UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 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, 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______.
As of March 1, 2002 there were 10,284,876 shares of the
registrant's common stock outstanding.
1
SteelCloud, Inc.
Form 10-Q Index
For the Quarterly period ended January 31, 2002
Description Page
Part I. Financial Information.............................................................. 3
Item 1. Financial Statements...............................................................
Consolidated Balance Sheets as of October 31, 2001 and January 31, 2002............. 3
Consolidated Statements of Operations for the three month periods ended January 31,
2001 and 2002 ....................................................... 4
Consolidated Statements of Cash Flows for the three month periods ended January 31,
2001 and 2002....................................................................... 5
Notes to the Consolidated Financial Statements...................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 8
Part II. Other Information................................................................... 12
Item 1. Legal Proceedings................................................................... 12
Item 6. Exhibits and Reports on Form 8-K.................................................... 13
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STEELCLOUD, INC.
CONSOLIDATED BALANCE SHEET
October 31, January 31,
2001 2002
------------ -------------
ASSETS (unaudited)
Current assets
Cash and cash equivalents $ 313,054 $ 223,499
Accounts receivable, net 6,201,621 4,967,427
Inventory, net 5,099,436 5,428,975
Income tax receivable 1,400,424 1,400,424
Prepaid expenses and other current assets 173,695 191,131
------------ ------------
Total current assets 13,188,230 12,211,456
Property and equipment, net 319,944 230,151
Equipment on lease, net 597,202 490,580
Goodwill and other intangible assets, net 2,770,572 2,672,018
Investments 150,000 150,000
Other assets 108,599 106,852
------------ ------------
Total assets $ 17,134,547 $ 15,861,057
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 3,293,030 $ 3,444,918
Accrued expenses 2,277,993 2,245,767
Notes payable, current 114,985 7,621
Unearned revenue 213,385 711,408
------------ ------------
Total current liabilities 5,899,393 6,409,714
Line of credit - long-term 3,836,754 1,566,437
Stockholders' equity
Common stock, $.001 par value: 50,000,000 shares authorized,
10,214,545 shares issued and outstanding at October 31, 2001
and January 31, 2002 10,215 10,215
Additional paid in capital 39,079,397 39,079,397
Treasury stock, 400,000 shares; (3,432,500) (3,432,500)
Accumulated deficit (28,258,712) (27,772,206)
------------ ------------
Total stockholders' equity 7,398,400 7,884,906
------------ ------------
Total liabilities and stockholders' equity $ 17,134,547 $ 15,861,057
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
3
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended
January 31,
2001 2002
------------ -----------
(restated)
Net revenues $ 7,188,899 $ 9,686,225
Cost of revenue 5,440,561 7,164,887
----------- -----------
Gross profit 1,748,338 2,521,338
Selling and marketing 160,765 319,723
General and administrative 1,283,541 1,569,061
Amortization of goodwill 98,554 98,554
----------- -----------
Income from operations 205,478 534,000
Interest expense, net (98,255) (50,449)
Other income - 4,155
----------- -----------
Income before income
taxes 107,223 487,706
Provision for income taxes - 1,200
----------- -----------
Net income 107,223 486,506
----------- -----------
Dividends to preferred stockholders (37,500) -
Cumulative effect of change in accounting principle (576,001) -
----------- -----------
Net income (loss) attributable to common stockholders $ (506,278) $ 486,506
=========== ===========
Earnings per share:
Earnings (loss) per share, basic and diluted $ (0.05) $ 0.05
=========== ===========
The accompanying notes are an integral part of these consolidated statements.
4
STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended
January 31,
2001 2002
----------- -----------
Operating activities
Net income $ 107,223 $ 486,506
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of property and equipment
467,500 242,657
Amortization of goodwill and other intangibles 98,554 98,554
Changes in operating assets and liabilities:
Accounts receivable 5,559,219 1,796,274
Income tax receivable (1,239,761) -
Inventory (3) (329,539)
Prepaid expenses and other assets 10,924 (15,689)
Accounts payable (4,344,243) 151,888
Accrued expenses (548,761) (32,226)
Deferred tax credit 1,122,886 -
Unearned revenue and other liabilities 104,039 (64,057)
----------- -----------
Net cash provided by operating activities 1,337,577 2,334,368
Investing activities
Purchase of property and equipment (248,909) (46,242)
Financing activities
Payments on notes payable (108,497) (107,364)
Repayments on line of credit, net (803,703) (2,270,317)
----------- -----------
Net cash used in financing activities (912,200) (2,377,681)
----------- -----------
Net (decrease) increase in cash and cash equivalents 176,468 (89,555)
Cash and cash equivalents at beginning of period 363,958 313,054
----------- -----------
Cash and cash equivalents at end of period $ 540,426 $ 223,499
=========== ===========
Supplemental cash flow information
Interest paid $ 111,891 $ 52,383
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 month periods ended January
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, 2000 and 1999.
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 January
31, 2002 was approximately $3,837,000 and $1,566,000, respectively.
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%. The Company will make monthly principal payments of
approximately $43,000 through the maturity date of July 5, 2003.
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.
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 quarter
ended January 31, 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.
6
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. Earnings Per Share
Basic and diluted earnings per common share are calculated by dividing the net
earnings (loss) available to common shareholders by the weighted average number
of common shares outstanding.
5. 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. During 1999, Microsoft asserted that IDP owed approximately
$800,000 under this agreement due primarily to amended billings by Microsoft
concerning sales by IDP to the U.S. Air Force in conjunction with the Desktop V
contract. On October 31, 2000, Microsoft filed suit against the Company, and its
subsidiary IDP, for breach of contract. In conjunction with the filing of the
claim, Microsoft further amended the original billings, which resulted in a
claim against the Company of approximately $1.3 million. Subsequent to October
31, 2000, 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 will exchange mutual full releases and the
Company agreed to pay Microsoft approximately $315,000 over a period of two
years. This will not have an impact on the Company's current operations as this
contingency has been previously recorded in the Company's consolidated financial
statements.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Founded in 1987, SteelCloud, Inc, based in Dulles, Virginia, designs, develops
and manufactures customized computers, appliances and network solutions. In
addition, the Company provides Information Technology ("IT") solutions support
for those hardware and networking solutions implemented.
The following discussion should be read in conjunction with the consolidated
financial statements. 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.
CRITICAL ACCOUNTING POLICIES
The Company believes the following represent its critical accounting policies:
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.
Legal Contingencies
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. We have accrued our
estimate of the probable costs for the resolution of these claims in our
consolidated financial statements. These estimates have been developed in
consultation with outside counsel handling our defense in these matters and are
based upon an analysis of potential results, assuming a combination of
litigation and settlement strategies. We do not believe these proceedings will
have a material adverse effect on our consolidated financial position. It is
possible, however, that future results of operations for any particular
quarterly or annual period could be materially adversely affected by changes in
our assumptions, or the effectiveness of our strategies, related to these
proceedings.
8
Impairment of Goodwill
We periodically evaluate acquired businesses for potential impairment
indicators. Our judgments regarding the existence of impairment indicators are
based on legal factors, market conditions and operational performance of our
acquired businesses. Future events could cause us to conclude that impairment
indicators exist and that goodwill associated with our acquired businesses is
impaired. Any resulting impairment loss could have a material adverse impact on
our financial condition and results of operations.
Accounts Receivable - Significant Customer
As of January 31, 2002, approximately 43% of our accounts receivable were
attributable to one commercial entity that owns several subsidiaries for which
we supply various OEM product lines (collectively, "customer"). Subsequent to
January 31, 2002, these accounts receivables have been fully collected. For the
three months ended January 31, 2002, revenues from this customer accounted for
approximately 79% of net revenues. Due to the nature and timing of deliveries of
this customer's products and services during the period then ended, we do not
anticipate concentration from this customer at this level to recur in future
periods. Future revenues and results of operations could be adversely affected
should this customer reduce their purchases, eliminate product lines or choose
not to continue to buy products and services from SteelCloud.
RESULTS OF OPERATIONS
For the three months ended January 31, 2002 compared to the three months ended
January 31, 2001
Net revenues for the three months ended January 31, 2002 were $9,686,225 as
compared to $7,188,899 for the three months ended January 31, 2001, an increase
of approximately 35%. During fiscal 2002, the Company experienced a significant
increase in the demand for network security appliances that attributed to the
significant increase in net revenues from the same period in fiscal 2001.
Gross margin, as a percentage of sales, increased to 26.0% for the three months
ended January 31, 2002 from 24.3% for the three months ended January 31, 2001.
The increase in profit margin results from changes in the Company's product
lines and product mix, which yielded higher gross margins. This margin increase
is a result of the Company's transition to the customized server appliance model
from the lower margin, direct, end-user Federal Government business.
For the three months ended January 31, selling and marketing expenses increased
to $319,723 in fiscal 2002 from $160,765 in fiscal 2001. The increase related to
sales commissions and incentives resulted from the significant revenue growth.
In addition, the Company made certain investments in its sales and marketing
programs in the first quarter of 2002.
General and administrative expenses increased to $1,569,061 for the three months
ended January 31, 2002 from $1,283,541 for the same period in fiscal 2001. The
Company manages its costs relative to its net revenues and gross margins. As a
result, the general and administrative costs increased proportionately with the
significant revenue and margin growth in the first quarter of fiscal 2002
compared to the same period in fiscal 2001.
9
Interest expense, net of interest income, decreased to $50,449 for the three
months ended January 31, 2002 from $98,255 for the three months ended January
31, 2001. The decrease is the result of the Company's reduction in its
outstanding debt during fiscal 2002 as well as an overall decrease in the
borrowing rate in fiscal 2002 compared to fiscal 2001.
The Company reported net income of $486,506 for the three months ended January
31, 2002, as compared to net income of $107,223 for the same period in the prior
year. This was a result of the Company's growth in gross margins derived from a
higher net revenue base during the three month period ended January 31, 2002.
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended January 31, 2002, the Company generated approximately
$2,334,368 in cash flow from its operating activities. The Company generated net
income of $486,506 and collected approximately $1,796,000 of its receivables.
The cash generated was used to purchase goods of approximately $329,539 net of
payments and to reduce accrued expenses by approximately $32,000.
Funds used for investing activities consisted of the purchase of property,
equipment and leased assets of $46,242. Net cash used for financing activities
consisted of net repayments on the line of credit of $2,270,317 and payments on
notes payable of $107,364.
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 January 31, 2002, the Company had an outstanding balance on the line
of credit of approximately $1,566,437 and available borrowing capacity of $2.7
million.
As of January 31, 2002, the Company had working capital of approximately $5.8
million. The Company believes the bank facility, together with cash on hand,
projected cash generated from operations, and income tax refunds due will
provide sufficient financial resources to finance the current operations of the
Company through fiscal 2002.
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.
10
Contractual Obligations and Commercial Commitments
The Company's significant contractual obligations as of January 31, 2002 are for
debt and operating leases. Debt by year of maturity, the Company's line of
credit and future rental payments under operating lease agreements are presented
below. The Company does not have any purchase obligations as of January 31,
2002. 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 After 5
year years years
----------------------------------- ------------------- ----------------- ----------------- -------- -------------
Notes Payable - Current $ 7,621 $ 7,621 - - -
----------------------------------- ------------------- ----------------- ----------------- -------- -------------
Long Term Debt $1,566,437 - $1,566,437 - -
----------------------------------- ------------------- ----------------- ----------------- -------- -------------
Operating Lease $1,638,894 $ 517,535 $1,121,359 - -
----------------------------------- ------------------- ----------------- ----------------- -------- -------------
The Company will receive $645,528 in aggregate sublease income through fiscal
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%. The Company will make monthly principal payments of
approximately $43,000 through the maturity date of July 5, 2003. As of March 1,
2002, the balance on the Company's line of credit was $0.
11
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. During 1999, Microsoft asserted that IDP owed approximately
$800,000 under this agreement due primarily to amended billings by Microsoft
concerning sales by IDP to the U.S. Air Force in conjunction with the Desktop V
contract. On October 31, 2000, Microsoft filed suit against the Company, and its
subsidiary IDP, for breach of contract. In conjunction with the filing of the
claim, Microsoft further amended the original billings, which resulted in a
claim against the Company of approximately $1.3 million. Subsequent to October
31, 2000, 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 will exchange mutual full releases and the
Company agreed to pay Microsoft approximately $315,000 over a period of two
years. This will not have an impact on the Company's current operations as this
contingency has been previously recorded in the Company's consolidated financial
statements.
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.
12
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1: Statement of computation of earnings per share.
(b) Reports on Form 8-K
There were no reports filed on Form 8-K during the three month period ended
January 31, 2002.
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.
SteelCloud, Inc
(Registrant)
Date: March 18, 2002 By: /s/ Thomas P. Dunne
---------------------------------------
Thomas P. Dunne
Chief Executive Officer
Date: March 18, 2002 By: /s/ Kevin M. Murphy
---------------------------------------
Kevin M. Murphy
Vice President, Finance
13