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 September 28, 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 SEPTEMBER 28, 2003
----- ---------------------
Common Stock, no par value per share 8,945,542
Transitional Small Business Disclosure Format (Check One);
YES NO X
----- -----
ESSEX CORPORATION
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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 CONSOLIDATED FINANCIAL INFORMATION
2
ESSEX CORPORATION
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CONSOLIDATED BALANCE SHEETS
September 28, December 29,
2003 2002
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash $ 871,764 $ 1,030,247
Accounts receivable, net 2,655,811 565,626
Prepayments and other 164,060 106,987
------------ ------------
Total Current Assets 3,691,635 1,702,860
------------ ------------
PROPERTY AND EQUIPMENT
Computers and special equipment 1,100,842 948,455
Furniture, equipment and other 329,921 219,112
------------ ------------
1,430,763 1,167,567
Accumulated depreciation and amortization (1,066,405) (845,360)
------------ ------------
Net Property and Equipment 364,358 322,207
------------ ------------
OTHER ASSETS
Goodwill 3,019,000 --
Patents, net 332,084 296,407
Other intangibles, net 135,390 --
Other 23,766 21,725
------------ ------------
Total Other Assets 3,510,240 318,132
------------ ------------
TOTAL ASSETS $ 7,566,233 $ 2,343,199
------------ ============ ============
The accompanying notes are an integral part of these statements.
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ESSEX CORPORATION
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CONSOLIDATED BALANCE SHEETS
September 28, December 29,
2003 2002
------------- -------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Advance from accounts receivable financing $ 266,064 $ 169,432
Accounts payable 652,180 659,977
Accrued wages and vacation 656,382 233,940
Accrued retirement plan contribution payable 254,580 65,000
Billings in excess of costs 159,000 135,000
Other accrued expenses 450,989 146,041
Capital leases 10,976 71,261
------------- -------------
Total Current Liabilities 2,450,171 1,480,651
------------- -------------
LONG-TERM DEBT
Convertible note payable due December 31, 2004 500,000 500,000
Note payable due December 31, 2004 100,000 --
Capital leases, net of current portion -- 4,390
------------- -------------
Total Long-Term Debt 600,000 504,390
------------- -------------
Total Liabilities 3,050,171 1,985,041
------------- -------------
SHAREHOLDERS' EQUITY
Common stock, no par value; 25 million shares
authorized; 8,945,542 and 7,790,398 shares
issued and outstanding, respectively 16,848,710 12,706,520
Additional paid-in capital 2,000,000 2,000,000
Prepaid warrant -- 50,000
Accumulated deficit 14,332,648) (14,398,362)
------------- -------------
Total Shareholders' Equity 4,516,062 358,158
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$ 7,566,233 $ 2,343,199
============= =============
The accompanying notes are an integral part of these statements.
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ESSEX CORPORATION
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CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THIRTY-NINE WEEK PERIODS
ENDED SEPTEMBER 28, 2003 AND SEPTEMBER 29, 2002
UNAUDITED
2003 2002
-------------- --------------
Revenues $ 11,220,333 $ 3,093,619
Costs of goods sold and services provided (7,041,896) (1,712,578)
-------------- --------------
Gross Margin 4,178,437 1,381,041
Selling, general and administrative expenses (3,418,644) (1,987,135)
Research and development (337,804) (1,226,854)
Amortization of other intangible assets (295,360) --
-------------- --------------
Operating Income (Loss) 126,629 (1,832,948)
Interest expense, net (60,915) (14,038)
-------------- --------------
Income (Loss) Before Income Taxes 65,714 (1,846,986)
Provision for income taxes -- --
-------------- --------------
Net Income (Loss) $ 65,714 $ (1,846,986)
============== ==============
Basic Earnings (Loss) Per Common Share $ 0.01 $ (0.25)
============== ==============
Diluted Earnings (Loss) Per Common Share $ 0.01 $ (0.25)
============== ==============
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,393,338 7,329,488
Effect of dilution -
Stock options 910,164 --
-------------- --------------
Diluted 9,303,502 7,329,488
============== ==============
The accompanying notes are an integral part of these statements.
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ESSEX CORPORATION
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CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THIRTEEN WEEK PERIODS
ENDED SEPTEMBER 28, 2003 AND SEPTEMBER 29, 2002
UNAUDITED
2003 2002
-------------- --------------
Revenues $ 4,070,392 $ 1,600,910
Costs of goods sold and services provided (2,379,954) (964,806)
-------------- --------------
Gross Margin 1,690,438 636,104
Selling, general and administrative expenses (1,428,393) (553,089)
Research and development (111,764) (260,621)
Amortization of other intangible assets (121,343) --
-------------- --------------
Operating Income (Loss) 28,938 (177,606)
Interest expense, net (17,716) (4,019)
-------------- --------------
Income (Loss) Before Income Taxes 11,222 (181,625)
Provision for income taxes -- --
-------------- --------------
Net Income (Loss) $ 11,222 $ (181,625)
============== ==============
Basic Earnings (Loss) Per Common Share $ 0.00 $ (0.02)
============== ==============
Diluted Earnings (Loss) Per Common Share $ 0.00 $ (0.02)
============== ==============
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,585,607 7,410,223
Effect of dilution -
Stock options 1,162,585 --
-------------- --------------
Diluted 9,748,192 7,410,223
============== ==============
The accompanying notes are an integral part of these statements.
6
ESSEX CORPORATION
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CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THIRTY-NINE WEEK PERIODS
ENDED SEPTEMBER 28, 2003 AND SEPTEMBER 29, 2002
UNAUDITED
2003 2002
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ 65,714 $ (1,846,986)
Adjustments to reconcile Net Income (Loss) to
Net Cash Used In Operating Activities:
Depreciation and amortization 126,950 110,994
Amortization of other intangible assets 295,359 --
Stock compensation expense 2,000 246,325
Inventory valuation reserve -- 15,000
Loss (gain) on disposition of fixed assets 1,271 (91)
Change in Assets and Liabilities:
Accounts receivable (822,638) (616,794)
Prepayments and other assets 26,681 15,804
Contract work in progress 65,000 --
Accounts payable (140,869) 546,198
Accrued wages, vacation and retirement 359,632 (74,654)
Other liabilities 113,341 60,427
------------- -------------
Net Cash Provided By (Used In) Operating Activities
92,441 (1,543,777)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of SDL (309,000) --
Purchases of property and equipment (143,710) (27,465)
Proceeds from sale of fixed assets -- 91
------------- -------------
Net Cash Used In Investing Activities (452,710) (27,374)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sales of common stock -- 1,250,003
Proceeds of note payable 100,000 --
Exercise of stock options 69,829 95,528
Short-term borrowings/repayments, net 96,632 321,600
Payment of capital lease obligations (64,675) (131,741)
------------- -------------
Net Cash Provided By Financing Activities 201,786 1,535,390
------------- -------------
CASH AND CASH EQUIVALENTS
Net decrease (158,483) (35,761)
Balance - beginning of period 1,030,247 568,178
------------- -------------
Balance - end of period $ 871,764 $ 532,417
============= =============
The accompanying notes are an integral part of these statements.
7
ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED 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 thirty-nine week periods ended September 28, 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 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 communications marketplace, particularly the productization of its
proprietary technologies in communications 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 the first
HYPERFINE WDM technology patent for the optical multiplexer in August 2003.
Since
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ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL INFORMATION
September 2000, the Company has received over $6 million in financing from its
Private Investors or their 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 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 or public sources to continue to finance business
development and to achieve initial market penetration.
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 in research and
development. 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 reduced by contingently
returnable shares 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 or conversion of convertible debt. 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 $266,000 of funds advanced as of September 28, 2003 and
$169,000 of funds advanced as of December 29, 2002.
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ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED 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 or sale of stock via a
registration statement for at least $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 September 28, 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 and the balance was received by September 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:
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ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL INFORMATION
Thirteen Week Periods Ended Thirty-Nine Week Periods Ended
------------------------------- -------------------------------
Sept. 28, 2003 Sept. 29, 2002 Sept. 28, 2003 Sept. 29, 2002
-------------- -------------- -------------- --------------
Net income (loss), as
reported $ 11,222 $ (181,625) $ 65,714 $ (1,846,986)
Less: Total stock-based
employee compensation
expense determined under
fair value based method 189,568 43,595 582,138 454,320
-------------- -------------- -------------- --------------
Pro forma loss $ (178,346) $ (225,220) $ (516,424) $ (2,301,306)
============== ============== ============== ==============
Income (loss) per share:
Basic-as reported $ 0.00 $ (0.02) $ 0.01 $ (0.25)
Basic-pro forma $ (0.02) $ (0.03) $ (0.07) $ (0.31)
Diluted-as reported $ 0.00 $ (0.02) $ 0.01 $ (0.25)
Diluted-pro forma $ (0.02) $ (0.03) $ (0.07) $ (0.31)
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, $128,000 in
the quarter ended June 2003 and $121,000 in the quarter ended September 28,
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
----------------------------- -----------------------------
Third Quarter Year-To-Date Third Quarter Year-To-Date
------------- ------------ ------------- ------------
Federal taxes at
statutory rates $ 4,000 $ 22,000 $ (62,000) $ (628,000)
State income taxes, net
of federal benefit 1,000 4,000 (9,000) (96,000)
Change in valuation
allowance (5,000) (26,000) 71,000 724,000
------------- ------------ ------------- ------------
Provision for income
taxes $ -- $ -- $ -- $ --
============= ============ ============= ============
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ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL INFORMATION
NOTE 8: Statements of Cash Flows - Supplemental Disclosure
There were no new capital leases entered into in the first nine months of 2003.
There were $62,000 of new capital leases entered into in the first nine months
of 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 transaction 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.
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ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED 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 Nine Months Ended
September 28, 2003
(Unaudited)
-----------------------------------
As Reported Pro Forma
--------------- ---------------
Revenues $ 11,220,000 $ 12,485,000
=============== ===============
Net Income $ 66,000 $ 328,000
=============== ===============
Earnings Per Share:
Basic $ 0.01 $ 0.04
=============== ===============
Fully diluted $ 0.01 $ 0.03
=============== ===============
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,393,338 8,571,907
Effect of Dilution -
Stock Options 910,164 910,164
--------------- ---------------
Diluted 9,303,502 9,482,071
=============== ===============
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 Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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.
In January 2003, the FASB issued Financial Interpretation No. 46 (FIN 46),
"Consolidation Of Variable Interest Entities". FIN 46 requires that if an entity
has a controlling financial interest in a variable interest entity, the assets,
liabilities and results of activities of the variable interest
13
ESSEX CORPORATION
NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL INFORMATION
entity should be included in the consolidated financial statements of the
entity. FIN 46 is effective immediately for all new variable interest entities
created or acquired after January 31, 2003. For variable interest entities
created or acquired prior to February 1, 2003, the provisions of FIN 46 must be
applied for the first interim or annual period beginning after June 15, 2003.
Since the Company is not involved with any variable interest entities, the
adoption of FIN 46 did not have a material impact on the Company's results of
operations or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial
Instruments With Characteristics Of Both Liabilities And Equity". SFAS No. 150
establishes standards on the classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. The provisions
of SFAS No. 150 are effective for financial instruments entered into or modified
after May 31, 2003 and to all other instruments that exist as of the beginning
of the first interim financial reporting period beginning after June 15, 2003.
The adoption of SFAS No. 150 did not have a material impact on the Company's
results of operations or financial position.
14
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.
OVERVIEW
The Company provides advanced optoelectronic and signal processing services and
products for U.S. Government intelligence and defense customers and
communications customers with whom we have established and maintained
long-standing and successful relationships. The Company provides optoelectronic
and signal processing services to classified U.S. Government customers under
next generation research and development contracts. The Company supports the
intelligence community's mission critical voice and video systems infrastructure
and provides systems engineering services to highly classified U.S. Government
customers. The Company builds optical communications and networking system
elements and components, as well as signal and image processing software
products. While the Company has historically sold our products to the
intelligence and defense markets, we believe our existing products and our
patent portfolio position us well to benefit from spending on next generation
technology that decreases the costs and increases the speed, performance and
security of existing communications networks.
Most of the Company's revenues are derived from contracts with the U.S.
Government, where the Company is either the prime contractor or a subcontractor,
depending on the contract. For the nine months ended September 28, 2003,
revenues derived from U.S. Government programs were $10.1 million, or 90% of the
Company's revenues. The Company's received 85% of its intelligence and defense
community revenues for the first nine months of 2003 from sole source contracts.
The Company's most significant expense is its cost of goods sold and services
provided, which consists primarily of direct labor and associated costs for
program personnel and direct expenses incurred to complete contracts, including
cost of materials and subcontract efforts. The Company's ability to accurately
predict personnel requirements, salaries and other costs, as well as to manage
personnel levels and successfully redeploy personnel, can have a significant
impact on its cost of goods sold and services provided. Selling, general and
administrative expenses consist primarily of costs associated with the Company's
management, finance and administrative groups, personnel training, business
development expenses which include bid and proposal efforts, and occupancy,
travel and other corporate costs.
15
ESSEX CORPORATION
STATUS
The Company has experienced growth in its U.S. 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 nine
months 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 advanced optoelectronics 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
communications systems support to the intelligence community. This work began in
January 2003 and is part of a multi-year $30 million award to provide such
services. The Company completed, effective March 1, 2003, the acquisition of
Sensys Development Laboratories, Inc. (SDL), a Maryland-based provider of system
and software engineering support services. (See Note 9 in Notes to Interim
Unaudited Consolidated Financial Information.) This merger added over 25 highly
skilled professionals to the Essex staff and an expected $4 million of annual
revenue in 2003.
In October 2003, the Company was awarded a new defense-related contract for
approximately $57 million over 4 years (a 3 month base period plus 4 option
years). This is a delivery order contract for software and systems engineering
and the delivery of custom systems to national priority programs. The Company is
the prime contractor and there are initially 6 team members/subcontractors who
will work on this program.
Since September 2000, the Company has closed on several equity private placement
funding transactions. Under the terms of these equity fundings, the Company has
received over $6.1 million and has issued 3.2 million shares of common stock.
The 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 Unaudited Consolidated Financial
Information for further details. The Company has also received proceeds of
$600,000 from the private placement of outstanding convertible and other debt.
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 optical processor enhanced
receiver architecture (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.
Prototypes of the HYPERFINE WDM technology are being demonstrated to prospective
strategic partners and investors. During the first nine months of 2003, the
Company sold ten of its initial HYPERFINE WDM family 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 entities that are in the wireless
communications market in order to determine the best communications applications
of such technology.
16
ESSEX CORPORATION
Essex was awarded a patent for its HYPERFINE WDM technology in August 2003. The
HYPERFINE WDM product is being demonstrated to prospective strategic partners
and investors. In light of the continued unfavorable conditions in the
communications markets, the market for our optical technologies and products has
been slow in developing; however, we have sold the first 10 HYPERFINE units to
our customers in the intelligence and defense communities. As noted above, we
are significantly expanding our U.S. Government business base. The expansion is
designed to take advantage of our government contracting experience and
technical expertise and the increased government contracting activity in the
defense, intelligence and homeland security areas. We are also pursuing sales of
HYPERFINE WDM in communications markets and other optical technologies in the
government marketplace. 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.
REVENUE RECOGNITION
The Company enters into three types of U.S. Government contracts: cost plus
fixed fee, fixed price and time and material. The Company recognizes revenue on
cost plus fixed fee 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 cost plus fixed fee 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
fixed price 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 fixed price product orders, revenue is not recorded
until the Company determines that the goods have been delivered and accepted by
the customer. On time and material 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 fixed price and cost plus fixed fee 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 cost plus fixed fee
contracts.
17
ESSEX CORPORATION
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.
GOODWILL AND OTHER INTANGIBLE ASSETS
The Company's business acquisitions typically result in goodwill and other
intangible assets, which affect the amount of future period amortization expense
and possible impairment expense that the Company will incur. The Company has
adopted Statement of Financial Accounting Standards ("SFAS") No. 142, which
requires that the Company, on an annual basis, calculate the fair value of the
reporting units that contain the goodwill and compare that to the carrying value
of the reporting unit to determine if impairment exists. Impairment testing must
take place more often if circumstances or events indicate a change in the
impairment status. Management judgment is required in calculating the fair value
of the reporting units.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of
items in the statement of operations in relation to revenue.
Nine Months Ended
(unaudited)
--------------------------------
Sept. 29, 2002 Sept. 28, 2003
-------------- --------------
Revenues 100.0% 100.0%
Costs of goods sold and services provided 55.4 62.8
Selling, general and administrative expenses 64.2 30.5
Research and development 39.7 3.0
Amortization of other intangible assets 0.0 2.6
-------------- --------------
Operating income (loss) (59.2) 1.1
Interest expense, net (0.5) (0.5)
-------------- --------------
Income (loss) before income taxes (59.7) 0.6
Benefit (provision) for income taxes 0.0 0.0
-------------- --------------
Net income (loss) (59.7)% 0.6%
============== ==============
REVENUES. Revenues were $11.2 million and $3.1 million in the first nine months
of fiscal 2003 and 2002, respectively. Revenues were $4.1 million and $1.6
million for the third quarters of fiscal 2003 and 2002, respectively. Revenues
in the first nine months of fiscal 2003 include $3.1million for seven months of
operations from SDL, which we acquired in March of this year. Excluding SDL,
revenues in the first nine months of 2003 were $8.1 million or $5.0 million
higher than the first nine months of 2002 due to several factors. A key factor
was the increased activity on the U.S. Government Missile Defense Agency program
for design of a next generation advanced optoelectronics radar processor, or
AOP, demonstration unit. This program generated revenues of
18
ESSEX CORPORATION
$3.0 million in the first nine months of fiscal 2003 compared to revenues of
$1.2 million in the comparable period of 2002 as the Company did not begin this
program until May 2002. The Company's communications services contracts
contributed $2.5 million of revenues in the first nine months of fiscal 2003 and
no revenue for the same period in fiscal 2002. Additionally, in the first nine
months of fiscal 2003, the Company sold $1.1 million of products and equipment,
including the sale of ten HYPERFINE WDM family devices, consisting of five
prototype demultiplexers and five of the new flat-top HYPERFINE WDM devices for
use in building advanced optical code division multiple access (OCDMA) systems
for $457,000 to several government and intermediate customers. The Company had
only $15,000 of such sales in the comparable period in 2002.
COST OF GOODS SOLD AND SERVICES PROVIDED. Cost of goods sold and services
provided increased $5.3 million to $7.0 million for the first nine months of
fiscal 2003 from $1.7 million for the comparable period in fiscal 2002. As a
percentage of revenues, cost of goods sold and services provided was
approximately 63% for the first nine months of 2003, compared to approximately
55% for the comparable period in fiscal 2002. In the first nine months of fiscal
2003, due to the SDL acquisition and communications sales referenced previously,
there was a significant increase in the direct labor and associated costs for
work performed at our customers' facilities. The Company received a lower markup
on work performed at customer facilities. Overall, the higher volume during the
first nine months of 2003 contributed a larger amount of gross profit, though at
a lower gross profit percentage.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $1.4 million to $3.4 million for the first
nine months of fiscal 2003 from $2.0 million for the comparable period in fiscal
2002. The increase was partially due to increased business development and
higher management costs in the government contracts area as well as continuing
costs in the optoelectronics and communications new device business areas.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses declined
$889,000 to $338,000 in the first nine months of 2003 compared to $1.2 million
in the comparable period in fiscal 2002. The Company incurred the majority of
its research and development on efforts related to optical communications
technology.
AMORTIZATION OF OTHER INTANGIBLE ASSETS. During the first nine months of fiscal
2003, amortization of other intangible assets was $295,000, all of which was
related to the SDL acquisition. The Company expects the remaining balance of
$135,000 of other intangible assets to be substantially amortized within
approximately six months. There was no amortization cost in the comparable
period in 2002.
NET INTEREST EXPENSE. Net interest expense was $61,000 and $14,000 in the first
nine months of 2003 and 2002, respectively. The increase in net interest expense
reflects an increase in the Company's debt and costs related to its accounts
receivable facility.
NET INCOME (LOSS). The Company recorded net income of $11,000 and a net loss
$182,000 in the third quarters of 2003 and 2002, respectively. Net income was
$66,000 and net loss was $1.8 million in the first nine months of 2003 and 2002,
respectively. The Company is in a net operating loss carryforward position for
book and tax purposes. No provision for or benefit from income taxes was
recognized in the first nine months of 2003 or 2002 due to the net operating
loss carryforwards. We adjusted our valuation reserves accordingly during these
periods.
19
ESSEX CORPORATION
BACKLOG
As of September 28, 2003, the Company had total contract backlog, funded and
unfunded, of approximately $52.6 million as compared with $52.1 million at
December 29, 2002. Of these amounts, funded backlog was $6.4 million and
unfunded backlog was $46.2 million at September 28, 2003 compared to $600,000
and $51.5 million, respectively, at fiscal year end 2002. Of the unfunded
backlog at September 28, 2003, approximately $19.0 million represents the
remaining balance of a $25.0 million U.S. Government five year Indefinite
Delivery Indefinite Quantity, or IDIQ, contract through 2007 to provide
technology to enhance Department of Defense radar programs. Unfunded backlog as
of September 28, 2003 also includes the remaining balance of approximately $24.6
million on our $30 million, ten-year contract to provide communications systems
support to the intelligence community. Backlog at September 28, 2003 does not
include the award of an approximately $57.0 million contract for software and
systems engineering that we received in October 2003. Funded backlog generally
consists of the sum of all contract amounts of work for which funding has been
approved and contracts signed, less the value of work performed under such
contracts.
FINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity and capital resource needs are to finance the costs of our
operations, to make capital expenditures, and to service our debt. Based upon
our current level of operations, we expect that our cash flow from operations
and amounts we are able to borrow under our accounts receivable facility, will
be adequate to meet our anticipated needs for the foreseeable future.
The Company evaluates its liquidity position using various factors. The
following represents some of the more important factors:
SELECTED FINANCIAL DATA AS OF
(In thousands)
-------------------------------------------
Sept. 28, December 29, Sept. 29,
2003 2002 2002
----------- ----------- -----------
Total Assets $ 7,566 $ 2,343 $ 2,211
=========== =========== ===========
Working Capital (Deficit) $ 1,241 $ 222 $ (300)
=========== =========== ===========
Current Ratio 1.51:1 1.15:1 0.83:1
=========== =========== ===========
Advance from Accounts Receivable
Financing $ 266 $ 169 $ 322
Capital Leases 11 76 121
Convertible Debt 500 500 --
Other Debt 100 -- --
----------- ----------- -----------
Total Debt/Financing $ 877 $ 745 $ 443
=========== =========== ===========
Shareholders' Equity $ 4,516 $ 358 $ 390
=========== =========== ===========
20
ESSEX CORPORATION
During the first nine months of fiscal 2003, net cash provided by operating
activities was $92,000. Cash provided from net income and non cash depreciation,
amortization and other charges of approximately $492,000 was offset by an
increase in accounts receivable net of the change in accounts payable and
accrued items of $400,000. The increase in accounts receivable during 2003 was
due to the increase in sales and does not reflect any change in payment cycle.
The Company's working capital at September 28, 2003 increased to $1.2 million
from $222,000 at fiscal year end 2002. The increase was primarily a result of
the acquisition of SDL in early 2003 for predominately common stock, which
resulted in a $613,000 increase in working capital after deducting the $309,000
of cash consideration paid.
During the first nine months of fiscal 2003, net cash used in investing
activities was $453,000. Of this amount, $309,000 represents the cash
consideration paid in the acquisition of SDL. The Company also spent $144,000 in
2003 for property and equipment to support our growing work force.
During the first nine months of fiscal 2003, net cash provided by financing
activities of $202,000 resulted primarily from the private placement of $100,000
in debt to a private investor and borrowings on accounts receivable. The Company
received $1.3 million in the first nine months of 2002 from private placements
of common stock. The funds have been used primarily for the development of the
optical telecommunications device technologies.
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 $266,000 of funds advanced as of September 28, 2003 and $169,000
as of December 29, 2002.
The Company has several device families under development, with development of
HYPERFINE WDM communications technology being the most advanced. In particular,
the Company has completed development on an alpha version of the HYPERFINE
multiplexer-demultiplexer and has delivered on orders for HYPERFINE WDM from
government and intermediate customers and will continue to seek orders from
these customers. However, the Company has not yet begun substantial further
efforts for communications 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 significant additional capital
depending on a number of variables, including the extent of reliance on
manufacturing, distribution and channel partner relationships. For example, if
the Company 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 or public sources to further finance development
and to achieve initial market penetration.
21
ESSEX CORPORATION
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 determined by the prospects for its
communications products under development and the growth in its core government
contracting areas. The Company does not anticipate incurring significant
marketing, sales or distribution expenses in the communications product area
unless and until there is a significant increase in the level of capital
spending on optical communications equipment and infrastructure. However, the
Company plans to continue research and development spending on optoelectronics
in 2003 at a reduced level. The goal of the reduced research and development
spending is to allow the Company to operate at an overall breakeven or better
level. Such research and development would be financed with internally generated
funds. If the Company decides to accelerate its communications products research
and development or marketing and distribution efforts beyond those which can be
internally financed, then the Company would have to raise additional funds from
outside sources. The Company may also seek additional funds from private or
public sources to pursue selected acquisitions of companies in the government
contracting or communications products areas. However, there can be no assurance
that such funds will be available on terms acceptable to the Company or at all.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
CONTRACTUAL CASH OBLIGATIONS
The following table shows the Company's contractual cash obligations due in the
three months ended December 28, 2003 and in each of fiscal 2004 and 2005. The
Company does not have contractual cash obligations due after 2005.
Three Months ended
December 28, 2003 Fiscal 2004 Fiscal 2005
------------------ --------------- ---------------
Operating leases $ 103,555 $ 240,916 $ 201,613
Capital leases 8,044 5,362 --
Notes payable (1) -- -- 600,000
Interest on notes payable (2) -- -- 122,363
------------------ --------------- ---------------
Total $ 111,599 $ 246,278 $ 923,976
================== =============== ================
-------------------
(1) The notes are payable on demand on or before December 31, 2004 and may be
prepaid upon certain notice requirements.
(2) Includes accrued interest at the contract rate through December 31, 2004.
In the event the holder converts the $500,000 convertible note into shares
of common stock on or before the maturity date, the accrued interest will
be waived.
22
ESSEX CORPORATION
INFLATION
Because of the Company's substantial activities in professional services and
product development, the Company is more labor intensive than firms involved
primarily in industrial activities. To attract and maintain higher caliber
professional staff, the Company must structure its compensation programs
competitively. The wage demand effect of inflation is felt almost immediately in
the Company's costs, however, the net effect during the periods presented is
minimal.
The inflation rate in the United States generally has little impact on the
Company's cost-reimbursable type contracts and other short-term contracts. For
longer-term, fixed-price type contracts, the Company endeavors to protect its
margins by including cost escalation provisions or other specific inflation
protective terms in these contracts.
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, SALES GROWTH AND THE ABILITY TO OBTAIN WORKING
CAPITAL, ALL OF WHICH INVOLVE RISKS AND UNCERTAINTIES THAT ARE DIFFICULT TO
PREDICT.
23
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, Leonard E. Moodispaw, the Company's Chief Executive
Officer and Joseph R. Kurry, Jr., the Company's Chief Financial Officer, have
concluded that 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 be recorded,
processed, summarized and reported within the time periods specified by the
Securities and Exchange Commission's rules and forms.
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.
24
ESSEX CORPORATION
PART II - OTHER INFORMATION
Item 6. Exhibits and Report on Form 8-K
(a) Exhibits
Exhibit 31.1 - Certification by the Chief Executive Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification by the Chief Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification by the Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350 Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 - Certification by the Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350 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: November 5, 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.)
25