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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 July 31, 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 No. 0-24015
STEELCLOUD, INC.
(Exact name of Registrant as specified in its charter)
VIRGINIA
(State or other jurisdiction of incorporation or organization)
54-1890464
(I.R.S. Employer Identification No.)
1306 Squire Court, Sterling, VA. 20166
(Address of principal executive offices) (zip code)
(703) 450-0400
(Registrant's telephone number, including area code)
(Former name or former address, if changed since last report) Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No______.
As of September 1, 2002 there were 10,047,661 shares of the
registrant's common stock outstanding.
SteelCloud, Inc.
Form 10-Q Index
For the Quarterly period ended July 31, 2002
Description Page
- ----------- ----
Part I. Financial Information.................................................................. 3
Item 1. Financial Statements...................................................................
Consolidated Balance Sheets as of July 31, 2002 and October 31, 2001................... 3
Consolidated Statements of Operations for the three and nine month periods
ended July 31, 2002 and 2001........................................................... 4
Consolidated Statements of Cash Flows for the nine month periods ended July 31,
2002 and 2001.......................................................................... 5
Notes to the Consolidated Financial Statements......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................. 9
Part II. Other Information...................................................................... 16
Item 1. Legal Proceedings...................................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders.................................... 16
Item 6. Exhibits and Reports on Form 8-K....................................................... 17
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STEELCLOUD, INC.
CONSOLIDATED BALANCE SHEETS
October 31, July 31,
2001 2002
------------ ------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 313,054 $ 1,402,430
Accounts receivable, net 6,201,621 5,112,500
Inventory, net 5,099,436 5,304,092
Income tax receivable 1,400,424 82,250
Deferred contract cost - 1,766,488
Prepaid expenses and other current assets 173,695 235,537
------------ ------------
Total current assets 13,188,230 13,903,297
Property and equipment, net 319,944 250,206
Equipment on lease, net 597,202 272,679
Goodwill and other intangible assets, net 2,770,572 2,474,910
Investments 150,000 37,500
Other assets 108,599 63,390
------------ ------------
Total assets $ 17,134,547 $ 17,001,982
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 3,293,030 $ 2,566,895
Accrued expenses 2,277,993 2,582,631
Notes payable, current 114,985 631,853
Unearned revenue 213,385 2,440,366
------------ ------------
Total current liabilities 5,899,393 8,221,745
Notes payable, long-term - 90,000
Line of credit, long-term 3,836,754 -
Stockholders' equity
Common stock, $.001 par value: 50,000,000 shares authorized,
10,214,545 and 10,447,611 shares issued at October 31, 2001 and
July 31, 2002, respectively;
10,215 10,448
Additional paid in capital 39,079,397 39,434,016
Treasury stock, at cost, 400,000 shares; (3,432,500) (3,432,500)
Accumulated deficit (28,258,712) (27,321,727)
------------ ------------
Total stockholders' equity 7,398,400 8,690,237
------------ ------------
Total liabilities and stockholders' equity $ 17,134,547 $ 17,001,982
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
3
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Nine Months Ended
July 31, July 31,
------------------------- -------------------------
2001 2002 2001 2002
(restated)
----------- ----------- ----------- -----------
Net revenues $ 7,203,426 $ 7,038,802 $21,720,709 $24,802,235
Cost of revenue 5,299,316 5,062,351 16,259,381 18,074,385
----------- ----------- ----------- -----------
Gross profit 1,904,110 1,976,451 5,461,328 6,727,850
Selling and marketing 182,963 328,039 563,375 902,458
General and administrative 1,036,272 1,399,134 3,593,052 4,383,542
Amortization of goodwill 98,554 98,554 295,662 295,662
----------- ----------- ----------- -----------
Income from operations 586,321 150,724 1,009,239 1,146,188
Interest expense, net 36,791 6,655 159,001 68,997
Other expense, net - 42,897 26,396 139,006
----------- ----------- ----------- -----------
Income before income taxes 549,530 101,172 823,842 938,185
Provision for income taxes 5,700 - 5,700 1,200
----------- ----------- ----------- -----------
Net income 543,830 101,172 818,142 936,985
Dividends to preferred stockholders 37,500 - 112,500 -
Cumulative effect of change in accounting principle - - 576,001 -
Net income attributable to common stockholders $ 506,330 $ 101,172 $ 129,641 $ 936,985
=========== =========== =========== ===========
Basic earnings per share $ 0.05 $ 0.01 $ 0.01 $ 0.09
Diluted earnings per share $ 0.04 $ 0.01 $ 0.01 $ 0.09
The accompanying notes are an integral part of these consolidated statements.
4
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
July 31,
2001 2002
--------------------------
Operating activities
Net income $ 818,142 $ 936,985
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of property and equipment 1,106,539 595,525
Amortization of goodwill and other intangibles 295,662 295,662
Loss on sale of leases - 5,396
Provision for bad debt - 261,740
Impairment charge - investment - 112,500
Stock Compensation Expense - 17,500
Changes in operating assets and liabilities:
Accounts receivable 5,803,077 827,381
Income tax receivable (1,259,118) 1,318,174
Inventory 898,715 (204,656)
Deferred contract cost - (1,766,488)
Prepaid expenses and other assets 19,182 (16,633)
Accounts payable (6,342,449) (726,135)
Accrued expenses 178,731 609,298
Deferred tax credit 1,108,386 -
Unearned revenue and other liabilities 154,597 2,226,981
----------- -----------
Net cash provided by operating activities 2,781,464 4,493,230
Investing activities
Purchase of property and equipment, net (461,876) (206,663)
Financing activities
Proceeds from exercise of common stock options - 272,694
Proceeds from notes payable - 725,000
Payments on notes payable (325,000) (358,131)
Repayments on line of credit, net (373,720) (3,836,754)
----------- -----------
Net cash used in financing activities (698,720) (3,197,191)
Net increase in cash and cash equivalents 1,620,868 1,089,376
Cash and cash equivalents at beginning of period 363,958 313,054
----------- -----------
Cash and cash equivalents at end of period $ 1,984,826 $ 1,402,430
=========== ===========
Supplemental cash flow information
Interest paid $ 52,750 $ 72,180
Income taxes paid $ 5,700 $ 1,200
The accompanying notes are an integral part of these consolidated financial
statements.
5
STEELCLOUD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The consolidated financial statements for the three and nine month periods ended
July 31, 2002 and 2001 are unaudited and include all adjustments which, in the
opinion of management, are necessary to present fairly the results of operations
for the periods then ended. All such adjustments are of a normal and recurring
nature. These consolidated financial statements should be read in conjunction
with the Annual Report on Form 10-K of SteelCloud, Inc. (the "Company") which
includes consolidated financial statements and notes thereto for the years ended
October 31, 2001 and 2000.
2. Debt
On January 18, 2002, the Company amended its primary line of credit whereby the
maximum availability was increased from $5 million to $7.5 million. The note
bears interest at the lower of (a) the Lender's Prime Rate per annum or (b) the
LIBOR Market Index Rate plus 2.5%. The line of credit expires on March 31, 2003.
The outstanding balance on the line of credit at October 31, 2001 and July 31,
2002 was approximately $3,837,000 and $0, respectively.
On February 1, 2002, the Company executed a promissory note in conjunction with
its line of credit in the amount of $725,000. The note bears interest at the
lower of (a) the Lender's Prime Rate per annum or (b) the LIBOR Market Index
Rate plus 2.5% and matures on July 5, 2003. The Company makes monthly principal
payments of approximately $43,000. The outstanding balance on the promissory
note at July 31, 2002 was approximately $512,000.
On April 1, 2002, the Company executed a two-year promissory note in conjunction
with a litigation settlement for approximately $240,000. The promissory note
bears interest at the prime rate and matures in May 2004. The Company makes
monthly payments of $10,000 plus accrued interest. The outstanding balance on
the note at July 31, 2002 was approximately $210,000.
3. Series A Convertible Preferred Stock
On March 13, 2000, the Company sold 3,000 shares of its Series A Convertible
Preferred Stock in a private placement, which is exempt from registration
provided by Regulation D Rule 506 promulgated by the Securities and Exchange
Commission under the Securities Act of 1933, as amended. The Company received
net proceeds of approximately $2.7 million, which was used to fund current and
future operations.
In addition, the Company issued warrants to the preferred investor and broker of
the transaction in the amount of 247,525 and 75,000 to purchase shares of the
Company's common stock at $3.64 and $4.57 per share, respectively.
6
During 2001, the Company implemented Emerging Issues Task Force ("EITF") Issue
No. 00-27, "Application of EITF Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios" to Certain Convertible Instruments" ("EITF 00-27"). Issue 1
of EITF 00-27 modified the calculation of beneficial conversion features for
convertible securities issued with detachable instruments for all transactions
subject to EITF Issue No. 98-5. In accordance with the transition provision of
EITF 00-27, companies are required to report any changes in the beneficial
conversion feature as a result of applying Issue 1 of EITF 00-27 as a cumulative
effect of a change in accounting principle at the time of implementation in
accordance with APB Opinion No. 20, "Accounting Changes". As a result of the
implementation of EITF 00-27, the Company restated its results for the six
months ended April 30, 2001 to record a charge representing an additional
allocation of value to the beneficial conversion feature of $576,001, or $0.06
per share, as a cumulative effect of a change in accounting principle.
In August 2001, the Company completed a transaction with its Preferred
Shareholders to redeem all of its outstanding Series A Convertible Preferred
Stock. Under the Redemption Agreement, the preferred shareholders retained
approximately 247,000 warrants previously issued. The Company delivered $2.5
million to its preferred shareholders in exchange for the then outstanding 2,620
shares of its Series A Convertible Preferred Stock. As a result of this
redemption, the Company had no outstanding shares of Series A Convertible
Preferred Stock as of October 31, 2001.
4. Contract Revenue
For the nine months ended July 31, 2002, the Company's deferred contract revenue
related to its server appliance contract awarded in January 2002 was
approximately $2.2 million. The deferred revenue represents payments received
for milestones achieved. This revenue will be recognized over the remaining life
of the contract, which is scheduled for completion in July 2003.
5. Earnings Per Share
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period and is calculated by dividing the net
earnings (loss) available to common shareholders by the weighted average number
of common shares outstanding. Diluted earnings per share is based on the
weighted average number of common shares outstanding plus common stock
equivalents associated with preferred stock, stock options and warrants to
purchase shares of common stock and is calculated by dividing net earnings
(loss) available to common shareholders by the weighted average number of common
shares outstanding used in the basic earnings per share calculation plus common
stock equivalents associated with preferred stock, stock options and warrants to
purchase shares of common stock.
7
6. Contingencies
Microsoft Licensing Agreement
In November 1998, International Data Products, Inc. (IDP), a wholly-owned
subsidiary of the Company, entered into a Government Integrator Agreement, as
amended, with Microsoft Corporation (Microsoft) for the licensing of certain
Microsoft software. On October 31, 2000, Microsoft filed suit against the
Company, and its subsidiary IDP, for breach of contract in the amount of
approximately $1.3 million. In response to that suit, the Company submitted a
motion to dismiss the case and filed a counterclaim of fraud on behalf of IDP in
the amount of $500,000. In March 2002, the Company and Microsoft agreed to
settle the dispute. Pursuant to the settlement, the Company and Microsoft
exchanged mutual full releases and the Company agreed to pay Microsoft
approximately $315,000. In accordance with the settlement, the Company paid
approximately $75,000 in cash and executed a two-year promissory note for the
balance of $240,000, maturing in May 2004 and bearing interest at the prime
rate. This will not have an impact on the Company's current operations as this
contingency was previously accrued in the Company's consolidated financial
statements.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained herein may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Because such statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, risks associated with the integration of
businesses following an acquisition, competitors with broader product lines and
greater resources, emergence into new markets, the termination of any of the
Company's significant contracts, the Company's inability to maintain working
capital requirements to fund future operations or the Company's inability to
attract and retain highly qualified management, technical and sales personnel.
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto included in Item 1 in this Quarterly
Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended
October 31, 2001 filed by the Company with the Securities and Exchange
Commission.
OVERVIEW
Founded in 1987, SteelCloud, Inc, based in Dulles, Virginia, designs, develops
and manufactures customized computer servers and network appliances. The
Company's primary business focus is to develop and manufacture products on an
OEM basis ("Original Equipment Manufacturer") for strategic software,
technology, and managed services partners. With its strategic partners,
SteelCloud creates and uniquely brands ready-to-use turnkey network server
appliance solutions combining both hardware and software. The Company integrates
its partner's, or other third-party software, into a custom designed server
platform. SteelCloud manufactures the resulting product under the partner's
brand name allowing the partner to deliver a complete turnkey solution.
SteelCloud's customer is its OEM partner rather than the end-user. The partner
is responsible for selling and distributing the OEM products developed by
SteelCloud. The Company enhances its product development and manufacturing
capability by providing custom supply chain and logistics support services to
its partners.
In addition to delivering computer products to the OEM market, SteelCloud
develops specialized servers and infrastructure products for large commercial
and government integrators, and certain governmental agencies. The Company is a
value-added reseller for the software products of its strategic partners and
certain other software providers. SteelCloud also provides Information
Technology (IT) support services to both the public sector and commercial
customers.
9
The following summarizes significant activity for the nine-month period ended
July 31, 2002.
Significant Contract
In January 2002, the Company was awarded several contracts by a Government
Integrator valued at more than $10.5 million for customized servers. The Company
commenced work under the contracts in February 2002 and is expected to complete
the contracts by July 2003. During the nine months ended July 31, 2002, the
Company recognized revenue of approximately $2.1 million and has deferred
contract revenue of approximately $2.2 million that will be recognized over the
life of the contracts.
Settlement of Licensing Claim
In November 1998, International Data Products, Inc. (IDP), a wholly-owned
subsidiary of the Company, entered into a Government Integrator Agreement, as
amended, with Microsoft Corporation (Microsoft) for the licensing of certain
Microsoft software. On October 31, 2000, Microsoft filed suit against the
Company, and its subsidiary IDP, for breach of contract in the amount of
approximately $1.3 million. In response to that suit, the Company submitted a
motion to dismiss the case and filed a counterclaim of fraud on behalf of IDP in
the amount of $500,000. In March 2002, the Company and Microsoft agreed to
settle the dispute. Pursuant to the settlement, the Company and Microsoft
exchanged mutual full releases and the Company agreed to pay Microsoft
approximately $315,000. In accordance with the settlement, the Company paid
approximately $75,000 in cash and executed a two-year promissory note for the
balance of $240,000, maturing in May 2004 and bearing interest at the prime
rate. This does not have an impact on the Company's current operations as this
contingency was previously accrued in the Company's consolidated financial
statements.
Sales Office Expansion
In December 2001 and March 2002, the Company established sales offices in
California and Boston, respectively, in order to meet the Company's growing
demands. These new office locations allow SteelCloud to expand its customer base
and to develop and deploy new products for its customers to promote future
revenue growth.
ISO Registration
SteelCloud has developed an environment of quality excellence by instilling, at
every level of the organization, the importance of customer satisfaction and
continual improvement. This experience led to the Company's decision, in January
2002, to implement a Quality System based on ISO 9001:2000, Quality Management
Systems - Requirements. ISO 9001:2000 is an internationally recognized quality
standard that provides a common sense, documented, business management system
that uncovers inefficiencies and provides a framework for Best Practices. The
Company expects registration to occur by March 2003.
10
CRITICAL ACCOUNTING POLICIES
The Company believes the following represents an update of its critical
accounting policies from October 31, 2001:
Significant Customers
As of July 31, 2002, approximately 42% of the Company's accounts receivable were
attributable to two commercial customers. Network Associates and its
subsidiaries ("NAI") accounted for approximately 27% and approximately 15% was
due from Lockheed Martin. As of September 1, 2002 approximately 30% of these
accounts receivables have been collected. For the three months ended July 31,
2002, these two customers accounted for approximately 53% of net revenues, or
46% and 7%, respectively. Given the nature of the products manufactured by the
Company as well as the delivery schedules established by its partners, revenue
and accounts receivable concentration by any single customer will fluctuate from
quarter to quarter. The Company anticipates that concentration levels will
decrease as their OEM customer base expands in future periods. Future revenues
and results of operations could be adversely affected should these customers
reduce their purchases, eliminate product lines or choose not to continue to buy
products and services from SteelCloud.
11
RESULTS OF OPERATIONS
For the three and nine months ended July 31, 2002 compared to the three and nine
months ended July 31, 2001
Net revenues for the three months ended July 31, 2002 were $7,038,802 as
compared to $7,203,426 a decrease of approximately 2% over the three months
ended July 31, 2001. Net revenues slightly decreased during the third quarter of
2002 primarily due to slower than expected acceptance rates by its customer
under its significant custom server contract. Although the Company was unable to
deliver the anticipated number of systems during the three months ended July 31,
2002, production volumes for those servers remained unchanged and as a result
recognition of these systems has been deferred until delivery is complete.
Accordingly, deferred revenues increased during the current quarter to
approximately $2.4 million at July 31, 2002 from approximately $213,000 as of
October 31, 2001. For the nine month period ended July 31, 2002 and 2001, net
revenues were $24,802,235 and $21,720,709, respectively, an increase of
approximately 14%. This increase was primarily the result of the Company's
growth trend experienced during its first two quarters of fiscal 2002.
Specifically, the Company experienced revenue growth from its server appliance
agreements with its significant customers. In response to the competitive
technology market, the Company continually modifies its product mix in order to
expand its customer base and provide future revenue growth.
For the three and nine month periods ended July 31, 2002, the Company continued
its trend of improved operating margins. As a percentage of net revenues, gross
margin increased to 28.08% for the three months ended July 31, 2002 from 26.43%
for the three months ended July 31, 2001. On a year to date basis, gross margin
increased from 25.14% during the first nine months of fiscal 2001 to 27.13%
during the same period of fiscal 2002. This increase in gross margin is
primarily the result of the Company modifying its product lines and product mix
it sells. The integration and support services, when bundled with hardware,
contribute to the overall increase in gross margins. Although development costs
associated with new products initially lower the gross margins, over time gross
margin improves as production volumes increase. Accordingly, gross margins as a
percentage of revenues, will fluctuate from quarter to quarter.
For the three months ended July 31, selling and marketing expenses increased to
$328,039 in fiscal 2002 from $182,963 in fiscal 2001, an increase of
approximately 79%. Selling and marketing expenses increased due to higher levels
of personnel costs associated with sales, sales initiatives and new product
releases. For the nine months ended July 31, selling and marketing expenses
increased from $563,375 in fiscal 2001 to $902,458 in fiscal 2002, approximately
a 60% increase. The increase can be attributable to certain investments in its
sales and marketing programs as evidenced by the Company expanding sales offices
into California and Boston during fiscal 2002. In addition, sales commissions
and incentives increased as a result of the revenue growth experienced during
the nine months ended July 31, 2002. The Company continues to invest in selling
and marketing initiatives in order to expand its customer base, and develop and
introduce new products for its partners. As a result, the Company is able to
maintain its diverse product line and product mix to promote future revenue
growth.
12
General and administrative expenses increased to $1,399,134 for the three months
ended July 31, 2002 from $1,036,272 for the same period in fiscal 2001, an
increase of approximately 35%. For the nine month period ended July 31, general
and administrative expenses increased to $4,383,542 in fiscal 2002 from
$3,593,052 in fiscal 2001, an increase of approximately 22%. In July 2001, the
Company settled certain liabilities for amounts less than accrued, whereby the
discounts received in these settlements reduced operating costs and expenses
incurred in defending and resolving those liabilities. Excluding those liability
settlements for fiscal 2001, general and administrative expenses for the three
and nine months ended July 31, 2002 increased approximately 1% and 11%,
respectively. In addition, for the three and nine months ended July 31, 2002,
the Company increased its valuation allowance for bad debt expense related to
certain receivables by approximately $161,000 and $262,000, respectively.
Management believes that it will continue to improve efficiencies and manage
costs to increase gross margins and maintain profitability.
Interest expense, net of interest income, decreased to $6,655 for the three
months ended July 31, 2002 from $36,791 for the three months ended July 31,
2001. For the nine months ended July 31, interest expense, net of interest
income, decreased to $68,997 in fiscal 2002 from $159,001 in fiscal 2001. The
decrease resulted from lower average debt balances combined with interest
savings from a decline in the short-term interest rate during fiscal year 2002.
Other expense, net of other income, primarily includes an impairment charge for
a permanent decline in fair value of an investment recorded under the cost
method. During fiscal 2002, the Company recorded a $112,500 impairment charge
for its investment in a private entity based on a decline in the fair value of
that investment below cost. For the three and nine month periods ended July 31,
other expense, net of other income, increased to $42,897 and $139,006,
respectively, in fiscal 2002 from $0 and $26,396, respectively, in fiscal 2001.
The increase is the result of recording a write down in the carrying value of
its investment during fiscal 2002.
The Company reported net income before dividends of $101,172 for the three
months ended July 31, 2002, as compared to net income before dividends of
$543,830 for the same period in the prior year. The decrease is primarily
attributable to the settlement of certain liabilities in FY2001. These
settlements were for amounts less than accrued and as a result reduced
operating expenses accordingly. For the nine months ended July 31, the Company
reported net income before dividends of $936,985 for fiscal 2002 as compared to
a net income before dividends of $818,142 for fiscal 2001. This was a result of
the Company's efforts to increase profit margins for the products sold and
services provided during the three and nine month periods ended July 31, 2002 as
well as the Company's efforts to manage costs relative to its net revenues.
13
LIQUIDITY AND CAPITAL RESOURCES
The principal source of the Company's cash is generated from its operations. For
the nine months ended July 31, 2002, the Company generated approximately
$4,493,230 in cash flow from its operating activities. The Company generated net
income of $936,985, collected approximately $827,381 of its receivables and
received unearned revenue of $2,226,981. In addition, the Company collected cash
of approximately $1,318,174 relating to its income tax receivables. The cash
generated was primarily used for accounts payable of approximately $726,135 and
deferred contract costs of $1,766,488.
Funds used for investing activities primarily consisted of the purchase of
property, equipment and leased assets of approximately $206,663. Net cash used
for financing activities consisted of net repayments on the line of credit of
approximately $3,836,754. During fiscal year 2002, the Company financed cash
though notes payable, net of ordinary payments, of approximately $366,869.
On January 18, 2002, the Company amended its existing line of credit from $5
million to $7.5 million, with an expiration date of March 31, 2003, bearing
interest at the lower of (a) prime rate or (b) the LIBOR Market Index Rate plus
2.5%. As of July 31, 2002, the Company had no advances on its line of credit;
however, the available borrowing capacity was approximately $3.3 million.
On February 1, 2002, the Company executed a promissory note in conjunction with
its line of credit in the amount of $725,000. The note bears interest at the
lower of (a) the Lender's Prime Rate per annum or (b) the LIBOR Market Index
Rate plus 2.5% and matures on July 5, 2003. The Company makes monthly principal
payments of approximately $43,000. The outstanding balance on the promissory
note at September 1, 2002 was approximately $469,000.
On April 1, 2002, the Company settled its litigation with Microsoft. In
conjunction with the settlement, the Company executed a two-year promissory note
with Microsoft for approximately $240,000 bearing interest at the prime rate and
with a maturity date of May 2004. The note is payable in monthly payments of
$10,000 plus accrued interest. As of September 1, 2002 the outstanding balance
on the note was approximately $200,000.
As of July 31, 2002, the Company had working capital of approximately $5.7
million and cash on hand of approximately $1.4 million compared to working
capital of approximately $7.3 million and cash on hand of approximately $313,000
as of October 31, 2001. The decrease in working capital is due to the
classification of the line of credit as long-term debt at October 31, 2001.
Accordingly, the $3.8 million line of credit balance was not included in the
working capital computation. The increase in cash is due to the collection of
trade receivables and tax refunds. The Company believes the bank facility,
together with cash on hand, and projected cash generated from operations will
provide sufficient financial resources to finance the current operations of the
Company through fiscal 2003.
From time to time, the Company may pursue strategic acquisitions or mergers,
which may require significant additional capital, and additional capital may be
required to satisfy unusual or infrequent expenses. In such event, the Company
may seek additional financing of debt and/or equity.
14
OFF-BALANCE SHEET ARRANGEMENTS
Contractual Obligations and Commercial Commitments
The Company's significant contractual obligations as of July 31, 2002 are for
debt and operating leases. Debt by year of maturity and future rental payments
under operating lease agreements are presented below. As of July 31, 2002, the
Company does not have an outstanding balance on its line of credit and does not
have any purchase obligations. The Company has not engaged in off-balance sheet
financing, commodity contract trading or significant related party transactions.
Contractual Obligations Payments Due by Period
------------------------------------------------------------------------------------
Total Less than 1 1-3 years 4-5 years After 5
year years
---------- ---------- ---------- ------------ ----------
Notes payable - current $ 631,853 $ 631,853 - - -
---------- ---------- ---------- ------------ ----------
Notes payable - long term 90,000 - 90,000 - -
---------- ---------- ---------- ------------ ----------
Operating lease 1,295,329 612,171 683,158 - -
---------- ---------- ---------- ------------ ----------
The Company will receive $437,262 in aggregate sublease income through fiscal
2003.
15
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 15, 2002, the Company held its 2001 Annual Meeting of Shareholders. At
the annual meeting, the Company's shareholders were asked to vote upon: (i) the
election of two class I Directors of the Company to serve until their respective
successors have been duly elected and qualified, (ii) the approval of an
amendment to the Company's 1997 Stock Option Plan, (iii) the approval of the
adoption of the Company's 2002 Stock Option Plan, (iv) the appointment of Ernst
& Young, LLP as the Company's independent certified public accountants for the
fiscal year ending October 31, 2002.
The following persons were elected as directors of the Company for the ensuing
year by votes next to such persons name:
For Withheld
Jay M. Kaplowitz 8,621,559 455,447
Richard Prins 8,631,459 445,437
Jay Kaplowitz and Richard Prins were each elected as Class I Directors and shall
serve until their respective successors have been fully elected and qualified.
The approval of an amendment to the Company's 1997 Stock Option Plan was
approved by the following vote:
For Against Abstain
3,655,026 638,418 35,842
The approval of the adoption of the Company's 2002 Stock Option Plan was
approved by the following vote:
For Against Abstain
3,637,393 634,016 56,477
Ernst & Young, LLP was approved to act as the Company's independent certified
public accountants for the ensuing year by the following vote:
For Against Abstain
9,039,813 23,947 13,136
16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1: Statement of computation of earnings per share.
Exhibit 99.1: Certification of CEO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 99.2: Certification of Vice President - Finance pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None
17
SIGNATURES
CERTIFICATION
I, Thomas P. Dunne, Chief Executive Officer of SteelCloud, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of SteelCloud, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 16, 2002
By: /s/ Thomas P. Dunne
----------------------------------
Thomas P. Dunne
Chief Executive Officer
EXPLANATORY NOTE REGARDING CERTIFICATIONS: Representation 4, 5 and 6 of the
Certifications as set forth in Form 10-Q have been omitted, consistent with the
Transition Provisions of SEC Exchange Act Release 34-46427, because this
Quarterly Report of Form 10-Q covers a period ending prior to the effective date
of Rules 13a-14 and 15d-14.
I, Edward Spear, President of SteelCloud, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of SteelCloud, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 16, 2002
By: /s/ Edward Spear
----------------------------------
Edward Spear
President
18
18
EXPLANATORY NOTE REGARDING CERTIFICATIONS: Representation 4, 5 and 6 of the
Certifications as set forth in Form 10-Q have been omitted, consistent with the
Transition Provisions of SEC Exchange Act Release 34-46427, because this
Quarterly Report of Form 10-Q covers a period ending prior to the effective date
of Rules 13a-14 and 15d-14.
I, Kevin Murphy, Vice President - Finance, of SteelCloud, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of SteelCloud, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 16, 2002
By: /s/ Kevin Murphy
----------------------------------
Kevin Murphy
Vice President - Finance
EXPLANATORY NOTE REGARDING CERTIFICATIONS: Representation 4, 5 and 6 of the
Certifications as set forth in Form 10-Q have been omitted, consistent with the
Transition Provisions of SEC Exchange Act Release 34-46427, because this
Quarterly Report of Form 10-Q covers a period ending prior to the effective date
of Rules 13a-14 and 15d-14.
19