UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the Transition period from to
Commission File Number 0-10772
ESSEX CORPORATION
(Exact name of registrant 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)
(301) 939-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
OUTSTANDING
CLASS AT APRIL 30, 2005
----- -----------------
Common Stock, no par value per share 21,091,821
ESSEX CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INDEX
o CONSOLIDATED BALANCE SHEETS
o UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
o UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
o NOTES TO INTERIM CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
2
ESSEX CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, December 31,
2005 2004
----------- -----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 21,943 $ 105,094
Accounts receivable, net 32,263 10,198
Note receivable - current portion 877 594
Prepayments and other 1,104 506
----------- -----------
Total Current Assets 56,187 116,392
----------- -----------
Property and Equipment
Computers and special equipment 3,653 2,667
Furniture, equipment and other 5,192 1,174
----------- -----------
8,845 3,841
Accumulated depreciation and amortization (1,837) (1,544)
----------- -----------
Net Property and Equipment 7,008 2,297
----------- -----------
Other Assets
Goodwill 72,403 11,842
Patents, net 323 313
Other intangibles, net 8,521 2,294
Note receivable - non-current 1,972 2,045
Other 842 383
----------- -----------
Total Other Assets 84,061 16,877
----------- -----------
TOTAL ASSETS $ 147,256 $ 135,566
=========== ===========
The accompanying notes are an integral part of these statements.
3
ESSEX CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, December 31,
2005 2004
----------- ----------
(Unaudited
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 4,806 $ 3,643
Accrued wages and vacation 4,229 1,845
Accrued retirement plans contribution payable 302 236
Advance payments 1,204 482
Other accrued expenses 7,138 1,773
Current portion of long-term debt 31 12
----------- ----------
Total Current Liabilities 17,710 7,991
Long-term debt 36 29
----------- ----------
Total Liabilities 17,746 8,020
----------- ----------
Shareholders' Equity
Common stock, no par value;
50 million shares authorized;
21,067 and 20,917 shares issued
and outstanding, respectively 137,959 137,531
Additional paid-in capital 2,000 2,000
Accumulated deficit (10,449) (11,985)
----------- ----------
Total Shareholders' Equity 129,510 127,546
----------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 147,256 $ 135,566
=========== ==========
The accompanying notes are an integral part of these statements.
4
ESSEX CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED
MARCH 31, 2005 AND MARCH 28, 2004
(UNAUDITED, IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2005 2004
---------- ----------
Revenues:
Services and products $ 23,423 $ 8,268
Purchased materials 2,255 5,973
---------- ----------
Total 25,678 14,241
---------- ----------
Costs of goods sold and services provided:
Services and products (16,554) (6,135)
Purchased materials (2,067) (5,860)
---------- ----------
Total (18,621) (11,995)
---------- ----------
Gross Margin 7,057 2,246
Selling, general and administrative expenses (5,194) (1,834)
Research and development (487) (141)
Amortization of other intangible assets (552) (35)
---------- ----------
Operating Income 824 236
Interest/dividend income 732 76
---------- ----------
Income Before Income Taxes 1,556 312
Provision for income taxes (20) --
---------- ----------
Net Income $ 1,536 $ 312
========== ==========
Basic Earnings Per Common Share $ 0.07 $ 0.02
========== ==========
Diluted Earnings Per Common Share $ 0.07 $ 0.02
========== ==========
Weighted Average Number of Shares
Basic 21,006 15,006
Effect of dilution -
Stock options 1,601 1,407
---------- ----------
Diluted 22,607 16,413
========== ==========
The accompanying notes are an integral part of these statements.
5
ESSEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED
MARCH 31, 2005 AND MARCH 28, 2004
(UNAUDITED AND IN THOUSANDS)
2005 2004
----------- -----------
Cash Flows From Operating Activities:
Net Income $ 1,536 $ 312
Adjustments to reconcile Net Income to Net
Cash Used By Operating Activities:
Depreciation and patent amortization 297 67
Amortization of other intangible assets 552 35
Contract reserves/account allowance 171 60
Change in Assets and Liabilities:
Accounts receivable (6,740) (5,949)
Prepayments and other assets (206) (401)
Advance payments 376 (37)
Accounts payable (1,810) 2,948
Accrued wages, vacation and retirement 206 (227)
Other accrued expenses 3,662 (202)
----------- -----------
Net Cash Used In Operating Activities (1,956) (3,394)
----------- -----------
Cash Flows From Investing Activities:
Acquisitions, net of cash acquired (71,850) --
Purchases of property and equipment (1,350) (110)
----------- -----------
Net Cash Used In Investing Activities (73,200) (110)
----------- -----------
Cash Flows From Financing Activities:
Sales of common stock (82) 1,192
Note receivable (376) --
Exercise of stock options 428 94
Debt borrowings/repayments, net (7,965) (104)
----------- -----------
Net Cash (Used In) Provided By Financing Activities (7,995) 1,182
----------- -----------
Cash and Cash Equivalents
Net decrease (83,151) (2,322)
Balance - beginning of period 105,094 31,835
----------- -----------
Balance - end of period $ 21,943 $ 29,513
=========== ===========
The accompanying notes are an integral part of these statements.
6
ESSEX CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
NOTE 1: GENERAL
Fiscal Year and Presentation
These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, Computer Science Innovations, Inc. ("CSI") which
was acquired on April 30, 2004 and The Windermere Group, LLC ("Windermere")
which was acquired on February 28, 2005. In addition, these statements reflect
the accounts and activities of Sensys Development Laboratories, Inc. ("SDL")
which was acquired March 1, 2003 and merged into the Company and the acquisition
of substantially all of the assets of Performance Group, Inc. ("PGI") on June
25, 2004. All material intercompany transactions have been eliminated in
consolidation. Certain amounts for 2004 have been reclassified to conform to the
2005 presentation.
Historically, Essex closed its fiscal year and its quarters on the last Sunday
of each period. On December 22, 2004, the Board of Directors approved changing
Essex's financial reporting to calendar year end and end-of-the month quarterly
reporting. This change is not significant for comparative purposes and is
effective for fiscal year end December 31, 2004 and all subsequent periods.
The information furnished in the accompanying Consolidated Balance Sheets,
Unaudited Consolidated Statements of Operations and Unaudited 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 consisting of normal recurring accruals that, in the opinion of
management, are considered necessary for a fair presentation of such
information. The operating results for the three months ended March 31, 2005 may
not be indicative of the results of operations for the year ending December 31,
2005, or any future period. This financial information should be read in
conjunction with the Company's 2004 audited consolidated financial statements
and footnotes thereto, included in the Annual Report on Form 10-K for the year
ended December 31, 2004. Significant accounting policies are detailed in our
Annual Report on Form 10-K for the fiscal year ended December 31, 2004. For a
discussion of our Critical Accounting Policies, refer to "Management Discussion
and Analysis of Financial Condition and Results of Operations" and the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2004.
NOTE 2: BASIC AND DILUTED EARNINGS PER SHARE
Basic earnings per common share are computed using the weighted average number
of common shares outstanding during the period reduced by contingently
returnable shares. Diluted earnings per common share incorporates the
incremental shares issuable upon the assumed exercise of stock options, warrants
and convertible debt. As of March 31, 2005 and March 28, 2004, the effect of the
incremental shares from options, warrants and contingent shares (if applicable)
of 35,000 and 110,600 respectively, have been excluded from diluted weighted
average shares as the effect would have been anti-dilutive.
7
ESSEX CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
NOTE 3: COMMON STOCK
In December 2004, the Company completed a follow-on public offering of 5.6
million shares of its common stock, including 568,000 shares from the exercise
of the underwriter's over-allotment option, and received a total net proceeds
from all shares issued of approximately $87.0 million.
The Company completed a follow-on public offering in December 2003 and issued
4.0 million shares of common stock. The Company received net proceeds of $31.4
million. In January 2004, the underwriters exercised their over-allotment option
and the Company sold an additional 150,000 common shares and received net
proceeds of $1.2 million.
In connection with the March 1, 2003 acquisition of SDL, the Company had issued
approximately 422,000 common shares into escrow. These shares were to be
released to certain SDL shareholders or returned to Essex based upon certain
factors, principally the future market price of the Company's stock. During the
first three months of 2004, the 422,000 shares in escrow were returned to the
Company in accordance with the terms of the purchase agreement.
NOTE 4: STOCK-BASED COMPENSATION
The Company currently applies the intrinsic value method in accounting for stock
options granted to employees and directors. Under the intrinsic value method,
compensation costs is the excess, if any, of the quoted market price of the
stock at grant date or other measurement date over the amount an employee must
pay to acquire the stock. If the Company had used the fair value based method,
net earnings and earnings per share would have been reduced to the pro forma
amounts listed in the below table.
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Three Months Ended
---------------------------------
March 31, 2005 March 28, 2004
-------------- --------------
Net income $ 1,536 $ 312
Less: Total stock-based employee
compensation expense determined under
fair value based method for all awards 838 761
-------------- --------------
Pro forma earnings (loss) $ 698 $ (449)
============== ==============
Earnings (loss) per share:
Basic-as reported $ 0.07 $ 0.02
Basic-pro forma $ 0.03 $ (0.03)
Diluted-as reported $ 0.07 $ 0.02
Diluted-pro forma $ 0.03 $ (0.03)
8
ESSEX CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
NOTE 5: AMORTIZATION OF OTHER INTANGIBLE ASSETS
The following value was assigned to intangible assets for the acquisitions noted
below:
Value Assigned to Intangible
(IN THOUSANDS) Assets
----------------------------
Assets of Entity As of As of
Acquired or Acquired March 31, December 31,
Date of Acquisition Entity 2005 2004
---------------------------- -------------------- ------------ ------------
February 28, 2005 Windermere $ 6,779 $ --
June 25, 2004 PGI 1,498 1,498
April 30, 2004 CSI 1,279 1,279
March 1, 2003 SDL 431 431
------------ ------------
Total Intangible
Assets Acquired 9,987 3,208
Less: Amortization 1,466 914
------------ ------------
Other Intangibles, net $ 8,521 $ 2,294
============ ============
Intangible assets relate primarily to customer relationships. In addition,
intangibles include non-compete agreements and intellectual property.
Intangibles are amortized over their estimated life, not exceeding five years.
Total amortization through March 31, 2005 amounts to approximately $1.5 million.
During the first three months of 2005, amortization of other intangible assets
was $552,000 as compared to $35,000 in the comparable period in 2004.
NOTE 6: INCOME TAXES
The Company is in a net operating loss ("NOL") carryforward position for book
and tax purposes.
The Company has established a valuation reserve for all of its deferred tax
assets. Such tax assets are available to be recognized and benefit future
periods. Management periodically evaluates the valuation allowance recorded
against net operating loss carryforwards and other deferred tax assets to assess
whether information exists to warrant reversal based upon a variety of factors
for generating future taxable income, such as historical and projected operating
performance. The Company had a deferred income tax asset valuation allowance of
$5.4 million at December 31, 2004.
NOTE 7: ACQUISITIONS
On February 28, 2005, the Company acquired 100% of the ownership and membership
interests of Windermere, which was headquartered in Annapolis, Maryland, for a
total initial purchase price of $72.0 million, including the initial payment of
$69.4 million and legal and other fees of
9
ESSEX CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
$2.6 million. Also, the purchase agreement includes terms for an additional
purchase payment in May 2006 of up to $30.0 million for an "earn-out" based on
profitability as specified in the purchase agreement. The sellers used $25.3
million of the proceeds from the initial purchase payment to repay the principal
and accrued interest due Essex under a promissory note and loan agreement dated
January 7, 2005.
Windermere provides engineering services, software development and information
technology solutions to government agencies, the intelligence community and
commercial customers. Windermere had revenues of $64.7 million, including $2.5
million of revenue from discontinued operations, for the calendar year ended
December 31, 2004.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition.
(IN THOUSANDS)
Cash $ 169
Current assets, net of cash acquired 16,115
Equipment and other 3,900
Goodwill 60,561
Intangible assets 6,779
------------
Total assets acquired 87,524
------------
Current liabilities (15,494)
Long term debt (11)
------------
Total liabilities assumed (15,505)
------------
Net assets acquired $ 72,019
============
Of the intangible assets of $6,779,000, there was $6,176,000 assigned to
contracts which have an estimated overall amortization life of less than five
years. The remaining balance was assigned to a non-compete covenant with an
estimated overall amortization life of four years.
The following information is presented on a pro forma basis as though the
business combination had been completed as of the beginning of the fiscal years
2005 and 2004.
(IN THOUSANDS,
EXCEPT PER SHARE
AMOUNTS) Three Months Ended Three Months Ended
March 31, 2005 March 28, 2004
-------------------------- --------------------------
As Reported Pro Forma As Reported Pro Forma
----------- ----------- ----------- -----------
Revenues $ 25,678 $ 37,444 $ 14,241 $ 28,793
=========== =========== =========== ===========
Net Income $ 1,536 $ 1,917 $ 312 $ 540
=========== =========== =========== ===========
Earnings Per Share:
Basic $ 0.07 $ 0.09 $ 0.02 $ 0.04
=========== =========== =========== ===========
Fully diluted $ 0.07 $ 0.08 $ 0.02 $ 0.03
=========== =========== =========== ===========
10
ESSEX CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
NOTE 8: MAJOR CUSTOMERS
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 award. For the first three months of 2005 and 2004, revenues
derived from U.S. Government programs were $24.0 million, or 93% and $14.2
million, or 100%, of the Company's total revenues, respectively. For the first
three months of 2005, revenue from the top three customer programs, all
performed for the same U.S. Government customer, were $13.8 million or 54% of
the Company's revenues. For the first three months of 2004, $9.2 million or 64%
of revenues were derived from one U.S. Government customer on one program.
NOTE 9: LINE OF CREDIT
Windermere has a $10.0 million revolving line of credit loan agreement with Bank
of America. In connection with the acquisition, Essex became a guarantor. The
line of credit is secured primarily by the accounts receivable of Windermere.
The line of credit expires on May 31, 2005 and will not be extended. The
agreement contains certain financial and other standard covenants regarding
restrictions on payments of dividends and capital expenditures. In connection
with the acquisition, these covenants have essentially been waived on a one-time
basis through May 31, 2005. Borrowings under the line of credit incur interest
at a floating rate above LIBOR and an unused fee of 25 basis points. In early
March 2005, Essex paid down the line which had a balance of $7.9 million at
February 28, 2005, the acquisition date. There were no borrowings outstanding as
of March 31, 2005. Essex is currently negotiating a line of credit that will be
available for operating or other corporate needs.
11
ESSEX CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 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. IN THIS FORM 10-Q, "WE", "US" AND "OUR" REFERS TO ESSEX
CORPORATION, INCLUDING ITS CONSOLIDATED SUBSIDIARIES.
OVERVIEW
Essex provides advanced signal, image, and information processing solutions
primarily for U.S. Government intelligence and defense customers. We create our
solutions by combining our services and expertise with hardware, software, and
proprietary and patented technology to meet our customers' requirements. During
the first quarter of 2005 we completed our acquisition of The Windermere Group,
LLC and its active subsidiaries ("Windermere") which was headquartered in
Annapolis Maryland. The Windermere acquisition adds breadth and depth to Essex
capabilities and intelligence customer set. In addition, Windermere adds
information assurance and cybersecurity solutions to the range of intelligence
technologies offered by Essex. Within the intelligence and defense communities
both Essex and Windermere have established and maintained long-standing and
successful customer relationships. We are also developing next generation
signal, image, information processing and information assurance solutions under
classified U.S. Government research and development awards. We have been able to
develop our current proprietary technology using a combination of government
funding and our own internal funding and we believe this combination will allow
us to continue to enhance and expand our technology and services for future
market needs.
Most of our revenues are derived from awards with the U.S. Government, where we
are either the prime contractor or a subcontractor depending on the award. For
the first three months of 2005 and 2004, revenues derived from the U.S.
Government programs were $24.0 million, or 93%, and $14.2 million, or 100%, of
our total revenues, respectively.
On certain projects, our customers require us to purchase and provide the
materials (which may include hardware, software and firmware) portion of the
total system solution, which entails our purchasing materials from third party
vendors and reselling it to our customers. We show the revenue and costs from
purchased materials separately since this revenue generally carries
significantly lower margins than our products and services revenue. The
purchased materials revenue is highly variable from quarter to quarter.
Our most significant expenses are cost of goods sold and services provided,
which consist primarily of direct labor and associated costs for program
personnel and direct expenses incurred
12
ESSEX CORPORATION
to complete projects, including the cost of materials and subcontract efforts.
Our ability to accurately predict personnel requirements, salaries and other
costs, as well as to manage personnel levels and utilize our personnel versus
subcontracting the work, can have a significant impact on our cost of goods sold
and services provided. Utilizing our own employees to complete projects results
in higher gross margins as compared to our enlisting subcontracted employees for
the same work. As a result, we seek to maximize our internal labor content on
our awards. Selling, general and administrative expenses consist primarily of
costs associated with our management, facilities, finance and administrative
groups and business development expenses which include bid and proposal efforts.
We have revenue from some awards on which our U.S. Government customers pay us
to perform research and development on their behalf. We also spend funds on
internal research and development, which are separately classified as such in
the financial statements. We are in a net operating loss carryforward position
for federal income tax purposes and in most states in which we operate.
On April 30, 2004, we acquired 100% of the common stock of Computer Science
Innovations, Inc., or CSI, which is headquartered in Melbourne, Florida, for
approximately $8.1 million in cash. CSI has proprietary techniques, algorithms
and tools that are used to build custom cognitive engines for a broad range of
intelligence, defense and commercial customers and applications. Cognitive
engines are software that includes predictive models and classifiers, and our
applications include the areas of fraud and anomaly detection, image and signal
recognition, information integration, knowledge management, network information
assurance, semantic processing and waveform analysis. CSI had revenue of
approximately $7.6 million in its fiscal year ended March 31, 2004, the last
full year prior to acquisition.
On June 25, 2004, we acquired substantially all of the assets of Performance
Group, Inc., or PGI, with main offices in Fredericksburg, Virginia, for
approximately $5.8 million in cash and $362,000 in assumed liabilities. PGI
provides services and systems in the areas of geographic information systems, or
GIS, image processing and analysis, spatial data development, environmental
consulting, visualization, and IT solutions to government and private sector
clients. PGI had revenue of approximately $4.5 million for calendar year ended
2003, the last full year prior to acquisition.
On February 28, 2005, we acquired 100% of the ownership and membership interests
of The Windermere Group, LLC and its active subsidiaries, or Windermere, which
was headquartered in Annapolis Maryland, for a total initial purchase price of
$72.0 million, including the initial payment of $69.4 million and legal and
other fees of $2.6 million. Also, the purchase agreement includes terms for an
additional purchase payment in May 2006 of up to $30.0 million for an "earn-out"
based on profitability as specified in the purchase agreement. Windermere
provides engineering services, software development and information technology
solutions to government agencies, the intelligence community and commercial
customers. Windermere had revenues of $64.7 million, including $2.5 million of
revenue from discontinued operations, for the calendar year ended December 31,
2004, or, on a pro forma basis, approximately 47% of the combined Windermere and
Essex revenue for the calendar year ended 2004. Essex has identified certain
material weaknesses in the internal control over financial reporting of its
newly acquired Windermere subsidiary. In light of these weaknesses, Essex
performed additional review procedures to assure that the financial statements
in this first quarter 10-Q for 2005 are in accordance with U.S. GAAP. Essex's
management is continuing to evaluate the internal controls of its newly acquired
subsidiary and is developing corrective action plans to address the material
internal control weaknesses identified to date.
13
ESSEX CORPORATION
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires us 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
ongoing basis, we re-evaluate our estimates, including those related to revenue
recognition, research and development, intangible assets and contingencies. We
base our estimates on historical experience and on various other assumptions
that we believe are 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. Estimates are used
when accounting for uncollectible accounts receivable, depreciation and
amortization, intangible assets, goodwill, and employee benefit plans and
contingencies, among others. Actual results may differ from these estimates
under different assumptions or conditions. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our financial statements.
REVENUE RECOGNITION
We enter into the following types of U.S. Government agreements:
o TIME AND MATERIAL. On time and material agreements, revenue is recognized
to the extent of billable rates multiplied by hours delivered, plus other
direct costs.
o COST PLUS FEE. We recognize revenue on cost plus fee arrangements to the
extent costs are incurred plus a proportionate amount of fee earned. We
must determine that the costs incurred are proper and that the ultimate
costs incurred will not overrun the expected funding on the project and
still deliver the scope of work proposed. Even though cost plus fee
arrangements generally do not require that we expend costs in excess of
the award 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, we must
determine that the indirect costs are properly accounted and allocated in
accordance with reasonable cost allocation methods.
o FIXED PRICE. On fixed price agreements, we 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 award for
the required services or product to be delivered.
Award or incentive fees may be received in lieu of, or in addition to, other
fees on time and material or cost plus contracts. Where award or incentive fees
are applicable, we record as revenue an estimate of the expected award or
incentive fee proportionate to the work performed. Estimated fee is based on our
experience under the contract or similar contracts and on on-going communication
with the client regarding performance.
We use historical technical performance experience where applicable to evaluate
progress on fixed price and cost plus fee jobs. We use historical government
audit experience in the indirect cost area to evaluate the propriety and
expected recovery of our indirect costs on cost plus fee agreements. The
following table sets forth the percentage of revenues under each type of
contract for the three months ended March 31, 2005 and March 28, 2004:
14
ESSEX CORPORATION
PERCENTAGE OF REVENUE BY CONTRACT TYPE
--------------------------------------
THREE MONTHS ENDED (UNAUDITED)
--------------------------------------
MARCH 31, 2005 MARCH 28, 2004
---------------- ----------------
Time and material 67.4% 91.3%
Cost plus fixed fee 18.8 5.9
Cost plus incentive fee 8.9 --
Fixed price 4.9 2.8
---------------- -----------------
Total 100.0% 100.0%
================ =================
The change for the respective periods is principally attributable to the
contract mix of the revenue associated with the Windermere acquisition.
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 overhead 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.
GOODWILL AND OTHER INTANGIBLE ASSETS
Business acquisitions typically result in the recording of goodwill and other
intangible assets, which affect the amount of future period amortization expense
and possible impairment expense that we will incur. We have adopted Statement of
Financial Accounting Standards, or SFAS, No. 142 which requires that we, 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.
Because of the integral technologies and operations of the acquisitions to date,
we have determined that Essex has only one corporate-wide reporting entity to
which this test applies.
STOCK OPTIONS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123R, "Share-Based
Payment", which is a revision of SFAS No. 123, "Accounting for Stock Issued to
Employees". SFAS No. 123R requires that all share-based payments to employees,
including grants of employee stock options, be valued at fair value on the grant
date and be expensed over the applicable vesting period. SFAS No. 123R is
effective for the Company on January 1, 2006. The Company will transition to
SFAS No. 123R using the "modified prospective application". Under the "modified
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ESSEX CORPORATION
prospective application", compensation costs will be recognized in the financial
statements for all new share-based payments granted after January 1, 2006.
Additionally, the Company will recognize compensation costs for the portion of
previously granted awards for which the requisite service has not been rendered
("nonvested awards") that are outstanding as of January 1, 2006 over the
remaining requisite service period of the awards. The compensation expense to be
recognized for the nonvested awards will be based on the fair value of the
awards. We are currently evaluating the effect that the adoption of SFAS No.
123R will have on our Financial Position and Results of Operations, and it is
possible that our adoption of this Standard may adversely affect our operating
results in future periods. At March 31, 2005, the total valuation of options
issued and vesting after January 1, 2006 is expected to be approximately
$75,000.
INCOME TAXES
Deferred income taxes are recorded under the asset and liability method whereby
deferred tax assets and liabilities are recognized for the future tax
consequences, measured by enacted tax rates, attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss carryforwards. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period the rate change becomes effective. Management periodically
evaluates the valuation allowance recorded against net operating loss
carryforwards and other deferred tax assets to assess whether information exists
to warrant reversal. At March 31, 2005, management has determined that reversal
of the existing valuation allowance is not warranted at this time because the
Company continues to experience significant book tax differences which the
Company's management believes should reduce taxable income substantially below
income reported on the financial statements. Those differences include
amortization of goodwill over fifteen years and the deduction associated with
the exercise of employee stock options. Also, while the Company achieved both
book and taxable profit in 2004, it did not have sufficient future firm funded
sales backlog at March 31, 2005 to ensure sufficient future taxable income to
realize the deferred tax asset.
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RESULTS OF OPERATIONS
The following table sets forth, for each period indicated, items in the
statement of our operations expressed as a percentage of total revenue.
Three Months Ended
---------------------------------
(UNAUDITED) March 31, 2005 March 28, 2004
-------------- --------------
Revenues:
Services and products 91.2 % 58.1 %
Purchased materials 8.8 41.9
-------------- --------------
Total 100.0 100.0
Costs of goods sold and services provided (72.5) (84.2)
-------------- --------------
Gross Margin 27.5 15.8
Selling, general and administrative expenses (20.2) (12.9)
Research and development (1.9) (1.0)
Amortization of other intangible assets (2.2) (0.2)
-------------- --------------
Operating income 3.2 1.7
Interest income (expense), net 2.8 0.5
-------------- --------------
Income before income taxes 6.0 2.2
Provision for income taxes 0.0 --
-------------- --------------
Net income 6.0 % 2.2 %
============== ==============
The following table sets forth, for each component of our revenues, the related
gross margin provided expressed as a percentage of the related revenues for the
periods indicated.
Three Months Ended
---------------------------------
(UNAUDITED) March 31, 2005 March 28, 2004
-------------- ---------------
Gross Margin by Revenue Type
Services and products 29.3 % 25.8 %
Purchased materials 8.3 % 1.9 %
REVENUES. Our revenues were $25.7 million and $14.2 million in the first three
months of 2005 and 2004, respectively. The 2005 results include one month of
revenue from the Windermere acquisition and a full three months of revenue from
the acquisitions of CSI and PGI. Windermere had revenues of $64.7 million,
including $2.5 million of revenue from discontinued operations, for the calendar
year preceding acquisition while PGI had revenue of approximately $4.5 million
for calendar year ended 2003, the last full year prior to acquisition. CSI had
revenue of approximately $7.6 million in its fiscal year ended March 31, 2004,
the last full year prior to acquisition. Other key factors for the higher
revenue were the increased activity on our $227.4 million multi-year award
(increased in December 2004 from the $57.1 million originally awarded in October
2003) for software and systems engineering and the delivery of custom systems to
national priority programs. Revenues from this award in the first three months
of 2005 and 2004 were $10.4 million and $9.2 million, respectively of which
$739,000 and $5.0 million, respectively, was for purchased materials.
GROSS MARGIN The improvement in total gross margin results from improved gross
margin on both our services and products revenue and on our purchased materials
revenue. Services and products gross margin increased to 29.3% for the first
three months of 2005 from 25.8% for the first three months of 2004 as a result
of a change in the mix of the work performed, particularly under our October
2003 award, moving from lower margin subcontract labor to higher margin internal
labor. In addition, this margin increased as a result of higher margins on
contracts
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ESSEX CORPORATION
obtained through acquisitions that occurred over the last year. However, the
gross margin on our Windermere acquisition is slightly below the pre-acquisition
Essex gross margin for the first three months of 2005, principally because of a
significant component of subcontractor revenue on its largest contract. As a
result, we expect a slight temporary decline in gross margin as the full impact
of Windermere occurs, beginning in the second quarter of 2005, and as it
continues its initial ramp up of that contract with subcontractors. Over time,
we expect to see a gradual shift of work to our staff on our October 2003 award
and on Windermere's largest contract, with a resulting improvement in gross
margin. The improvement in gross margin on purchased materials to 8.3% from 1.9%
resulted from a new short term contract with a materials component that had a
higher margin along with higher margins for materials on acquired contracts and
rate increases on other contracts.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses ("SG&A") increased $3.4 million to $5.2 million for the
first three months of 2005 from $1.8 million for the comparable period in 2004.
SG&A has increased to support the higher volume of business as well as including
the SG&A of the acquired businesses. SG&A as a percentage of services and
products revenue was 22.2% of services and products revenue for the first three
months of 2005 and 2004. SG&A as a percentage of total revenue was 20.2% for the
first three months of 2005 compared to 12.9% for the first three months of 2004.
Approximately 42% of the revenues generated in the first three months of 2004
were low margin materials revenue which required little administrative support.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased
$346,000 to $487,000 in the first three months of 2005 compared to $141,000 in
the comparable period in 2004. We incurred the majority of our research and
development on efforts related to optical communications technology. In 2005, we
also incurred research and development costs associated with our cognitive
systems.
AMORTIZATION OF OTHER INTANGIBLE ASSETS. During the first three months ended
March 31, 2005, amortization of other intangible assets increased by $517,000 to
$552,000 compared to $35,000 in the comparable period in 2004. This increase
primarily related to the Windermere, PGI and CSI acquisitions, all of which
occurred subsequent to the first three months of 2004.
NET INTEREST INCOME (EXPENSE). Net interest/dividend income was $732,000 in the
first three months of 2005 compared to $76,000 in the comparable period in 2004.
The net interest income reflects the temporary investment of the proceeds from
our 2004 stock offering, and also $285,000 from a $25 million loan to Windermere
prior to its purchase by Essex.
NET INCOME. We recorded net income of $1,536,000 and $312,000 in the first three
months of 2005 and 2004, respectively. We are in a net operating loss
carryforward position for book and tax purposes. We recognized a provision for
state income taxes of $20,000 in the first three months of 2005 for states where
our net operating loss is not available.
BACKLOG
Our awards with the U.S. Government generally extend over multiple years. Funded
backlog generally consists of the sum of all award amounts for which funding has
been approved and awards granted, less the value of work performed under such
awards. Since the U.S. Government operates under annual appropriations, our
customers typically fund awards on an
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incremental basis, generally for periods of one year or less. In many cases, our
awards include unexercised options. Accordingly, a significant amount of our
backlog is "unfunded." We include in unfunded backlog the total value of signed
contracts, less funding to date. Unfunded backlog includes awards options based
upon expected performance levels for those options. Unfunded backlog does not
include any estimate of future potential delivery orders that might be awarded
under indefinite delivery indefinite quantity contracts.
As of March 31, 2005, we had total backlog, funded and unfunded, of $408.1
million as compared with $102.0 million at March 28 2004. Of these amounts,
funded backlog was $103.6 million and unfunded backlog was $304.5 million at
March 31, 2005 compared to $31.3 million and $70.7 million, at the three months
ended March 31, 2004. Unfunded backlog at March 31, 2005 includes the remaining
balance of $153.2 million on our $227.4 million multi-year award in which the
ceiling was significantly increased (from its original $57.1 million October
2003 award) in December 2004 for software and systems engineering. At March 31,
2004 unfunded backlog on this contract was $24.8 million. Unfunded backlog at
March 31, 2005 also includes the remaining balance of $80.7 million on
Windermere's $105.1 million multi-year award for engineering services which was
awarded in September 2004. Both Windermere and Essex are subcontractors on a
single contract to provide communication systems support to the intelligence
community through 2011. The total contract value of both subcontracts was $46.1
million. The total unfunded backlog for both subcontracts at March 31, 2005 was
$18.6 million. Unfunded backlog for the Essex subcontract was $22.9 million at
March 31, 2004.
Our total backlog has increased significantly during the first three months of
2005 from the period ending December 31, 2004 due to the Windermere acquisition.
We expect 72.8% of our total backlog to be utilized after December 31, 2005.
FINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity and capital resource needs are to finance the costs of our
operations and to make capital expenditures and acquisitions. Based upon our
current level of operations, we expect that our cash flow from operations and
amounts of cash on hand will be adequate to meet our anticipated needs for at
least the next twelve months.
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ESSEX CORPORATION
We evaluate our liquidity position using various factors. The following
represents some of the more important factors:
(IN THOUSANDS) SELECTED FINANCIAL DATA AS OF
March 31, December 31, March 28,
2005 2004 2004
(Unaudited) (Audited) (Unaudited)
------------ ------------ ------------
Total Assets $ 147,256 $ 135,566 $ 43,702
============ ============ ============
Working Capital $ 38,477 $ 108,40 $ 34,560
============ ============ ============
Current Ratio 3.17:1 14.57:1 7.47:1
============ ============ ============
Capital Leases 38 41 --
Other Debt 29 -- --
------------ ------------ ------------
Total Debt/Financing $ 67 $ 41 $ --
============ ============ ============
Shareholders' Equity $ 129,510 $ 127,546 $ 38,361
============ ============ ============
During the first three months of 2005, net cash used in operating activities was
$2.0 million. Cash used in the first three months of 2005 was from an increase
of $4.5 million in accounts receivable, net of the change in accounts payable
and other liabilities offset by net income and non-cash depreciation,
amortization and other charges of approximately $2.5 million. An increase in
accounts receivable during the first three months of 2005 was primarily due to
the December 2004 expansion of the Company's $57.1 million October 2003 award to
a $227.4 million award which delayed billings during the first three months of
2005 due to operating and accounting changes required under the modified award.
On April 1, 2005 we received a payment under this award of $1.7 million of
which, without the expansion award, we would have expected to have received
within the first three months of 2005.
During the first three months of 2005, net cash used in investing activities was
$73.2 million, of which $71.8 million, net of cash acquired in the acquisition,
was for the acquisition of Windermere. We also expended $1.4 million for
property, equipment and leasehold improvements to support our growing work
force. Our working capital at March 31, 2005 decreased to $38.5 million from
$108.4 million at fiscal year end 2004. The decrease was primarily a result of
the acquisition of Windermere for cash.
During the first three months of 2005, net cash used in financing activities was
$8.0 million which primarily represented the cash pay down of the acquired
Windermere line of credit to reduce interest expense.
The Company expects to satisfy its operating cash requirements for the remainder
of 2005 from its projected positive operating cash flows and existing cash
balance. To the extent that future acquisitions, capital requirements, or an
additional payment under the Windermere purchase agreement requires cash beyond
our expected positive cash flows and existing cash balance, we are in the
process of negotiating a bank line of credit.
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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 and time and material 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, 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.
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ESSEX CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company had no variable rate debt outstanding as of March 31, 2005.
Our exposure to market risk relates to changes in interest rates on short-term
investment of the remaining proceeds of our stock offerings. Presently, such
investments earn approximately 2.5%. Based upon our investments during the first
three months of 2005, a hypothetical 1% increase or decrease in interest rates
would have increased or decreased income by $10,000 for every $1.0 million
invested and would have increased or decreased our annual cash flow and interest
income by a comparable amount.
ITEM 4. CONTROLS AND PROCEDURES
On February 28, 2005, we acquired 100% of the ownership and membership interests
of Windermere for a total initial purchase price of $72.0 million, including the
initial payment of $69.4 million and legal and other fees of $2.6 million.
Windermere provides engineering services, software development and information
technology solutions to government agencies, the intelligence community and
commercial customers. Windermere had revenues of $64.7 million, including $2.5
million of revenue from discontinued operations, for the calendar year ended
December 31, 2004, or, on a pro forma basis, approximately 47% of the combined
Windermere and Essex revenue for the calendar year ended 2004.
Essex has identified certain material weaknesses in the internal control over
financial reporting of its newly acquired Windermere subsidiary. In light of
these weaknesses, Essex performed additional review procedures to assure that
the financial statements in this first quarter 10-Q for 2005 are in accordance
with U.S. GAAP. Essex's management is continuing to evaluate the internal
controls of its newly acquired subsidiary and is developing corrective action
plans to address the material internal control weaknesses identified to date.
In connection with the preparation of this form 10-Q, an evaluation was
performed under the supervision and with the participation of Essex's management
(including the Chief Executive Officer and Chief Financial Officer) of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15e under the Exchange
Act). In light of the proximity of the consummation of the Windermere
acquisition to the end of the first quarter for 2005 and management's ongoing
evaluation and corrective action with respect to the internal controls of the
Windermere subsidiary, Essex's management has excluded the disclosure controls
and procedures of the Windermere subsidiary from its evaluation. Subject to the
foregoing, based on their most recent evaluation, Essex's Chief Executive
Officer and Chief Financial Officer believe Essex's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) are effective
as of the end of the period covered by this Form 10-Q.
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ESSEX CORPORATION
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
For more information on the Company's business and risk factors, see the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2004.
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ESSEX CORPORATION
ITEM 6. 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 *
*These exhibits are being "furnished" with this periodic report and are not
deemed "filed" with the Securities and Exchange Commission and are not
incorporated by reference in any filing of the Company under the Securities Act
of 1933 or the Securities Exchange Act of 1934, whether made before or after the
date hereof and irrespective of any general incorporation by reference language
in any such filing.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ESSEX CORPORATION
(Registrant)
Date: May 10, 2005
/s/ Lisa G. Jacobson
----------------------------------------------------
Lisa G. Jacobson
Executive Vice President and Chief Financial Officer
(Ms. Jacobson is the Principal Financial and Chief Accounting Officer of the
Registrant and has been duly authorized to sign on behalf of the Registrant.)
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