ESSEX CORPORATION
FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 29, 2003
Commission File Number 0-10772
ESSEX CORPORATION
(Exact name of small business issuer as specified in its charter)
Virginia 54-0846569
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9150 Guilford Road, Columbia, Maryland 21046
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (301) 939-7000
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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
----- -----
State the number of shares outstanding of each of the issuer's class of Common
Stock as of the latest practicable date.
OUTSTANDING
CLASS AT AUGUST 8, 2003
----- -----------------
Common Stock, no par value per share 8,932,542
Transitional Small Business Disclosure Format (Check One);
YES NO X
----- -----
ESSEX CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
INDEX
o CONSOLIDATED BALANCE SHEETS
o CONSOLIDATED STATEMENTS OF OPERATIONS
o CONSOLIDATED STATEMENTS OF CASH FLOWS
o NOTES TO INTERIM FINANCIAL INFORMATION
2
ESSEX CORPORATION
CONSOLIDATED BALANCE SHEETS
June 29, December 29,
2003 2002
------------- -------------
ASSETS
CURRENT ASSETS
Cash $ 552,913 $ 1,030,247
Accounts receivable, net 3,024,062 565,626
Prepayments and other 197,793 106,987
Contract work in progress 175,795 --
------------- -------------
Total Current Assets 3,950,563 1,702,860
------------- -------------
PROPERTY AND EQUIPMENT
Computers and special equipment 1,049,155 948,455
Furniture, equipment and other 356,647 219,112
------------- -------------
1,405,802 1,167,567
Accumulated depreciation and amortization (1,082,165) (845,360)
------------- -------------
323,637 322,207
------------- -------------
OTHER ASSETS
Goodwill 3,019,000 --
Patents, net 333,639 296,407
Other intangibles, net 256,732 --
Other 27,441 21,725
------------- -------------
3,636,812 318,132
------------- -------------
TOTAL ASSETS $ 7,911,012 $ 2,343,199
------------ ============= =============
The accompanying notes are an integral part of these statements.
3
ESSEX CORPORATION
CONSOLIDATED BALANCE SHEETS
June 29, December 29,
2003 2002
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Advance from accounts receivable financing $ 471,661 $ 169,432
Accounts payable 654,749 659,977
Accrued wages and vacation 926,237 233,940
Accrued retirement plan contribution payable 218,821 65,000
Billings in excess of costs 173,000 135,000
Other accrued expenses 365,163 146,041
Capital leases 17,561 71,261
------------- -------------
Total Current Liabilities 2,827,192 1,480,651
LONG-TERM DEBT
Convertible note payable 500,000 500,000
Note payable 100,000 --
Capital leases, net of current portion -- 4,390
------------- -------------
Total Liabilities 3,427,192 1,985,041
------------- -------------
STOCKHOLDERS' EQUITY
Common stock, no par value; 25 million
shares authorized; 8,931,547 and
7,790,398 shares issued and outstanding,
respectively 16,827,690 12,706,520
Additional paid-in capital 2,000,000 2,000,000
Prepaid warrant -- 50,000
Accumulated deficit (14,343,870) (14,398,362)
------------- -------------
4,483,820 358,158
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$ 7,911,012 $ 2,343,199
============= =============
The accompanying notes are an integral part of these statements.
4
ESSEX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE TWENTY-SIX WEEK PERIODS
ENDED JUNE 29, 2003 AND JUNE 30, 2002
2003 2002
------------- --------------
Revenues $ 7,149,941 $ 1,492,709
Costs of goods sold and services provided (4,661,942) (747,772)
------------- -------------
Gross Margin 2,487,999 744,937
Selling, general and administrative expenses (1,990,251) (1,434,046)
Research and development (226,040) (966,233)
Amortization of other intangible assets (174,017) --
------------- -------------
Operating Income (Loss) 97,691 (1,655,342)
Interest expense, net (43,199) (10,019)
------------- -------------
Income (Loss) Before Income Taxes 54,492 (1,665,361)
Provision for income taxes -- --
------------- -------------
Net Income (Loss) $ 54,492 $ (1,665,361)
============= =============
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,437,723 7,289,120
Effect of dilution -
Stock options 1,128,075 --
------------- -------------
Diluted 9,565,798 7,289,120
============= =============
Basic Earnings (Loss) Per Common Share $ 0.01 $ (0.23)
============= =============
Diluted Earnings (Loss) Per Common Share $ 0.01 $ (0.23)
============= =============
The accompanying notes are an integral part of these statements.
5
ESSEX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THIRTEEN WEEK PERIODS
ENDED JUNE 29, 2003 AND JUNE 30, 2002
2003 2002
------------- -------------
Revenues $ 4,148,607 $ 729,433
Costs of goods sold and services provided (2,619,731) (359,033)
------------- -------------
Gross Margin 1,528,876 370,400
Selling, general and administrative expenses (1,204,377) (733,669)
Research and development (94,094) (468,184)
Amortization of other intangible assets (128,291) --
------------- -------------
Operating Income (Loss) 102,114 (831,453)
Interest expense, net (27,541) (3,877)
------------- -------------
Income (Loss) Before Income Taxes 74,573 (835,330)
Provision for income taxes -- --
------------- -------------
Net Income (Loss) $ 74,573 $ (835,330)
============= =============
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,919,916 7,353,348
Effect of dilution -
Stock options 1,128,075 --
------------- -------------
Diluted 10,047,991 7,353,348
============= =============
Basic Earnings (Loss) Per Common Share $ 0.01 $ (0.12)
============= =============
Diluted Earnings (Loss) Per Common Share $ 0.01 $ (0.12)
============= =============
The accompanying notes are an integral part of these statements.
6
ESSEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE TWENTY-SIX WEEK PERIODS
ENDED JUNE 29, 2003 AND JUNE 30, 2002
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ 54,492 $ (1,665,361)
Adjustments to reconcile Net Income (Loss) to
Net Cash Used In Operating Activities:
Depreciation and amortization 84,299 73,258
Amortization of other intangible assets 174,017 --
Stock compensation expense 2,000 246,325
Loss (gain) on disposition of fixed assets 564 (91)
Change in Assets and Liabilities:
Accounts receivable (1,190,889) 109,214
Prepayments and other assets (13,448) 2,260
Contract work in progress (110,795) --
Accounts payable (106,300) 47,533
Accrued wages, vacation and retirement 593,728 (18,107)
Other liabilities 10,681 (40,098)
------------ ------------
Net Cash Used In Operating Activities (501,651) (1,245,067)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of SDL (309,000) --
Purchases of property and equipment (60,338) (7,432)
Proceeds from sale of fixed assets 707 91
------------ ------------
Net Cash Used In Investing Activities (368,631) (7,341)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sales of common stock -- 1,000,003
Proceeds of note payable 100,000 --
Exercise of stock options 48,809 93,528
Short-term borrowings/repayments, net 302,229 36,280
Payment of capital lease obligations (58,090) (83,406)
------------ ------------
Net Cash Provided By Financing Activities 392,948 1,046,405
------------ ------------
CASH AND CASH EQUIVALENTS
Net decrease (477,334) (206,003)
Balance - beginning of period 1,030,247 568,178
------------ ------------
Balance - end of period $ 552,913 $ 362,175
============ ============
The accompanying notes are an integral part of these statements.
7
ESSEX CORPORATION
NOTES TO INTERIM FINANCIAL INFORMATION
NOTE 1: General
FISCAL YEAR AND PRESENTATION
These statements cover Essex Corporation and its wholly-owned subsidiary, Sensys
Development Laboratories, Inc. (the "Company"). The Company is on a 52/53-week
fiscal year ending the last Sunday in December. Years 2003 and 2002 are 52-week
fiscal years. Certain amounts for 2002 have been reclassified to conform to the
2003 presentation.
The information furnished in the accompanying Unaudited Consolidated Balance
Sheets, Consolidated Statements of Operations and Consolidated Statements of
Cash Flows have been prepared in accordance with accounting principles generally
accepted in the United States of America for interim financial information. In
the opinion of management, such information contains all adjustments considered
necessary for a fair presentation of such information. The operating results for
the thirteen and twenty-six week periods ended June 29, 2003 may not be
indicative of the results of operations for the year ending December 28, 2003,
or any future period. This financial information should be read in conjunction
with the Company's 2002 audited consolidated financial statements and footnotes
thereto, included in the Annual Report on Form 10-KSB/A No. 1 filed with the
Securities and Exchange Commission.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Estimates are used when accounting for
uncollectible accounts receivable, inventory obsolescence and valuation,
depreciation and amortization, intangible assets, employee benefit plans and
contingencies, among others. Actual results could differ from those estimates.
IMPORTANT BUSINESS RISK FACTORS
The Company has historically been principally a supplier of technical services
under contracts or subcontracts with departments or agencies of the U.S.
Government, primarily the military services and other departments and agencies
of the Department of Defense. The Company's revenues have been and continue to
come from such programs. The Company is focusing on and expanding in this
business area. See Note 9 - Acquisition of Sensys Development Laboratories, Inc.
In recent years, the Company has expended significant funds to transition into
the commercial marketplace, particularly the productization of its proprietary
technologies in telecommunications and optoelectronic processors. In June 2000,
the Company announced that it had filed applications to secure patent protection
for innovative technologies in two communications device families: Fiberoptic
HYPERFINE WDM (wavelength division multiplexing) devices and wireless optical
processor enhanced receiver architecture. The Company received a Notice of
Allowance for the first HYPERFINE WDM patent in June 2003. Since September 2000,
8
ESSEX CORPORATION
NOTES TO INTERIM FINANCIAL INFORMATION
the Company has received over $6 million in financing from its Private Investors
or affiliates to advance its programs to capitalize upon these inventions. The
long-term success of the Company in these areas is dependent on its ability to
successfully develop and market products related to its communications devices
and optoelectronic processors. The success of these efforts is subject to
changing technologies, availability of additional financing, competition and
market acceptance.
Primarily due to the expenditures for development and marketing of its
optoelectronics products and services, particularly the optical
telecommunications device technologies, the Company incurred significant losses
in 2002 and 2001. To the extent funds are available, the Company plans to
continue research and development spending in 2003 in the optoelectronics
operations.
The Company is seeking to establish joint ventures or strategic partnerships
including licensing of its technologies with major industrial concerns to
facilitate these goals. The Company will also seek additional funds under
appropriate terms from private sources to continue to finance development and to
achieve initial market penetration. Significant delays in the commercialization
of the Company's optoelectronic products, failure to market such products or
failure to raise substantial additional working capital for such commercial
products could have a significant adverse effect on the Company's future
operating results and future financial position.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. Such costs include
direct labor and materials as well as a reasonable allocation of indirect costs.
However, no general and administrative costs are included. Equipment which has
alternative future uses is capitalized and charged to expense over its estimated
useful life.
NOTE 2: Basic and Diluted Earnings (Loss) Per Share
Basic earnings (loss) per common share are computed using the weighted average
number of common shares outstanding during the period and, in 2002, common
shares issuable upon the required conversion of preferred stock. Diluted
earnings per common share incorporates the incremental shares issuable upon the
assumed exercise of stock options and warrants. Such incremental shares were
anti dilutive for the 2002 periods presented.
NOTE 3: Accounts Receivable Financing
The Company has a working capital financing agreement with an accounts
receivable factoring organization. Under the agreement, the factoring
organization may purchase certain of the Company's accounts receivable subject
to full recourse against the Company in the case of nonpayment by the customers.
The Company generally receives 85%-90% of the invoice amount at the time of
purchase and the balance when the invoice is paid. The Company is charged an
interest fee and other processing charges, payable at the time each invoice is
paid. There were $472,000 of funds advanced as of June 29, 2003 and $169,000 of
funds advanced as of December 29, 2002.
9
ESSEX CORPORATION
NOTES TO INTERIM FINANCIAL INFORMATION
NOTE 4: Common Stock; Warrants; Preferred Stock
The Company's Articles of Incorporation authorize 1 million shares of preferred
stock, par value $0.01 per share, the series and rights of which may be
designated by the Board of Directors in accordance with applicable state and
federal law. In September 2000, the Board designated 500,000 shares of such
preferred stock as Series B which were issued to Private Investors for
$2,000,000. The 500,000 Series B shares were converted as required into
2,000,000 shares of common stock in September 2002. No Series A or Series B
preferred shares are currently outstanding.
In connection with the issuance of Series B preferred stock, the Company also
issued common stock warrants to the preferred stock holders. These warrants are
for an additional 2 million shares of common stock. The warrants expire in
September 2005 and can be exercised at a nominal price of $2,000. The warrants
become exercisable under certain terms and conditions, such as the market price
of the common stock exceeding $10 through $20 per share for 5 consecutive days,
or the occurrence of an additional private placement of $10 million where the
valuation of the Company exceeds $50 million. The warrants would also become
exercisable upon a sale of all or substantially all of the assets of the Company
or a merger or acquisition of the Company. The Company has determined that the
warrants had a nominal fair value at issuance due to the restrictive covenants.
The Company has reserved 2 million shares of common stock in connection with the
possible exercise of the related common stock warrants. As of June 29, 2003,
these warrants were not exercisable.
In March 2002, the Company amended existing private placement agreements for its
common stock with its Private Investors or their affiliates. The agreements were
increased from $500,000 to $1.5 million, of which $250,000 was received in
December 2001, $500,000 was received in the first quarter of 2002, $500,000 was
received in second quarter of 2002 and $250,000 was received in the third
quarter of 2002. Under the agreements, the Company issued 500,000 shares of
common stock.
NOTE 5: Stock-Based Compensation
The Company accounts for stock options granted to employees and directors using
the intrinsic value based method of accounting. Under this method, the Company
does not recognize compensation expenses for the stock options because the
exercise price is equal to the market price of the underlying stock on the date
of the grant. If the Company had used the fair value based method of accounting,
net earnings and earnings per share would have been reduced to the pro forma
amounts listed in the table below. The Black-Scholes option pricing model was
used to calculate the pro forma stock-based compensation costs. For purposes of
the pro forma disclosures, the assumed compensation expense is amortized over
the option's vesting periods. The pro forma information is consistent with
assumptions used in the year end calculations. Accordingly, net income (loss)
and earnings (loss) per share would be as follows:
10
ESSEX CORPORATION
NOTES TO INTERIM FINANCIAL INFORMATION
June 29, 2003 June 30, 2002
------------- -------------
Net income (loss), as reported $ 54,492 $ (1,665,361)
Less: Total stock-based employee compensation
expense determined under fair value based method for
all awards 392,570 410,725
------------- -------------
Pro forma loss attributable to common stockholders
$ (338,078) $ (2,076,086)
============= =============
Loss per share:
Basic-as reported $ 0.01 $ (0.23)
Basic-pro forma $ (0.04) $ (0.28)
Diluted-as reported $ 0.01 $ (0.23)
Diluted-pro forma $ (0.04) $ (0.28)
NOTE 6: Amortization of Other Intangible Assets
In connection with the March 1, 2003 acquisition of Sensys Development
Laboratories, Inc. (See Note 9), there was $431,000 of value assigned primarily
to contracts backlog. The overall amortization life is expected to be less than
one year and $46,000 of amortization was recognized in March 2003 and $128,000
in the quarter ended June 29, 2003.
NOTE 7: Income Taxes
The Company is in a net operating loss (NOL) carryforward position for book and
tax purposes. Income tax expense reconciled to the tax computed at statutory
rates is as follows:
2003 2002
----------------------------------------- -----------------------------------------
Second Quarter Second Quarter
Year-To-Date Year-To-Date
------------------- ------------------ ------------------ -------------------
Federal taxes at statutory
rates $ 25,000 $ 18,000 $ (284,000) $ (566,000)
State income taxes, net of
federal benefit 4,000 3,000 (43,000) (87,000)
Change in valuation
allowance (29,000) (21,000) 327,000 653,000
------------------- ------------------ ------------------ -------------------
Provision for income
taxes $ -- $ -- $ -- $ --
=================== ================== ================== ===================
11
ESSEX CORPORATION
NOTES TO INTERIM FINANCIAL INFORMATION
NOTE 8: Statements of Cash Flows - Supplemental Disclosure
There were no new capital leases entered into in the first quarters of 2003 or
2002.
NOTE 9: Acquisition of Sensys Development Laboratories, Inc.
As of March 1, 2003, the Company acquired 100% of the common stock of Sensys
Development Laboratories, Inc. ("SDL"). The assigned value of the consideration
and related expenses was approximately $4,405,000. Under the terms of the
agreement, the Company paid $309,000 in cash and issued approximately 683,000
shares of common stock. The agreement further provides that an additional number
of shares up to 422,000 may be released from escrow on the first anniversary of
closing based upon certain factors. The Company also issued approximately
195,000 non-qualified fully vested options for its common stock at below market
exercise prices in exchange for SDL fully vested outstanding options. In
accordance with Emerging Issues Task Force 99-12, Determination of the
Measurement Date for the Market Price of Acquirer Securities Issued in a
Purchase Business Combination, the value of the stock consideration was based
upon the weighted average market price of the Company's common stock a few days
before and after February 28, 2003, the date the deal terms were agreed to and
announced.
SDL provides both system and software engineering technical support to U.S.
Government customers and prime contractors supporting government programs. SDL
has an established workforce with specialized experience and credentials. For
its most recent fiscal year ended September 30, 2002, SDL had revenues of over
$3 million.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition.
Current assets $ 1,447,000
Equipment and other 33,000
Goodwill 3,019,000
Intangible assets 431,000
--------------
Total assets acquired 4,930,000
Current liabilities (525,000)
--------------
Net assets acquired $ 4,405,000
==============
The intangible assets of $431,000 are primarily assigned to contract backlog
which has an estimated overall amortization life of less than one year.
12
ESSEX CORPORATION
NOTES TO INTERIM FINANCIAL INFORMATION
The following information is presented on a pro forma basis as though the
business combination had been completed as of the beginning of fiscal 2003.
For The Six Months Ended June 29, 2003
(in Thousands) (Unaudited)
------------------------------------------
As Reported Pro Forma
------------------ ------------------
Revenues $ 7,150,000 $ 8,415,000
================== ==================
Net Income $ 54,000 $ 316,000
================== ==================
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,437,723 8,914,090
Effect of Dilution -
Stock Options 1,128,075 1,128,075
------------------ ------------------
Diluted 9,565,798 10,042,165
================== ==================
Earnings Per Share:
Basic $ 0.01 $ 0.04
================== ==================
Fully diluted $ 0.01 $ 0.03
================== ==================
Included in the pro forma revenues and net income are $420,000 and $155,000,
respectively, from a product sale by SDL which is not expected to occur in
future periods.
NOTE 10: Recent Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123", which is effective for financial statements for fiscal years ending after
December 15, 2002, with early adoption permitted. SFAS No. 148 enables companies
that choose to adopt the fair value based method to report the full effect of
employee stock options in their financial statements immediately upon adoption,
and to make available to investors better and more frequent disclosure about the
cost of employee stock options. As further discussed within Note 5, the Company
will continue to apply the disclosure-only provisions of both SFAS No. 123 and
SFAS No. 148.
13
ESSEX CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION AND OTHER SECTIONS
CONTAIN FORWARD-LOOKING STATEMENTS THAT ARE BASED ON MANAGEMENT'S EXPECTATIONS,
ESTIMATES, PROJECTIONS AND ASSUMPTIONS. WORDS SUCH AS "EXPECTS", "ANTICIPATES",
"PLANS", "BELIEVES", "ESTIMATES" AND VARIATIONS OF SUCH WORDS AND SIMILAR
EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS THAT
INCLUDE, BUT ARE NOT LIMITED TO, PROJECTIONS OF REVENUES, EARNINGS, SEGMENT
PERFORMANCE, CASH FLOWS AND CONTRACT AWARDS. SUCH FORWARD-LOOKING STATEMENTS ARE
MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE
AND INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT.
THEREFORE, ACTUAL FUTURE RESULTS AND TRENDS MAY DIFFER MATERIALLY FROM WHAT IS
INDICATED IN FORWARD-LOOKING STATEMENTS DUE TO A VARIETY OF FACTORS.
STATUS
The Company's business is focused upon applications of its proprietary
optoelectronics technology and products for commercial and U.S. Government
customers and signal and image processing technology for U.S. Government
customers.
The Company has experienced growth in its government business and has been
actively pursuing growth strategies from internal efforts and external merger
sources. These efforts have resulted in profitable operations for the first half
of 2003. In 2002, under a 5-year $25 million Indefinite Delivery Indefinite
Quantity contract, the Company received an initial funding of $2.4 million to
develop a next generation optoelectronic radar processor. This initial phase was
substantially completed in 2002, and in January 2003 the Company received a $3.7
million follow-on award to complete the design and deliver a prototype processor
before the end of 2003. The Company received a new subcontract in November 2002
to provide at least $3 million annually in telecommunications systems support in
the area of modernization, project management, integration and engineering
analysis. This work began in January 2003 and is part of the multi-year $30
million award to provide such services. The Company completed, effective March
1, 2003, the merger with Sensys Development Laboratories, Inc. (SDL), a
Maryland-based provider of technical engineering and software support services.
(See Note 9 in Notes to Interim Financial Information.) This merger added over
25 highly skilled professionals to the Essex staff and an expected $4 million of
annual revenue in 2003.
Since September 2000, the Company has closed on several equity private placement
funding transactions with the Private Investors. Under the terms of the equity
funding, the Company has received over $6.1 million and the Private Investors
and their affiliates received approximately 3.2 million shares of common stock.
The Private Investors were also issued warrants for an additional two million
shares of common stock. The warrants can be exercised for a nominal price under
certain conditions. See Note 4 of Notes to Interim Financial Information for
further details. The Company has also received proceeds of $600,000 from the
private placement of outstanding convertible and other debt.
14
ESSEX CORPORATION
The Company's primary use of the private placement funds has been to patent,
develop and commercialize its key leading-edge optical technologies, principally
the fiberoptic HYPERFINE WDM devices and wireless OPERA(TM) technology. The
purpose of the HYPERFINE WDM device is to increase the number of usable
communications channels within a single optical fiber. The purpose of OPERA(TM)
is TO increase capacity and improve voice and data quality of wireless systems.
These inventions arose from the Company's work and expertise in the optical
device and communications fields.
The Company has prototypes of the HYPERFINE WDM technology which are being
demonstrated to prospective strategic partners and investors. In the first half
of 2003, the Company has sold several prototypes of its initial HYPERFINE WDM
devices. The Company is also developing applications for using HYPERFINE WDM to
achieve privacy in an all optical network. The Company is developing simulations
of its OPERA(TM) wireless receiver device technology and is undertaking to
determine the various market entry points fOR such device technology. The
Company is also holding discussions with various established commercial entities
that are in the wireless communications market in order to determine the best
commercial applications of such technology.
The development of the commercial HYPERFINE WDM devices required a diversion of
labor resources from revenue generation in 2002 and 2001. Because of the
emphasis on development, the Company was unable in 2002 and 2001 to maintain
customer programs of sufficient volume and to expand such work to consistently
achieve an overall breakeven or better level of operations on such revenues.
In light of the continued unfavorable conditions in the telecommunications
markets, the commercial market for the Company's optical technologies and
products has been slow in developing. As a consequence, the Company has opted to
significantly expand the government business base creating a Company which
provides total solutions to customer problems. The expansion has enabled the
Company to record a small profit for the first half of fiscal 2003 while
continuing commercial product development and marketing, although at reduced
levels to the extent funds are available. The Company is also pursuing sales of
its commercial HYPERFINE WDM and other optical technologies in the government
marketplace. The Company plans to continue to expand its government programs
while pursuing research and development (R&D) and marketing activities in the
commercial products area to the extent funds are available. See "FINANCIAL
CONDITION - LIQUIDITY AND CAPITAL RESOURCES".
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, the Company re-evaluates its estimates, including those related
to revenue recognition, R&D, inventories, intangible assets, income taxes and
contingencies. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The Company believes the following critical
accounting policies affect its more significant judgments and estimates used in
the preparation of its financial statements.
15
ESSEX CORPORATION
REVENUE RECOGNITION
For U.S. Government customers, the Company provides services and products under
a variety of contract types, namely cost plus fixed fee (CPFF), fixed price (FP)
and time & material (T&M). The Company recognizes revenue on CPFF contracts to
the extent costs are incurred plus a proportionate amount of fee earned. The
Company must determine that the costs incurred are proper and that the ultimate
costs incurred will not overrun the expected funding on the contract and still
deliver the scope of work proposed. Even though CPFF contracts generally do not
require that the Company expend costs in excess of the contract value, such
expenditures may be required in order to achieve customer satisfaction and
receive additional work. In addition, since the reimbursable costs include both
direct and indirect costs, the Company must determine that the indirect costs
are properly accounted for and allocated in accordance with government cost
accounting requirements. On FP level-of-effort service contracts, the Company
must determine that the costs incurred provide a proportionate amount of
progress on the work and that the ultimate costs incurred will not overrun the
funding on the contract and the required hours will be delivered. On FP product
orders, revenue is not recorded until the Company determines that the goods have
been delivered and accepted by the customer. On T&M contracts, revenue is
recognized to the extent of billable rates multiplied by hours delivered, plus
other direct costs. This is generally the most straightforward revenue
computation. The Company uses historical technical performance experience where
applicable to evaluate progress on FP and CPFF jobs. The Company uses historical
government audit experience in the indirect cost area to evaluate the propriety
and expected recovery of its indirect costs on CPFF contracts.
RESEARCH AND DEVELOPMENT
The Company has expended significant amounts for research and development for
new products. In accordance with generally accepted accounting principles, the
Company expenses and does not capitalize and add to inventory such expenditures.
When product design and prototypes are finalized and product marketability and
viability have been established, expenditures for inventory are treated
accordingly. There is a judgmental aspect to this decision which could result in
the over expensing in some cases or the early capitalization in other cases of
such expenditures.
REVENUES
Revenues were $7,150,000 and $1,493,000 in the first halves of fiscal 2003 and
2002, respectively. Revenues were $4,149,000 and $729,000 for the second
quarters of fiscal 2003 and 2002, respectively. Revenues in the first half of
2003 include $1,886,000 for four months of operations from recently acquired
SDL. Excluding SDL, revenues in the first half of 2003 were $5,264,000 or
$3,771,000 higher than the first half of 2002 due to several factors. A major
factor was the increased activity on the U.S. Government Missile Defense Agency
program for design of a next generation advanced optoelectronics radar processor
(AOP) demonstration unit. This program had revenues of $2,172,000 in the first
half of 2003 compared to revenues of $162,000 in the first half of 2002 as the
Company did not begin this program until May 2002. The Company also had
$1,545,000 of revenues on contracts in its Communications Services Division
which was formed in late 2002. Additionally, the Company sold $723,000 of
commercial equipment, including the sale of five prototype HYPERFINE WDM
demonstration units for $210,000 to several government and intermediate
customers. There were no such sales in 2002.
16
ESSEX CORPORATION
As of June 29, 2003, the Company had funded backlog of approximately $5.9
million, unfunded backlog of $47.9 million and total backlog of $53.8 million
compared to total backlog of $55.8 million at December 29, 2002.
EXPENSES AND NET INCOME (LOSS)
The Company recorded net income of $74,000 and a net loss $835,000 in the second
quarters of 2003 and 2002, respectively. Net income was $54,000 and net loss was
$1,665,000 in the first half periods of 2003 and 2002, respectively. During the
first half of fiscal 2003 amortization of other intangibles was $174,000, all of
which was related to the SDL acquisition. The remaining balance of $257,000 of
other intangibles will be substantially amortized within approximately one year.
There was no comparable amortization cost in the same period in 2002. Cost of
goods sold and services (COGS) provided as a percentage of revenues for the
first half of 2003 was 65%, which was significantly higher than the 50% in 2002.
In 2002, the major component of COGS was direct labor and associated costs. In
2003, due to the AOP program referenced above, there was a significant increase
in the direct materials and equipment component of COGS. The Company receives a
higher markup on direct labor than direct material and equipment costs. Overall,
the higher volume in 2003 contributed a larger amount of gross profit, though at
a lower gross profit percentage. The net income improved as a larger amount of
fixed expenses were covered by the higher revenue volume.
Research and development (R&D) declined between the first half periods,
amounting to approximately $226,000 in 2003 compared to $966,000 in 2002. The
majority of the R&D costs were incurred on efforts related to optical
telecommunications technology. The Company expects, subject to the availability
of funds, to continue its R&D spending in the optical and telecommunications
areas during the remainder of 2003.
During the first half of 2003, the Company had higher selling, general and
administrative expenses ("SG&A"), partially due to increased business
development and higher management costs in the government contracts area as well
as continuing costs in the optoelectronics and telecommunications new device
business areas as the Company seeks to commercialize its optoelectronic
telecommunications products and services. Overall, SG&A expenses have become
proportionally lower relative to the higher 2003 revenue volume. High SG&A
expenses contributed to the operating loss in the first half of 2002.
CORPORATE MATTERS
Total interest expense was $43,000 and $10,000 in the first half periods of 2003
and 2002, respectively. The Company has increased its borrowing to finance the
growth in its business as reflected in the higher accounts receivable balance.
The Company is in a net operating loss (NOL) carryforward position for book and
tax purposes. No provision from income taxes was recognized in the first half of
2003 due to the NOL.
17
ESSEX CORPORATION
FINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES
The Company evaluates its liquidity position using various factors. The
following represents some of the more important factors:
===========================================
SELECTED FINANCIAL DATA ($ Thousands)
AS OF
-------------------------------------------
June 29, December 29, June 30,
2003 2002 2002
------------- ------------ ------------
Total Assets $ 7,911 $ 2,343 $ 1,302
============ ============ ============
Working Capital (Deficit) $ 1,123 $ 222 $ (323)
============ ============ ============
Current Ratio 1.40:1 1.15:1 0.67:1
============ ============ ============
Advance from Accounts Receivable Financing $ 472 $ 169 $ 36
Capital Leases 18 76 170
Convertible Debt 500 500 --
Other Debt 100 -- --
------------ ------------ ------------
Total Debt/Financing $ 1,090 $ 745 $ 206
============ ============ ============
Stockholders' Equity $ 4,484 $ 358 $ 320
============ ============ ============
As a result of the acquisition of SDL for predominately common stock, the
Company's working capital increased by approximately $613,000 after deducting
the $309,000 of cash consideration paid. The consideration amount paid is shown
as a cash outflow from investing activities in the consolidated statements of
cash flows.
In 2003, net cash provided by financing activities of $393,000 resulted from the
increased borrowings on accounts receivable and the private placement of
$100,000 in debt to a member of its Private Investors. In 2002, the net cash
provided by financing activities is primarily from the Company completing
several private placements of equity or debt securities to its Private Investors
or their affiliates. The Company received $2,000,000 and $3,000,000 in fiscal
2002 and fiscal 2001, respectively, including the $1,000,000 in the first half
of 2002 from these private placements. The funds have been and are to be used
primarily for the development of the optical telecommunications device
technologies.
In 2003, net cash used in operating activities of $502,000 was due to the
increase in accounts receivable, partially offset by non cash depreciation and
amortization charges. The increase in accounts receivable is due to increased
volume and a slightly longer payment cycle on certain new contracts. This
increase was also offset by the increase in accrued wages, vacation and other
liabilities due to growth in personnel operating costs. In 2002, the net cash
used in operating
18
ESSEX CORPORATION
activities resulted from the losses incurred by the Company primarily due to the
expenditures for development of its optoelectronics products and services.
The Company has several device families under development, with development of
HYPERFINE WDM fiber optic communications technology being the most advanced. In
particular, the Company has completed development on an alpha version of the
HYPERFINE multiplexer-demultiplexer and has received orders for HYPERFINE WDM
from government customers and will continue to seek orders from theses
customers. However, the Company has not yet begun substantial further efforts
for commercial applications due to the current depressed state of the industry.
The Company is continuing to develop and refine the HYPERFINE devices and
related technologies to the extent funding is available. The Company estimates
that efforts related to a full rollout of the remainder of the HYPERFINE family
of devices would require between five to ten million dollars depending on a
number of variables, including the extent of reliance on manufacturing,
distribution and channel partner relationships. For example, if Essex enters
into a strategic partnership with a large commercial company, the working
capital required would tend toward the lower amounts in the range.
The Company is seeking to establish joint ventures or strategic partnerships,
including the licensing of its technologies to major industrial concerns to
facilitate these goals. The Company might also seek additional funds under
appropriate terms from private sources to further finance development and to
achieve initial market penetration. If the Company does not successfully
commercialize its optoelectronic products or raise substantial additional
working capital for such commercial products, then these events could have a
significant adverse effect on the Company's future operating results and
financial position.
The Company has a working capital financing arrangement with an accounts
receivable factoring organization. Under the agreement, the factoring
organization may purchase certain of the Company's accounts receivable subject
to full recourse against the Company in the case of nonpayment by the customers.
The Company generally receives 85%-90% of the invoice amount at the time of
purchase and the balance when the invoice is paid. The Company is charged an
interest fee and other processing charges, payable at the time each invoice is
paid. There was $472,000 of funds advanced as of June 29, 2003 and $169,000 as
of December 29, 2002.
The Company expects to satisfy its operating cash requirements for the remainder
of 2003 from existing cash flows or from borrowings under its current working
capital accounts receivable financing arrangements. The timing and extent of the
Company's working capital needs will be tied directly to the prospects for its
commercial products under development. The Company does not anticipate incurring
significant marketing, sales or distribution expenses in the commercial product
area unless and until there is a significant increase in the level of capital
spending on optical telecommunications equipment and infrastructure. However,
the Company plans to continue R&D spending on optoelectronics in 2003 at a
reduced level. The reduced R&D spending is intended to allow the Company to
operate at an overall breakeven or better level. Such R&D would be financed with
internally generated funds. If the Company decides to accelerate its commercial
products R&D and/or marketing and distribution efforts beyond those which can be
internally financed, then the Company would have to raise additional funds from
outside sources. However, there can be no assurances in this regard and we
expect that the Company will need significant financing in the future if we
pursue acquisitions.
19
ESSEX CORPORATION
THE PRECEDING PARAGRAPHS DISCUSSING THE COMPANY'S FINANCIAL CONDITION CONTAIN
FORWARD-LOOKING STATEMENTS. THE FACTORS AFFECTING THE ABILITY OF THE COMPANY TO
MEET ITS FUNDING REQUIREMENTS AND MANAGE ITS CASH RESOURCES INCLUDE, AMONG OTHER
THINGS, THE AMOUNT AND TIMING OF PRODUCT SALES, INVENTORY TURNOVER, THE
MAGNITUDE OF FIXED COSTS AND THE ABILITY TO OBTAIN WORKING CAPITAL, ALL OF WHICH
INVOLVE RISKS AND UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT.
20
ESSEX CORPORATION
ITEM 3. CONTROLS AND PROCEDURES
Based on their most recent evaluation, which was completed within 90 days of the
filing of this Form 10-QSB, the Company's Chief Executive Officer and Chief
Financial Officer believe the Company's disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) are effective to ensure that
information required to be disclosed by the Company in this report is
accumulated and communicated to the Company's management, including its
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. There were no significant
changes in the Company's internal controls or other factors that could
significantly affect these controls subsequent to the date of their evaluation
and there were no corrective actions with regard to significant deficiencies and
material weaknesses.
21
ESSEX CORPORATION
PART II - OTHER INFORMATION
Item 6. Exhibits and Report on Form 8-K
(a) Exhibits
Exhibit 99.1 - Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
None
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
ESSEX CORPORATION
(Registrant)
Date: August 8, 2003
/S/ JOSEPH R. KURRY, JR.
-------------------------
Joseph R. Kurry, Jr.
Senior Vice President
Treasurer and Chief Financial Officer
(Mr. Kurry is the Principal Financial and Accounting Officer and has been duly
authorized to sign on behalf of the Registrant.)
22
ESSEX CORPORATION
SECTION 302 CERTIFICATION
I, Leonard E. Moodispaw, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Essex Corporation;
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 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 the 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; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether 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.
Dated August 8, 2003 /S/ LEONARD E. MOODISPAW
-----------------------------------
Leonard E. Moodispaw
President and Chief Executive Officer
SECTION 302 CERTIFICATION
I, Joseph R. Kurry, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Essex Corporation;
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 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 the 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; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether 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.
Dated August 8, 2003 /S/ JOSEPH R. KURRY, JR.
-----------------------------------
Joseph R. Kurry, Jr.
Senior Vice President, Treasurer and
Chief Financial Officer