In June 1999, the Company supplemented its
working capital position by raising approximately $19.7 million (net) through
the private placement of approximately 1.2 million shares of its common stock.
In February 2000, the Company raised an additional $40.9 million (net) for use
in connection with potential acquisitions and other general corporate purposes
through the private placement of 1.4 million additional shares of its common
stock.
For the nine months ended June 30, 2002, the Company generated approximately
$2.4 million of cash from operating activities, and generated $4.2 million from
investing activities, net of approximately $2.9 million used for newly
capitalized software development costs and $1.0 million for the purchase of
fixed assets.
The Company has a line of credit agreement with a local bank for $10.0 million
for general corporate purposes. Borrowings under the line are due on demand with
interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5 to
2.4% based on the ratio of funded debt to earnings before interest, taxes and
depreciation (EBITDA). The line of credit is secured by the Company's billed and
unbilled accounts receivable and has certain financial covenants, including
minimum net worth and liquidity ratios. The line expires February 29, 2004
The Company had no balance outstanding at June 30, 2002, under the line of
credit.
The Company also has access to a $2.0 million equipment lease line of credit
that had a balance of approximately $140,000 at June 30, 2002.
The Company currently anticipates that its current cash balances, amounts
available under its lines of credit and net cash provided by operating
activities will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. The Company plans
to continue to invest in the on-going development and improvement of its current
software products, EPOCH and OASYS, as well as the development of new products
through the use of its current cash balances and cash provided by operating
activities.
The Company believes that inflation did not have a material impact on the
Company's revenues or income from operations during the nine months ended June
30, 2002 or in past fiscal years.
-16-
FORWARD LOOKING STATEMENTS
Certain of the statements contained in the Management's Discussion and Analysis
of Financial Condition and Results of Operations section, in other parts of this
10-Q, and in this section, including those under the headings "Outlook" and
"Liquidity and Capital Resources," are forward looking. In addition, from time
to time, the Company may publish forward-looking statements relating to such
matters as anticipated financial performance, business prospects, technological
developments, new products, research and development activities and similar
matters. Forward-looking statements can be identified by the use of
forward-looking terminology such as "may", "will", "believe", "expect",
"anticipate", "estimate", "continue", or other similar words, including
statements as to the intent, belief, or current expectations of the Company and
its directors, officers, and management with respect to the Company's future
operations, performance, or positions or which contain other forward-looking
information. These forward-looking statements are predictions. No assurances can
be given that the future results indicated, whether expressed or implied, will
be achieved. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. While the Company believes
that these statements are and will be accurate, a variety of factors could cause
the Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's statements.
The Company's business is dependent upon general economic conditions and upon
various conditions specific to its industry, and future trends cannot be
predicted with certainty. Particular risks and uncertainties that may affect the
Company's business, other than those described elsewhere herein, include the
following:
. A significant portion of the Company's revenue is derived from
contracts or subcontracts funded by the U.S. Government, which
are subject to termination without cause, government regulations
and audits, competitive bidding, and the budget and funding
process of the U.S. Government.
. The presence of competitors with greater financial resources and
their strategic response to the Company's services.
. The potential obsolescence of the Company's services due to the
introduction of new technologies.
. The response of customers to the Company's marketing strategies
and services.
. The Company's commercial contracts are subject to strict
performance and other requirements.
. The intense competition in the satellite ground system industry.
. Risks related to the Company's acquisition strategy. In
particular, the Company may not be able to find any attractive
candidates or it may find that the acquisition terms proposed by
potential acquisition candidates are not favorable to the
Company. In addition, the Company may compete with other
companies for these acquisition candidates, which competition may
make an acquisition more expensive for the Company. If the
Company is unable to identify and acquire any suitable
candidates, the Company may not be able to find alternative uses
for the cash proceeds of its previous private placements that
improve the Company's business, financial conditions, or results
of operations to the extent that an acquisition could. In
addition, the integration of the acquired business or businesses
may be costly and may result in a decrease in the value of the
Company's common stock for the following reasons, among others:
. the Company may not adequately assess the risks inherent in
a particular acquisition candidate or correctly assess the
candidate's potential contribution to the Company's
financial performance;
. the Company may need to divert more management resources to
integration than it planned, which may adversely affect its
ability to pursue other more profitable activities;
. the difficulties of integration may be increased by the
necessity of coordinating geographically separated
organizations, integrating personnel with disparate
backgrounds and combining different corporate cultures;
-17-
. the Company may not eliminate as many redundant costs as it
anticipated in selecting acquisition candidates; and
. an acquisition candidate may have liabilities or adverse
operating issues that the Company failed to discover through
its due diligence prior to the acquisition.
. Changes in activity levels in the Company's core markets.
While sometimes presented with numerical specificity, these forward-looking
statements are based upon a variety of assumptions relating to the business of
the Company, which although considered reasonable by the Company, may not be
realized. Because of the number and range of the assumptions underlying the
Company's forward-looking statements, many of which are subject to significant
uncertainties and contingencies beyond the reasonable control of the Company,
some of the assumptions inevitably will not materialize and unanticipated events
and circumstances may occur subsequent to the date of this document. These
forward-looking statements are based on current information and expectation, and
the Company assumes no obligation to update. The actual experience of the
Company and the results achieved during the period covered by any particular
forward-looking statement may vary materially. Therefore, these forward-looking
statements should not be regarded as a representation by the Company or any
other person that these estimates will be realized. There can be no assurance
that any of these expectations will be realized or that any of the
forward-looking statements contained herein will prove to be accurate.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II. OTHER INFORMATION
ITEM 4. SUBMISION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on April 17, 2002.
The following matters were voted on by stockholders, and received the votes
indicated.
1. The stockholders elected the following individuals to the Board of
Directors:
DIRECTOR FOR AGAINST ABSTAIN BROKER NON-VOTES
Steven R. Chamberlain 7,848,246 143,442 14,864 1,225,276
Thomas L. Gough 7,849,246 142,442 14,864 1,225,276
Bonnie K. Wachtel 7,879,367 112,321 14,864 1,225,276
Dominic Laiti 7,877,988 113,700 14,864 1,225,276
R. Doss McComas 7,989,188 2,500 14,864 1,225,276
2. The stockholders approved the Company's 2002 Stock Option Plan:
FOR AGAINST ABSTAIN BROKER NON-VOTES
4,343,253 643,280 459,322 3,785,973
3. The stockholders ratified the appointment of Ernst & Young LLP as the
Company's independent auditors for the fiscal year ending September 30,
2002:
FOR AGAINST ABSTAIN BROKER NON-VOTES
7,768,399 3,153 2,632 1,457,644
-18-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
3.1 Articles of Restatement of the Company (Incorporated by reference
to the Registration Statement on Form S-3 (File No. 333-82499)
filed with the Commission on July 8, 1999).
3.2 Amended and Restated Bylaws of the Company (Incorporated by
reference to the Company's Annual Report on Form 10-K for the
Fiscal Year ended September 30, 2000 filed with the Commission on
December 21, 2000).
11.1 Computation of Per Share Earnings.
99.1 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K
None
-19-
SIGNATURES
Pursuant to the requirements 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.
INTEGRAL SYSTEMS, INC.
----------------------
(Registrant)
Date: August 13, 2002 By: /s/
------------------------ -------------------------------------
Thomas L. Gough
President & Chief Operating Officer
Date: August 13, 2002 By: /s/
------------------------ -------------------------------------
Elaine M. Parfitt
Vice President &
Chief Financial Officer
-20-