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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 April 30, 2003
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, Dulles, 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
------ ------.
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 June 1, 2003 there were 10,121,808 shares of the registrant's
common stock outstanding.
SteelCloud, Inc.
Form 10-Q Index
For the Quarterly period ended April 30, 2003
Description Page
Part I. Financial Information............................................................... 3
Item 1. Financial Statements................................................................
Consolidated Balance Sheets as of October 31, 2002 and April 30, 2003............... 3
Consolidated Statements of Operations for the three and six month periods ended
April 30, 2002 and 2003 ....................................................... 4
Consolidated Statements of Cash Flows for the six month periods ended April 30,
2002 and 2003....................................................................... 5
Notes to the Consolidated Financial Statements...................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risks......................... 17
Item 4. Controls and Procedures............................................................. 17
Part II. Other Information................................................................... 18
Item 1. Legal Proceedings................................................................... 18
Item 4. Submission of Matters to a vote of Security Holders................................. 18
Item 6. Exhibits and Reports on Form 8-K.................................................... 19
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STEELCLOUD, INC.
CONSOLIDATED BALANCE SHEETS
October 31, April 30,
2002 2003
------------------ --------------------
ASSETS (unaudited)
Current assets
Cash and cash equivalents $751,323 $561,467
Accounts receivable, net of allowance for doubtful
accounts of $293,000 as of October 31, 2002 and
April 30, 2003
6,082,340 4,301,092
Inventory, net 4,180,812 3,882,346
Deferred tax asset 400,000 400,000
Income tax receivable 55,392 55,392
Prepaid expenses and other current assets 208,892 350,366
Deferred contract costs 2,039,339 1,234,408
Assets held for sale 953,320 332,347
------------------ --------------------
Total current assets 14,671,418 11,117,418
Property and equipment, net 304,081 350,890
Equipment on lease, net 574,272 396,244
Goodwill and other intangible assets, net 1,778,059 1,778,059
Other assets 304,922 278,682
------------------ --------------------
Total assets $17,632,752 $13,921,293
================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $3,620,580 $2,810,054
Accrued expenses 1,542,277 1,514,144
Notes payable, current 503,823 253,899
Unearned revenue 4,507,859 1,866,465
Liabilities related to held for sale operations 641,145 434,139
------------------ --------------------
Total current liabilities 10,815,684 6,878,701
Note payable, long-term 60,000 31,139
Stockholders' equity
Common stock, $.001 par value: 50,000,000 shares authorized,
10,447,611 and 10,521,558 shares issued and outstanding at October
31, 2002 and April 30, 2003 10,448 10,522
Additional paid in capital 39,553,017 39,618,541
Treasury stock, 400,000 shares at October 31, 2002 and April 30, 2003,
respectively (3,432,500) (3,432,500)
Accumulated deficit (29,373,897) (29,185,110)
------------------ --------------------
Total stockholders' equity 6,757,068 7,011,453
------------------ --------------------
Total liabilities and stockholders' equity $17,632,752 $13,921,293
================== ====================
The accompanying notes are an integral part of these consolidated financial
statements.
3
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
April 30, April 30,
2002 2003 2002 2003
--------------- ---------------- ---------------- ----------------
Net revenues $7,626,046 $8,219,870 $16,980,112 $15,854,038
Cost of revenue 5,501,406 6,381,862 12,341,270 12,473,693
--------------- ---------------- ---------------- ----------------
Gross profit 2,124,640 1,838,008 4,638,842 3,380,345
Selling and marketing 247,375 336,225 561,196 634,949
Research and product development - 110,595 - 110,595
General and administrative 1,204,388 1,247,092 2,505,337 2,375,820
Amortization of goodwill 98,554 - 197,108 -
--------------- ---------------- ---------------- ----------------
Income from continuing operations 574,323 144,096 1,375,201 258,981
Interest expense, net 8,337 7,899 58,196 13,739
Other expense, net 72,944 - 68,789 -
--------------- ---------------- ---------------- ----------------
Income before income taxes 493,042 136,197 1,248,216 245,242
Provision for income taxes - - 1,200 -
--------------- ---------------- ---------------- ----------------
Net income from continuing operations 493,042 136,197 1,247,016 245,242
Loss from discontinued operations 143,736 26,954 411,204 56,455
--------------- ---------------- ---------------- ----------------
Net income $ 349,306 $ 109,243 $ 835,812 $ 188,787
=============== ================ ================ ================
Earnings per share (basic):
Earnings from continuing operations $0.05 $ 0.01 $0.12 $ 0.02
Discontinued operations (0.01) - (0.03) -
--------------- ---------------- ---------------- ----------------
Net earnings per share $0.04 $ 0.01 $0.09 $ 0.02
=============== ================ ================ ================
Earnings per share (diluted):
Earnings from continuing operations $0.04 $ 0.01 $0.11 $ 0.02
Discontinued operations (0.01) - (0.03) -
--------------- ---------------- ---------------- ----------------
Net earnings per share $0.03 $ 0.01 $0.08 $ 0.02
=============== ================ ================ ================
Weighted-average shares outstanding, basic 9,915,645 10,070,309 9,863,110 10,058,236
Weighted-average shares outstanding, diluted 11,121,418 10,459,199 10,787,035 10,433,425
The accompanying notes are an integral part of these consolidated statements.
4
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
April 30,
2002 2003
--------------------------------
Operating activities
Net income $835,812 $188,787
Loss from discontinued operations 411,204 56,455
--------------------------------
Net income from continuing operations 1,247,016 245,242
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of property and equipment 405,947 176,843
Amortization of goodwill and other intangibles 197,108 -
Provision for bad debt 100,577 -
Impairment charge - investment 75,000 -
Stock compensation expense 17,500 -
Changes in operating assets and liabilities:
Accounts receivable 2,571,269 1,781,248
Income tax receivable 1,315,674 -
Inventory 2,774 334,932
Prepaid expenses and other assets 44,306 (115,234)
Deferred contract costs (1,465,167) 804,931
Accounts payable (2,004,405) (810,526)
Accrued expenses 791,058 (28,133)
Unearned revenue and other liabilities 1,594,092 (2,641,394)
--------------------------------
Net cash provided (used) by operating activities 4,892,749 (252,091)
Investing activities
Purchase of property and equipment (192,939) (43,060)
Financing activities
Proceeds from issuance of common stock - 56,166
Proceeds from exercise of common stock options 228,288 9,432
Proceeds (payments) on notes payable 528,978 (317,815)
Repayments on line of credit, net (3,836,754) -
--------------------------------
Net cash used in financing activities (3,079,488) (252,217)
Net increase (decrease) in cash and cash equivalents of continuing
operations 1,620,322 (547,368)
Net cash (used in) provided by operating activities of discontinued
operations (443,749) 357,512
Cash and cash equivalents at beginning of period 282,318 751,323
--------------------------------
Cash and cash equivalents at end of period $1,458,891 $561,467
================================
Supplemental cash flow information
Interest paid $52,383 $8,914
Income taxes paid $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 six month periods ended
April 30, 2003 and 2002 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, 2002 and 2001.
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", as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation--Transition and Disclosure" which requires pro-forma
disclosure of compensation expense associated with stock options under the fair
value method.
The Company's pro forma information follows:
Three Months Ended Six Months Ended
April 30, April 30,
2002 2003 2002 2003
------------ ------------- ------------ -------------
Net earnings, as reported.......................... $ 349,306 $ 109,243 $ 835,812 $188,787
Less: Total stock based employee compensation
expense determined under the fair-value based
method............................................. 341,607 103,314 573,796 211,407
------------ ------------- ------------ -------------
Pro-Forma net earnings (loss)...................... $ 7,699 $ 5,929 $ 262,016 $ (22,620)
============ ============= ============ =============
Basic earnings per share as reported................ $ 0.04 $ 0.01 $ 0.09 $ 0.02
============ ============= ============ =============
Basic pro-forma net earnings per share.............. $ 0.00 $ 0.00 $ 0.03 $ 0.00
============ ============= ============ =============
Diluted earnings per share as reported............... $ 0.03 $ 0.01 $ 0.08 $ 0.02
============ ============= ============ =============
Diluted pro-forma net earnings per share............. $ 0.00 $ 0.00 $ 0.02 $ 0.00
============ ============= ============ =============
6
3. Discontinued Operations
The Company continually evaluates its operating facilities with regard to its
long-term strategic goals established by management and the Board of Directors.
Operating facilities, which are not expected to contribute to the Company's
future operations are either closed or sold. On October 25, 2002, management,
with the approval of the Board of Directors, determined that its Puerto Rico
Industrial Manufacturing Operation ("PRIMO") would no longer contribute to
future operations and therefore adopted a plan to dispose that operation
effective on that date. The plan estimates that disposal will be complete in the
later part of fiscal 2003. Accordingly, the Company has reflected PRIMO as
discontinued operations in the current financial statements. As a result, prior
year amounts have been reclassified to segregate the continuing operations from
the discontinued operations. The Company is pursuing a sale of the PRIMO
business. However, if a suitable buyer is not found in the foreseeable future,
management may choose to shut down the PRIMO operations. The loss associated
with the discontinued operation was approximately $27,000 and $56,000 for the
three and six-month periods ended April 30, 2003. The Company believes that
given the current environment of that market, discontinuing the operation was
the best alternative.
A summary of the financial information for the discontinued operation is as
follows:
Three Months Ended Six Months Ended
April 30, April 30,
2002 2003 2002 2003
------------ ------------ ------------ ------------
Net revenues........................... $451,162 $36,348 $783,321 $80,992
Gross profit........................... 105,421 34,456 112,557 67,837
Loss from discontinued operations...... (143,736) (26,954) (411,204) (56,455)
October 31, April 30,
2002 2003
---------------- ---------------
Accounts receivable, net............................. $ 682,978 $ 127,488
Inventory, net....................................... 188,698 161,471
Other assets......................................... 81,644 43,388
---------------- ---------------
Total assets......................................... 953,320 332,347
================ ===============
Accrued expenses..................................... $590,526 $383,520
Accounts payable and other liabilities............... 50,619 50,619
---------------- ---------------
Total liabilities.................................... 641,145 434,139
================ ===============
7
4. Inventory and Deferred Contract Costs
Inventory consists of materials and components used in the assembly of the
Company's products and are stated at the lower of cost or market as determined
by the first-in first-out (FIFO) method. The Company periodically evaluates its
inventory obsolescence reserve to ensure inventory is recorded at net realizable
value. As of April 30, 2003, the Company had an inventory reserve of
approximately $585,000. Of that reserve, approximately $460,000 relates to
inventory on-hand resulting from the termination of a significant contract with
the Federal Government for which a claim has been submitted to recover those
inventory costs. The Company believes that as part of the adjudication process,
there will be negotiations of our initial claim amount. Accordingly, our reserve
is based on our best estimate of that adjudication process. The remainder of our
reserve represents estimates of potential shrinkage that are inherent in the
purchasing and assembly process.
Deferred contract costs represents costs associated with products where title
has transferred but revenue has been deferred in accordance with the Company's
revenue recognition policy. At April 30, 2003, the Company had recorded
approximately $1.2 million of deferred contract costs.
5. Debt
On March 31, 2003, the Company amended its primary line of credit whereby the
maximum availability was decreased from $7.5 million to $3.5 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, 2004.
There was no outstanding balance on the line of credit at October 31, 2002 and
April 30, 2003.
On February 1, 2002, the Company executed a promissory note in conjunction with
their 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's monthly principal
payments are approximately $43,000. The outstanding balance on the promissory
note at October 31, 2002 and April 30, 2003 was approximately $384,000 and
$128,000 respectively.
On April 1, 2002, the Company executed a two-year promissory note in conjunction
with a litigation settlement reached in March 2002 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 October 31, 2002 and April 30, 2003 was
approximately $180,000 and $120,000 respectively.
6. Contract Revenue
For the six-month period ended April 30, 2003, the Company's deferred contract
revenue related to a server appliance contract awarded was approximately $1.6
million. The deferred revenue represents payments received for milestones
achieved prior to shipment. This revenue will be recognized over the remaining
life of the contract as units are shipped under the contract, which is scheduled
for completion in August 2003.
8
7. Earnings Per Share
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period and is calculated by dividing the net
earnings (loss) available to common shareholders by the weighted average number
of common shares outstanding. Diluted earnings per share is based on the
weighted average number of common shares outstanding plus common stock
equivalents associated with stock options and 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 stock options.
9
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, 2002 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. Steel
Cloud'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.
10
FISCAL 2003
Product Development
In fiscal 2003, SteelCloud undertook initiatives to enhance its product
offerings and improve its margins. Product packaging including the appliance
chassis has become a major differentiating factor in the marketing of an
appliance server. SteelCloud has increased its capability to develop both custom
and standard chassis offerings for its clients. The result of this work has been
three new appliance platforms that can be easily tailored to the needs of a
particular software package or technology. The Company believes that the
intellectual property that it has developed will enable it to be more
competitive from a packaging perspective while decreasing the costs necessary to
bring a product to market. With its goal of increasing margins, in the second
quarter of fiscal 2003, SteelCloud expanded its appliance business model to
encompass more direct control in the development and marketing of its
appliances. The Company is developing a family of hardened (highly secured
operating system) security appliances that it will offer as SteelCloud product
or as co-branded appliances with its software partners. Accordingly, the Company
commenced its research and development activities associated with these new
product offerings in its second quarter of fiscal 2003. During the quarter, the
Company incurred research and development costs of $110,600, which is a
significant increase over the same period in the prior year. The Company will
continue to incur these costs as these products are brought to market. The
Company anticipates that these products will be released to market in the latter
part of fiscal 2003.
Discontinued Operations
The Company continually evaluates its operating facilities with regard to its
long-term strategic goals established by management and the Board of Directors.
Operating facilities, which are not expected to contribute to the Company's
future operations are either closed or sold. On October 25, 2002, management,
with the approval of the Board of Directors, determined that its Puerto Rico
Industrial Manufacturing Operation ("PRIMO") would no longer contribute to
future operations and therefore adopted a plan to dispose that operation
effective on that date. The plan estimates that disposal will be complete in the
latter part of fiscal 2003. Accordingly, the Company has reflected PRIMO as
discontinued operations in the current financial statements. As a result, prior
year amounts have been reclassified to segregate the continuing operations from
the discontinued operations. The Company is pursuing a sale of the PRIMO
business. However, if a suitable buyer is not found in the foreseeable future,
management may choose to shut down the PRIMO operations. The loss associated
with the discontinued operation was approximately $27,000 and $56,000 for the
three and six-month periods ended April 30, 2003. The Company believes that
given the current environment of that market, discontinuing the operation was
the best alternative.
11
Goodwill and Other Intangible Assets
Effective November 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets". As a result, the Company no longer amortizes goodwill
and periodically tests goodwill for possible impairment. For the three and six
month periods ended April 30, 2003, reduction in goodwill amortization was
approximately $99,000 and $197,000. Summarized below are the effects on net
income and net income per share if we had not amortized goodwill pursuant to the
provisions of SFAS No. 142 for all periods presented.
Three Months Ended Six Months Ended
April 30, April 30,
2002 2003 2002 2003
------------- ------------ ------------ ------------
Net income
As reported.............................. $ 349,306 $ 109,243 $835,812 $188,787
Add goodwill amortization................ 98,554 - 197,108 -
------------- ------------ ------------ ------------
Adjusted net income...................... $ 447,860 $ 109,243 $1,032,920 $188,787
Earnings per share:
Basic:
As reported.............................. $0.04 $0.01 $0.09 $0.02
Add goodwill amortization................ 0.01 - 0.02 -
------------- ------------ ------------ ------------
Adjusted earnings per share (basic)...... $0.05 $0.01 $0.11 $0.02
Diluted:
As reported.............................. $0.03 $0.01 $0.08 $0.02
Add goodwill amortization................ 0.01 - 0.02 -
------------- ------------ ------------ ------------
Adjusted earnings per share (diluted).... $0.04 $0.01 $0.10 $0.02
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 August 2003. For the three-month and six-month periods ended
April 30, 2003, the Company recognized revenue of approximately $2.5 million and
$4.4 million, respectively (or approximately 31% and 28%, respectively, of total
net revenues). The Company has deferred revenues of approximately $1.6 million
and deferred contract costs of approximately $1.2 million associated with this
contract as of April 30, 2003. These amounts will be recognized over the life of
the contracts as units are shipped. In addition, for the six-month period ended
April 30, 2003, the Company had other contracts with this same customer totaling
approximately $172,000 or 1% of its net revenues.
12
CRITICAL ACCOUNTING POLICIES
The Company believes the following represents an update of its critical
accounting policies from October 31, 2002:
Significant Customers
As of April 30, 2003, the Company generated approximately $4.6 million and $1.7
million or 29% and 11% of its total net revenues from contracts and awards with
Lockheed Martin and General Services Administration for the six-month period
then ended, 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 its customer base and new product offerings expand 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.
Revenue Recognition
The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements (SAB 101), as amended by
SAB 101A and 101B. SAB 101 requires that four basic criteria must be met before
revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2)
delivery has occurred or services rendered; (3) the fee is fixed and
determinable: and (4) collectibility is reasonably assured. Determination of
criteria (3) and (4) are based on management's judgments regarding the fixed
nature of the fee charged for services rendered and products delivered and the
collectibility of those fees. Should changes in conditions cause management to
determine these criteria are not met for certain future transactions, revenue
recognized for any reporting period could be adversely affected.
Hardware products sold are generally covered by a warranty for periods ranging
from one to three years. The Company accrues a warranty reserve for estimated
costs to provide warranty services. The Company's estimate of costs to service
its warranty obligations is based on historical experience and expectation of
future conditions. To the extent the Company experiences increased warranty
claim activity or increased costs associated with servicing those claims, its
warranty accrual will increase resulting in decreased gross profit.
For technology support services under time and material contracts, the Company
recognizes revenue as services are provided based on contracted rates and
materials are delivered.
13
RESULTS OF OPERATIONS
For the three and six months ended April 30, 2003 compared to the three and six
months ended April 30, 2002
Net revenues for the three months ended April 30 were $8,219,870 in fiscal 2003
as compared to $7,626,046 in fiscal 2002, an increase of approximately 8%.
Revenues from contracts and government awards increased to approximately $4.5
million in fiscal 2003 from $1.7 million in fiscal 2002, an increase of
approximately 159%. The increase was primarily the result of a $1.5 million
award with the federal government in the second quarter of fiscal 2003 in
addition to increased deliveries on the Company's $10 million server appliance
contract. Revenues under the server appliance contract for the three months
ended April 30, 2003 was approximately $2.5 million compared to approximately
$1.4 million for the same period in fiscal 2002. In addition, the Company
experienced revenue growth in its OEM products, reselling activities and
consulting services. These increases offset a decrease in revenue from one of
the Company's significant customers, Network Associates, for which the supply
agreement expired on December 31, 2002. Revenues from this customer were
approximately $3.6 million for the three months ended April 30, 2002 compared to
approximately $221,000 for the three months ended April 30, 2003, a decrease of
approximately $3.4 million. For the six month period ended April 30, 2003 and
2002, net revenues were $15,854,038 and $16,980,112, respectively. Revenues
under the Network Associates supply agreement for the six months ended April 30,
2003 and 2002 were approximately $435,000 and $11.1 million, respectively. The
Company will continue to expand its sales force and product offerings in order
to diversify its revenue sources.
Gross margins, as a percentage of net revenues, decreased to 22.4% for the three
months ended April 30, 2003 from 27.9% for the three months ended April 30,
2002. The decrease in gross margin is primarily the result of the Company's
shift in its product mix and revenue sources during fiscal 2003. Accordingly,
gross margins as a percentage of revenues, will fluctuate from quarter to
quarter. In addition, the Company has not begun to realize the anticipated
effects of its new strategy to boost margins via new product development.
For the three months ended April 30, selling and marketing expenses increased
36% to $336,225 in fiscal 2003 from $247,375 in fiscal 2002. In fiscal 2003, the
Company increased its sales force to expand markets and produce revenue growth.
During the second quarter of fiscal 2003, costs associated with new sales
positions and sales incentives increased by approximately $50,000 over the same
period in fiscal 2002. For the six months ended April 30, selling and marketing
expenses increased to $634,949 in fiscal 2003 from $561,196 in fiscal 2002,
approximately a 13% increase. The Company continues to invest in selling and
marketing initiatives in order to expand its customer base and successfully
deploy its new product offerings.
14
General and administrative expense for the three months ended April 30, 2003
increased approximately 4% to $1,247,092 from $1,204,388 for the same period in
fiscal 2002. As a percentage of net revenues, general and administrative costs
decreased slightly to 15% for fiscal 2003 from 16% in fiscal 2002. During the
second quarter of fiscal 2003, the Company increased its general and
administrative salaries and benefits by approximately $54,000 over the same
period in the previous year. For the six month period ended April 30, general
and administrative expenses decreased approximately 5% to $2,375,820 in fiscal
2003 from $2,505,337 in fiscal 2002. The reduction of approximately $130,000
primarily is the result of overall decreased salaries and benefits in fiscal
2003 compared to fiscal 2002.
It is important to note that during the second quarter of fiscal 2003, the
Company commenced its efforts in developing its own products and appliances.
Accordingly, the Company incurred approximately $110,600 of research and
development costs for the three months ended April 30, 2003. The Company will
continue to incur these expenses in order to bring these products to market. The
Company anticipates that these products will be released to market during the
latter part of fiscal 2003.
Other expense, including interest, for the three months ended April 30, 2003
decreased to $7,899 from $81,281 for the three months ended April 30, 2002.
Interest expense remained flat during fiscal 2002 and 2003, decreasing slightly
from $8,337 to $7,899, respectively. For the six months ended April 30, 2003,
other expense, including interest, decreased to $13,739 from $126,985 for the
six months ended April 30, 2002. The decrease is the result of the Company
recording an impairment charge of $75,000 relating to the decline in market
value of one of its investments during the second quarter of fiscal year 2002.
In addition, the decrease can be attributable to the Company's reduction in its
outstanding debt during fiscal 2003 as well as an overall decline in the
short-term interest rate in fiscal 2003 compared to fiscal 2002.
For the three and six month periods ending April 30, 2003, there was no
provision for income taxes, as the Company has approximately $8.5 million in net
operating loss carryforwards for income tax reporting purposes, which are
available to offset current and future taxable income. A valuation allowance has
been established against the associated deferred tax asset to reflect the asset
at an amount that more likely than not will be realized.
The Company reported net income from continuing operations of $136,197 for the
three months ended April 30, 2003, as compared to net income from continuing
operations of $493,042 for the same period in the prior year. For the six months
ended April 30, the Company reported net income from continuing operations of
$245,242 for fiscal 2003 as compared to a net income from continuing operations
of $1,247,016 for fiscal 2002. This decrease was a result of the Company's
decline in gross margins and the increase in selling, general and administrative
costs during the three and six-month periods ended April 30, 2003.
15
LIQUIDITY AND CAPITAL RESOURCES
The principal source of the Company's cash is from its operations. For the six
months ended April 30, 2003, the Company used approximately $252,091 in cash
flow for its operating activities. The Company generated net income from
continuing operations of $245,242, collected approximately $1,781,248 of its
receivables, reduced inventory by $334,932 and recognized deferred costs of
$804,931. The cash generated was primarily used to pay accounts payable and
accrued expenses of approximately $810,526. In addition, the Company recognized
deferred revenue of $2,641,394.
Funds used for investing activities consisted of the purchase of property,
equipment and leased assets of approximately $43,060. Net cash used for
financing activities consisted of repayments of notes payable of $317,815.
On March 31, 2003, the Company amended its existing line of credit from $7.5
million to $3.5 million, with an expiration date of March 31, 2004, bearing
interest at the lower of (a) prime rate or (b) the LIBOR Market Index Rate plus
2.5%. As of April 30, 2003, the Company had no advances on its line of credit;
however, the available borrowing capacity was approximately $3.4 million.
On February 1, 2002, the Company executed a promissory note in conjunction with
their 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 June 1, 2003 was approximately $85,000.
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 June 1, 2003 the outstanding balance on the
note was approximately $110,000.
As of April 30, 2003, the Company had working capital of approximately $4.2
million and cash on hand of approximately $561,000 compared to working capital
of approximately $3.9 million and cash on hand of approximately $751,323 as of
October 31, 2002. The increase in working capital is due the collection of
receivables, reduction of inventory and recognition of deferred contract
revenues and costs. 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.
16
OFF-BALANCE SHEET ARRANGEMENTS
Contractual Obligations and Commercial Commitments
The Company's significant contractual obligations as of April 30, 2003 are for
debt and operating leases. Debt by year of maturity and future rental payments
under operating lease agreements are presented below. As of April 30, 2003, 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 $ 253,899 $ 253,899 - - -
- ----------------------------------- ----------------- ---------------- --------------- ------------- -------------
Notes payable - long term $ 31,139 - $ 19,353 $11,786 -
- ----------------------------------- ----------------- ---------------- --------------- ------------- -------------
Operating lease $ 707,977 $ 433,316 $ 274,661 - -
- ----------------------------------- ----------------- ---------------- --------------- ------------- -------------
The Company will receive $109,317 in aggregate sublease income through the
remainder of fiscal 2003.
Management believes that these commitments will be satisfied with current
operating cash flow.
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
$38,000.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 15, 2002, the Company held its 2002 Annual Meeting of Shareholders. At
the annual meeting, the Company's shareholders were asked to vote upon: (i) the
election of two Class II directors, and (ii) the appointment of an independent
accounting firm for the ensuing year.
The following persons were elected as directors of the company for the ensuing
year by the votes next to such persons name:
FOR WITHHELD
James Bruno 9,333,196 52,859
VADM E.A. Burkhalter, Jr. USN 9,327,246 58,809
James Bruno and VADM E.A. Burkhalter, Jr. USN were each elected as Class II
Directors and shall serve until their respective successors have been duly
elected and qualified.
Grant Thornton LLP was approved to act as the Company's independent certified
public accountants for the ensuing year by the following vote:
FOR AGAINST ABSTAIN
9,364,010 17, 285 4,760
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1: Statement of computation of earnings per share.
99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 by Thomas P. Dunne
99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 by Kevin Murphy
(b) Reports on Form 8-K
On March 13, 2003, the Company filed a report on Form 8-K pursuant to Item 5
"Other Events" and Item 7 "Financial Statements, Pro Forma Financial Information
and Exhibits".
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.
June 11, 2003 STEELCLOUD, INC.
By: /s/ Thomas P. Dunne
-------------------
Name: Thomas P. Dunne
Title: Chief Executive Officer
By: /s/ Kevin Murphy
----------------
Name: Kevin Murphy
Title: Vice President Finance
19
CERTIFICATIONS
I, Thomas P. Dunne, 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;
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;
4.The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5.The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls.
6.The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: June 11, 2003
/s/ Thomas P. Dunne
------------------------
Thomas P. Dunne
Chief Executive Officer
20
I, Edward Spear, 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;
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;
4.The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5.The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls.
6.The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: June 11, 2003
/s/ Edward Spear
----------------
Edward Spear
President
21
I, Kevin Murphy, 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;
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;
4.The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5.The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls.
6.The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: June 11, 2003
/s/ Kevin Murphy
----------------
Kevin Murphy
Vice President Finance
22