UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2008
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to
________________
Commission file number 0-24015
SteelCloud, Inc.
(Exact name of registrant as specified in its charter)
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54-1890464 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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20171 |
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(Address of principal executive offices) |
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(Zip Code) |
(703) 674-5500
(Registrant’s telephone number, including area
code)
Securities registered pursuant to Section 12 (b) of
the Exchange Act
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Title of each class |
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Name of exchange on which registered |
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None. |
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Securities registered pursuant to Section 12 (g) of
the Act:
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Title of each class |
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Name of exchange on which registered |
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Common Stock, $.001 par value per share |
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Nasdaq Capital Market |
Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ Nox
Indicate by
check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes ¨ Nox
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 if there is disclosure of delinquent filers in response to Item 405
of Regulation S-K contained herein and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.¨
Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See definition
of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
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Large accelerated filer ¨ |
Accelerated filer ¨ |
Non-accelerated filer ¨ |
Smaller reporting company x |
Indicate by
check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Act).Yes ¨ No
x
The
aggregate market value of the voting stock held by non-affiliates of the issuer
as of April 30, 2008 was $16,076,001.
The number
of shares outstanding of the registrant's Common Stock on January 27, 2009 was
14,738,376.
Documents incorporated by reference:
Portions of the Definitive
Proxy Statement to be filed pursuant to Regulation 14A for SteelCloud,
Inc.’s annual meeting for 2008 are incorporated by reference into Part
III of this Form 10-K.
STEELCLOUD, INC
2008 ANNUAL REPORT ON FORM 10-K
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PART I |
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PART II |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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Changes in and Disagreements with Accountants on Accounting and Financial Disclosures |
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PART III |
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
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Certain Relationships and Related Transactions, and Director Independence |
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(Item 10 – Item 14 information is incorporated by reference from portions of the Company’s definitive Proxy Statement to be filed pursuant to Regulation 14A) |
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ii
FORWARD-LOOKING STATEMENTS
This Annual Report on form
10-K contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended (the “Securities Act”)
and Section 21e of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”) and the Private Securities Litigation Reform Act of
1995 and SteelCloud, Inc. intends that such
forward-looking statements be subject to the safe harbors created
thereby. The forward-looking statements relate to future events or
the future financial performance of SteelCloud, Inc. including, but not limited
to, statements contained in: Item 1. “Business”
and Item 7. “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” Readers
are cautioned that such statements, which may be identified by words including
‘‘anticipates,’’ ‘‘believes,’’
‘‘intends,’’ ‘‘estimates,’’ ‘‘expects,’’
and similar expressions, are only predictions or estimations and are subject to
known and unknown risks and uncertainties. In evaluating such
statements, readers should consider the various factors identified in this
Annual Report on Form 10-K which could cause actual events, performance or
results to differ materially from those indicated by such
statements. In light of the significant uncertainties inherent in
the forward-looking information included herein, the inclusion of such information
should not be regarded as a representation by SteelCloud, Inc.or
any other person that its objectives or plans will be
achieved. SteelCloud, Inc. does not undertake and specifically
declines any obligation to update any forward-looking statements or to publicly
announce the results of any revisions to any statements to reflect new
information or future events or developments.
iii
PART I
General
Founded
in 1987, SteelCloud, Inc. (referred to herein as the “Company,” or
“SteelCloud,” “we,” “our,”
“ours,” and “us”) is a leading manufacturer of embedded
integrated computing systems solutions for the federal marketplace and
Independent Software Vendors (“ISV(s)”). We design,
manufacture and integrate specialized servers for federal market prime
contractors (“federal integrators”) and ISVs who use the
specialized servers to deliver application software to their clients.
We
were originally incorporated as Dunn Computer Operating Company on July
27, 1987 under the laws of the
Unless
the context otherwise requires, the "Company," "Dunn Computer
Corporation," or “SteelCloud” ”we,”
“our,” “ours,” and “us” refers to
SteelCloud, Inc., its predecessor and its subsidiaries. Our
principal executive offices are located at
Going Concern
We
have had recurring annual operating losses since our fiscal year ended October
31, 2004. We expect that such losses will continue at least until
our fiscal year ending October 31, 2009. The report of our
independent registered public accounting firm on our consolidated financial
statements for the fiscal year ended October 31, 2008 contains an explanatory
paragraph regarding our ability to continue as a going concern based upon our
history of net losses.
We
are dependent upon available cash and operating cash flow to meet our capital
needs. We are considering all strategic options to improve our
liquidity and provide us with working capital to fund our continuing business
operations which include equity offerings, asset sales or debt financing as
alternatives to improve our cash needs however, there can be no assurance that
we will be successful in negotiating financing on terms agreeable to us or at
all. If adequate funds are not available or are not available on
acceptable terms, we will likely not be able to take advantage of unanticipated
opportunities, develop or enhance services or products, respond to competitive
pressures, or continue as a going concern. There is no assurance we
will be successful in raising working capital as needed. There are
no assurances that we will have sufficient funds to execute our business plan,
pay our operating expenses and obligations as they become due or generate
positive operating results.
We
are in the process of executing on several restructuring initiatives which have
occurred from late 2008 to the present that include:
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A reorganization in November 2008 that included personnel terminations from all parts of the organization; |
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Sales of certain of our leased assets to customers; |
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Elimination of all non-essential costs; and |
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Reduction of occupancy costs. |
While
we believe that these initiatives will better align our costs with our
anticipated revenues going forward, it will take time for these initiatives to
have an impact on our net revenue and operating income.
1
Target Market
Our
primary target markets are (1) the embedded integrated computing systems
market, specifically within the industrial automation and military Commercial
off the Shelf (“COTS”) servers segments, and (2) the
BlackBerry® Enterprise Server market for both Federal government and the
domestic and international commercial markets. Embedded integrated
computing systems are typically defined as purpose built systems that are not
visible to the operator and whose primary function is non-office application
related. Embedded integrated computing systems also tend to be
ruggedized for deployment in harsh environments that typical computing systems
can not handle.
We
utilize multiple channel models, indirect channels via federal systems
integrators and manufacturer representatives and direct to ISVs. We
believe that our embedded integrated computing systems are best suited to
address the high volume needs of material handling applications such as postal
automation while our SteelWorks®
Federal Systems Integrator
Federal
integrators outsource their specialized requirements to us and consider us to
be their ”virtual hardware engineering
division.” We design and manufacture specialized embedded integrated
computing systems that are the foundation upon which the integrators develop
and deliver their application software. This allows the integrators
to shift their attention away from computing systems hardware and systems
software logistics to their core application software and services. As
a result, integrators improve customer satisfaction,
shorten time to delivery and lower overall development costs.
We
complement our embedded integrated computing systems, which are often designed
to withstand harsh environmental conditions, with software integration, quality
testing and program lifecycle management services. We also provide
configuration management, logistics and support services that are unavailable
from traditional computer vendors.
Independent Software
Vendors (ISV)
For
our ISV customers, we are their “virtual hardware engineering
division.” Similar to our federal integrator business, we
create a unique product for the ISV by integrating the ISV’s software
onto a specialized appliance platform running Linux or one of Microsoft’s
operating systems.
In
addition, we augment the ISV’s internal capabilities by taking
responsibility for those tasks which are necessary to successfully bring an
appliance to market, but which are impractical for its software partners to
perform. Services include branding, asset tagging, supply chain and
inventory management, fulfillment, logistics and program
management. The final ISV deliverable is a branded, unique,
optimized appliance that is ready-to-deploy when it arrives at the ISV’s
end customer’s site.
Our
specialized servers and appliances are engineered and developed according to
New Product Realization procedures which are compliant with SteelCloud’s
ISO 9001:2000 Certified Quality Management System.
BlackBerry®
As
an extension of our ISV business, we developed an appliance solution
specifically for the Blackberry Enterprise Server
(“BES”). Developed in conjunction with Research in
Motion (“RIM”), we believe the BES appliance solution is the single
best way to implement the Blackberry Enterprise Server software
environment. SteelWorks
In
addition, we developed SteelWorks FedMobile, our
Blackberry Enterprise Server software appliance solution specifically for the
Department of Defense (“DoD”) and other
related agencies. The SteelWorks FedMobile
appliance builds upon our commercial appliance by automating the application of
the Defense Information Systems Agency’s (“DISA”)
and DoD’s Security
Technical Implementation Guide (“STIG”)
to the BES installation process. The STIG
mandates the policies for which the DoD
and related agencies must operate their wireless communications. As
a result, our appliance solution allows those agencies to be STIG compliant in a fraction of the time, cost or resources
allocated to what is an otherwise time intensive, manual process.
2
Professional Services
We provide
information technology (“IT”) consulting and contract staffing
solutions for our clients. Our consultants are subject matter
experts in network infrastructure complexities and security technologies
including firewalls, content inspection, intrusion detection, spam and
vulnerability scanning. For our contract staffing solutions, our
personnel function as “virtual” employees, performing work directly
under the auspices of client management and serve as an extension to the client’s
in-house staff resources
Government Contracts
In fiscal year 2008, we
derived approximately 26% of our revenues from sales of hardware and services
to
GSA Contract
We
have a multiple award schedule contract with the U.S. General Services
Administration (the “GSA Contract”). The GSA Contract
was originally awarded in April 1996. It was renewed in fiscal years
2002 and 2007, and is valid through March 31, 2012. In August 2006,
GSA Contract auditors awarded us an “Outstanding” rating for our
management and execution of the GSA Contract. The GSA Contract
enables government IT purchasers to acquire all of their needed goods and
services from a particular vendor and largely limits the competition to
selected vendors holding GSA Contracts. For the fiscal year ended
2008, our GSA Contract had sales of approximately $1.2 million, which accounted
for approximately 6% of our net revenues.
Commercial Contracts
Our
commercial customer base consists of several Fortune 500 companies as well as
medium-size commercial customers.
Given
the nature of the products we manufacture as well as the delivery schedules
established by our partners, revenue and accounts receivable concentration by
any single customer will fluctuate from quarter to quarter. Future
revenues and results of operations could be adversely affected should a customer
reduce its purchases, eliminate product lines, or choose not to continue to buy
products and services from us. We intend to diversify and increase
our commercial customer base in the upcoming fiscal year.
Significant Customer
Contract
During
fiscal year 2008, we were awarded a contract by a major federal
integrator. The contract called for us to supply ruggedized
systems. Over the seven month contract engagement, during fiscal
year 2008, we produced approximately 2,650 units and recognized approximately
$7.8 million of revenue associated with this contract.
Manufacturing and
Production
Our
manufacturing and production operations are capable of assembling in excess of
100,000 systems per year in our existing
Our
Quality Management System has been ISO 9001:2000 certified since April
2004. Our ISO 9001:2000 certified Quality Management System
establishes measurable quality objectives throughout the organization and
provides procedures for continuous quality improvement in all aspects of our
business. This certification is particularly critical to our success
because it promotes continuous improvement in product reliability, on-time
deliveries, and communication; all of which directly benefit customers and
strengthen relationships. In February 2007, we passed a
recertification audit of our entire ISO 9001:2000 Quality Management System to
ensure that it conformed to the standard. The recertification
further demonstrates our commitment to quality, customer satisfaction and
continuous improvement. The current certification is valid through
March 2010.
3
Marketing
We
market our products and services to software companies, federal integrators,
select commercial accounts, and state, federal, and local government
agencies. We use an in-house sales force and program managers to
market our products and services. Our products and services are
marketed worldwide, either directly through our own sales personnel, or through
the marketing organizations of our appliance customers. Strong
customer relationships are critical to our success. We believe that
a key to building customer loyalty is a team of knowledgeable and responsive
account managers with professional technical and support staff. We
assign each customer a trained account manager, to which subsequent calls to us
are directed. The account manager is augmented with a program
manager for our larger customers. We believe that these strong
one-on-one relationships improve the likelihood the customer may consider us
for future purchases. We intend to continue to provide our customers
with products and technical services that offer the customer the best possible
return on a customer’s investment.
We
use electronic commerce technologies in our marketing efforts and expect our
customers will continue to utilize these technologies. Prospective
customers also use the Internet to advertise new business
opportunities. We also use the Internet to research and reference
vendor information. We maintain an Internet website containing our
GSA catalogue and product offerings located at www.steelcloud.com.
Joint Venture
In
October 2008, we created a joint venture in the United Arab Emirates (UAE) region with XSAT, LLC, A UAE organization focused on wireless communications and
technology (“XSAT”). SteelCloud
MEA, LLC (Middle East,
Competition
The
markets for our products and services are highly competitive. Many
of our competitors offer broader product lines, have greater economies of
scale, and may have more substantial financial, technical, marketing, and other
resources. These competitors may benefit from earlier market entry,
volume purchasing advantages, and product and process technology license
arrangements that are more favorable in terms of pricing and availability than
our arrangements.
The
IT industry is ever changing. Industry pricing is very aggressive
and we expect pricing pressures to continue. The industry is also
characterized by rapid changes in technology and customer preferences, short
product life cycles, and evolving industry standards.
We
compete with a large number of custom computer manufacturers, resellers and IT
services companies. We believe it is likely that these competitive
conditions will continue in the future. There can be no assurance we
will continue to compete successfully against existing or new competitors that
may enter markets in which we operate.
Our
principal competitors in the specialized server markets are companies
specializing in building server products and providing some level of
integration services.
Federal Government Market
We
sell our specialized servers to the federal government through federal
integrators. We also sell our server products, engineering services
and software products directly to government end users. Software
products come from Microsoft, CA, McAfee, Network General, and
others. In addition, we provide consulting services, consulting
project work and staffing services.
Sales
to the federal government are realized through our own GSA schedule, via the
GSA schedules of our strategic partners and through federal government market
integrators. The GSA’s Federal Supply Services Schedule is a
list of pre-approved vendors from which the government and/or federal agencies
may purchase goods and services. Our GSA Schedule GS-35F-4085D is an
effective procurement vehicle for us.
4
We
believe the government's criteria for selecting vendors consists of price,
quality, familiarity with the vendor, and size and financial capability of the
vendor. The government has increased the amount of IT products
acquired through the GSA Schedule. Our GSA Schedule provides the
government with a broad range of IT products and consulting services.
Commercial Market
The
commercial market for our IT products and services is highly fragmented, served
by thousands of small value-added resellers, specialized manufacturers,
software companies and consulting services firms. Many of these
companies service a small geographic area and resell national brand computers,
network hardware, and/or software.
Our
IT solutions are differentiated in the commercial (and federal government)
market with technical expertise and professional consulting
services. We believe our professional services group competes
effectively in the
In
the ISV server appliance market, the principal elements of competition are
product reliability, quality, customization, price, customer service, technical
support, value-added services, and product availability. We
distinguish our ISV server appliance offerings with specialized services such
as engineering design, configuration management, logistics, supply chain
management and fulfillment services.
Research and Development
By
investing in product development, we believe we will have more control over the
functionality and marketing of our products. We also believe that
the resulting intellectual property will increase the competitiveness of our
offerings and improve product margins. During fiscal 2008, we
incurred research and development costs of approximately
$702,000. We will continue to incur costs for product development in
the future.
We
invest in intellectual property in the form of proprietary products such as
SteelWorks®. SteelWorks® is an appliance
management software that provides self-management and self-maintenance
functionality to our appliance server offerings and allows our customers to
quickly create a fully integrated turnkey appliance server. We are
working to expand SteelWorks® to address the needs of small to midsize
businesses that require access to company data and attachments via their
Blackberry handheld device. This product is called SteelWorks®
Suppliers
We
devote significant resources to establishing and maintaining relationships with
our key suppliers and when possible, purchase directly from component
manufacturers such as Intel and SuperMicro. We
also purchase multiple products directly from large national and regional
distributors such as Synnex, Ingram Micro, Avnet, and
Bell Microproducts.
Certain
suppliers provide us with incentives in the form of discounts, rebates,
credits, cooperative advertising, and market development funds. We
must continue to obtain products at competitive prices from leading suppliers
in order to provide competitively priced products for our
customers. We believe our relationships with our key suppliers to be
good and believe that generally, there are multiple sources of supply available
should the need arise. In the event we are unable to purchase
components from existing suppliers, we have alternative suppliers we can rely
upon.
Patents, Trademarks and
Licenses
We
work closely with computer product suppliers and other technology developers to
stay abreast of the latest developments in computer
technology. While we do not believe our continued success depends
upon the rights to a patent portfolio, there can be no assurance that we will
continue to have access to existing or new technology for use in our products.
On
March 20, 2008, we were issued patent 3,396,156 titled
”SteelWorks”.
On
September 15, 2008, we were issued community trademark Registration 006430359
(European); Japan #948064 (International), Canada Application Approval titled
“SteelRestore”.
On
October 21, 2008, we were issued patent 3,521,899 titled “Sure
Audit”.
5
We
conduct our business under the trademarks and service marks of
“SteelCloud,” “SteelCloud Company” and “Dunn
Computer Corporation.” We believe our copyrights, trademarks
and service marks have significant value and are an important factor in the
marketing of our products.
Employees
As
of October 31, 2008 and January 23, 2009, we had 48 and 32 employees,
respectively. None of our employees are covered by a collective
bargaining agreement and we consider our relationships with our employees to be
good.
We
believe our future success depends in large part upon our continued ability to
attract and retain highly qualified management, technical, and sales
personnel. We have an in-house training and mentoring program to
develop our own supply of highly qualified technical support
specialists. There can be no assurance, however, that we will be
able to attract and retain the qualified personnel necessary for our business.
Not
applicable.
ITEM 1B. UNRESOLVED
STAFF COMMENTS
Not
applicable.
We
lease approximately 24,000 square feet for our operations facility and
approximately 19,000 square feet for our headquarters. Both our
operations facility and headquarters are located in
We
have no material legal claims pending against us.
There
are routine legal claims pending against us, but in the opinion of management,
liabilities, if any, arising from such claims will not have a material adverse
effect on our financial condition and results of operation.
ITEM 4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
There
were no matters submitted to a vote of our security holders during the fourth
quarter of fiscal year 2008.
6
PART II
ITEM 5. MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Market Information
Prior
to the quotation of our common stock beginning on April 22, 1997, there
was no established trading market for our common stock. Our common
stock is listed on The NASDAQ Stock Market, Inc.’s Capital
Market. We changed our symbol from “DNCC”
to “SCLD” on October 19, 2000.
The
following table sets forth the high and low selling prices as reported on the
NASDAQ Capital Market through January 18, 2009, for each fiscal quarter during
the fiscal years ended October 31, 2008 and 2007, as well as for the first
quarter of fiscal 2009 through January 27, 2009. These quotations
reflect inter-dealer prices without retail mark-up, markdown, or commission and
may not represent actual transactions.
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Fiscal 2007 |
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High |
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Low |
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First Quarter |
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$ |
1.34 |
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$ |
0.61 |
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Second Quarter |
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$ |
1.47 |
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$ |
0.94 |
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Third Quarter |
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$ |
1.74 |
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$ |
1.12 |
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Fourth Quarter |
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$ |
1.68 |
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$ |
1.12 |
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Fiscal 2008 |
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High |
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Low |
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First Quarter |
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$ |
1.25 |
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$ |
0.87 |
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Second Quarter |
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$ |
1.21 |
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$ |
0.80 |
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Third Quarter |
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$ |
1.58 |
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$ |
1.06 |
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Fourth Quarter |
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$ |
1.26 |
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$ |
0.56 |
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Fiscal 2009 |
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High |
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Low |
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First Quarter (through January 27, 2009) |
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$ |
0.75 |
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$ |
0.30 |
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On January
27, 2009, the closing price of our common stock as reported on the NASDAQ
Capital Market was $0.38 per share. There were approximately 5,100
shareholders of the common stock of the Company as of such date.
Dividend Policy
We
have not paid cash dividends on our common stock and do not intend to do so in
the foreseeable future.
Repurchase of Securities
We
did not repurchase any of our common stock during the fiscal year ended October
31, 2008.
Issuance of Unregistered
Common Stock
On
March 7, 2007, we issued 21,504 shares of our common stock to members of
our Board of Directors. The shares were valued at
$0.99. The total expense associated with this stock issuance was
approximately $21,000.
Warrants
On
September 14, 2007, we issued 100,000 warrants in exchange for investor
relations services valued at approximately $56,000. The warrants
were issued at an exercise price of $1.28 and expire on September 14,
2012. The fair value of the warrants was estimated in four equal
tranches over a four-month vesting period using the Black-Scholes
Option pricing fair value model.
On
October 24, 2003, we sold 1,887,500 shares of our common stock to private
and institutional investors in a private placement transaction at a price of
$4.00 per share. We received gross proceeds of $7,550,000 in
connection with this transaction. Brean
Murray & Co., Inc. and Ferris, Baker Watts, Incorporated acted as
co-placement agents in connection with this private offering. The
co-placement agents received an aggregate of $437,500 in cash and warrants to
purchase 107,422 shares of our common stock as commissions in connection with
this offering. Additionally, in connection with this transaction, we
issued warrants to purchase 493,359 and 85,938 shares of our common stock at an
exercise price of $5.81 and $4.00 per share, respectively, which expired on
October 24, 2008. The securities were sold pursuant to an exemption
from registration provided by section 4(2) of the Securities Act.
NASDAQ
Given
the current extraordinary market conditions, NASDAQ has determined to suspend
the bid price and market value of publicly held shares requirements through
Friday, April 17, 2009. In that regard, on October 16, 2008, NASDAQ
filed an immediately effective rule change with the Securities and Exchange
Commission, such that companies will not be cited for any new concerns related
to bid price or market value of publicly held shares
deficiencies. On December 19, 2008, NASDAQ extended the suspension
of these requirements. These rules, after the extension, will be
reinstated on Monday, April 20, 2009.
NASDAQ
believes that this temporary suspension will allow companies to focus on
running their businesses, rather than satisfying market-based requirements that
are largely beyond their control in the current
environment. Moreover, this temporary suspension should help to
restore investor confidence in affected NASDAQ companies as the suspension will
allow investors to make decisions without considering the likelihood of a very
near-term delisting.
Not
applicable.
ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain
statements contained herein may constitute forward-looking statements within
the meaning of Section 27A of the
Securities Act, Section 21E of the Exchange Act and the Private Securities
Litigation Reform Act of 1995. Because such statements include risks
and uncertainties, actual results may differ materially from those expressed or
implied by such forward-looking statements. Factors that could cause
actual results to differ materially include, but are not limited to, risks
associated with the integration of businesses following an acquisition,
concentration of revenue from one source, competitors with broader product
lines and greater resources, emergence into new markets, the termination of any
of our significant contracts or partnerships, our inability to maintain working
capital requirements to fund future operations or our inability to attract and
retain highly qualified management, technical and sales personnel.
You
should read the following discussion and analysis in conjunction with the
audited Financial Statements and Notes attached thereto, and the other
financial information appearing elsewhere in this Annual Report.
8
Overview
Founded
in 1987, we are a leading manufacturer of embedded integrated computing systems
solutions for the federal marketplace and ISVs. We design,
manufacture and integrate specialized servers for federal market prime
contractors (“federal integrators”) and Independent Software
Vendors (“ISV”s) who use the specialized
servers to deliver application software to their clients.
For
ISV customers, we design, manufacture and integrate low-maintenance servers
(called “appliances” in this market) so ISVs can make their
software product easier to deploy and support, more competitive and open new
markets by delivering their application software on fully-integrated,
ready-to-use appliances.
In
addition, we serve information technology end users directly, in both the
public and private sectors, with products and services focused on IT centric
solutions. Our IT centric solutions include our appliance servers,
products from our strategic partners along with our consulting services.
Our
ISO 9001:2000 certified Quality Management System establishes measurable
quality objectives throughout the organization and provides procedures for
continuous quality improvement in all aspects of our business. This
certification is particularly critical to our success in the federal government
market space as most government end customers require their contractors and
sub-contractors to be ISO 9001:2000 certified.
Fiscal Year 2008
Significant Customer
Contract
During
fiscal year 2008, we were awarded a contract by a major Federal
Integrator. The contract called for us to supply ruggedized
systems. Over the seven month contract engagement, during fiscal
year 2008, we produced approximately 2,650 units and recognized approximately
$7.8 million of revenue associated with this contract.
Launching of SteelWorks
In
2008, we launched our SteelWorks Mobile and SteelWorks FedMobile
appliance solutions. As an extension of our ISV business, we
developed an appliance solution specifically for the Blackberry Enterprise
Server (“BES”). Developed in conjunction with Research
in Motion (“RIM”), we believe the BES appliance solution is the
single best way to implement the Blackberry Enterprise Server software
environment. SteelWorks
In
addition, we developed SteelWorks FedMobile, our
Blackberry Enterprise Server software appliance solution specifically for the
Department of Defense (“DoD”) and other
related agencies. The SteelWorks FedMobile
appliance builds upon our commercial appliance by automating the application of
DISA’s (Defense Information Systems Agency) and
DoD’s Security
Technical Implementation Guide (“STIG”)
to the BES installation process. The STIG
mandates the policies for which the DoD
and related agencies must operate their wireless communications. As
a result, our appliance solution allows those agencies to be STIG compliant in a fraction of the time, cost or resources
allocated to this otherwise time intensive, manual process.
Joint Venture
In
October 2008, we created a joint venture in the United Arab Emirates (UAE) region with XSAT. SteelCloud
MEA, LLC (Middle East,
Services Business
Growth and Focus
In
fiscal 2008, we increased our focus on our professional services
business. We currently serve customers primarily in the metropolitan
9
In
addition, we have won contracts with National Zoo, Blue Cross Blue Shield
Association, Graduate Management Admissions Council and WMATA. We anticipate further expansion of the
professional services business in fiscal 2009.
Critical Accounting
Policies
The preparation of financial statements in conformity
with
The
significant accounting policies used in the preparation of our financial
statements are described in Note 3 “Significant Accounting
Policies” to our Financial Statements. Some of these
significant accounting policies are considered to be critical accounting
policies. A critical accounting policy is defined as one that has
both a material impact on our financial condition and results of operations and
requires us to make difficult, complex and/or subjective judgments, often as a
result of the need to make estimates about matters that are inherently
uncertain.
We
believe that the following critical accounting policies reflect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue Recognition
We
recognize revenue in accordance with the SEC Staff Accounting Bulletin No. 104,
“Revenue Recognition in Financial Statements, corrected copy”
(“SAB 104”). Generally, SAB 104 requires that four basic criteria must be met
before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred or services rendered; (3) the fee is fixed
and determinable; and (4) collectability is reasonably assured.
Effective
for revenue arrangements entered into in fiscal periods beginning after June
15, 2003, we have adopted Emerging Issues Task Force Issue No. 00-21, “Revenue
Arrangements with Multiple Deliverables” (“EITF
00-21”). Issued in December 2002 by the Financial Accounting
Standards Board (“FASB”), EITF 00-21
addresses certain aspects of the accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. EITF 00-21 addresses when and, if so, how an arrangement
involving multiple deliverables should be divided into separate units of
accounting. EITF 00-21 does not change
otherwise applicable revenue recognition criteria. In the event we
enter into a multiple element arrangement and there are undelivered elements as
of the balance sheet date, we assess whether the elements are separable and
have determinable fair value in determining the amount of revenue to record.
We
recognize revenue associated with the resale of maintenance contracts on a net
basis in accordance with Emerging Issues Task Force Issue No 99-19, “Reporting
Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”), and interpretations thereof.
We
derive our revenue from the following sources: product sales, information
technology support services, software license as a reseller and support sales
and software training and implementation services.
For
product sales where title transfers upon shipment and risk of loss transfers to
our customer, we generally recognize revenue at the time of
shipment. For product sales where title and risk of loss transfers
upon destination, we generally recognize revenue when products reach their
destination. Revenue from hardware leased to customers under
operating lease arrangements is recognized over the contract
term. When product and installation services that are not essential
to the functionality of the product are sold as part of a bundled agreement,
the fair value of the installation services, based on the price charged for the
services when sold separately, is deferred and recognized when the services are
performed. The products sold are generally covered by a warranty
ranging from one to three years. We accrue an estimated warranty
reserve in the period of sale to provide for estimated costs associated with
providing warranty services.
In
October 2008 we began delivering our appliance solution specifically developed
for Blackberry Enterprise Servers (“BES”). This solution
is bundled hardware-software system and subject to American Institute of
Certified Public Accountants’ Statement of Position (“SOP”)
97-2, “Software Revenue Recognition,” as modified by
SOP 98-9, “Modification of SOP 97-2, Software Revenue
Recognition, with Respect to Certain Transactions.” Our software does
not require significant modification and customization services. We
do not have vendor-specific objective evidence (“VSOE”)
of fair value for our software. Accordingly, when the software is
sold in conjunction with the Company’s hardware, software revenue is
recognized upon delivery of the hardware.
10
For
services revenue under time and material contracts, we recognize revenue as
services are provided based on the hours of service at stated contractual
rates.
We
incur shipping and handling costs, which are recorded in cost of revenues.
Typically
our deferred revenue includes amounts received from customers for which revenue
has not been recognized. This generally results from certain
customer contracts, ISV releases, warranties, hardware maintenance and support,
and consulting services. The deferred revenue associated with customer
contracts and ISV releases represents payments received for milestones achieved
prior to recognition of revenue. This revenue will be recognized as
products are shipped. Revenues from warranties and hardware
maintenance and support are recognized ratably over the service term selected
by the customer. Deferred service revenues from consulting are
recognized as the services are performed.
Equity-Based
Compensation
We
adopted Statement of Financial Accounting Standards No. 123 (Revised 2004),
“Share-Based Payment” (“SFAS
No. 123R”) on November 1, 2005. Issued in December 2004 by the
FASB, SFAS No. 123R requires that the fair value
compensation cost relating to share-based payment transactions be recognized in
financial statements. Under the provisions of SFAS
No. 123R, share-based compensation cost is measured at the grant date, based on
the fair value of the award, and is recognized over the employee’s
requisite service period. The fair value of the stock options and
employee stock purchase plan (“ESPP”)
awards was estimated using a Black-Scholes option
valuation model. This model requires the input of highly subjective
assumptions and elections in adopting and implementing SFAS
No. 123R, including expected stock price volatility and the estimated life of
each award. The fair value of equity-based awards is amortized over
the vesting period of the award and we have elected to use the straight-line
method for amortizing our stock option and ESPP
awards. We adopted the modified prospective transition method as
provided by SFAS No. 123R and compensation costs for
all awards granted after the date of adoption and the unvested portion of
previously granted awards outstanding are measured at their estimated fair
value.
Income Taxes
We
recognize deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
bases of certain assets and liabilities. A valuation allowance is
established, as necessary, to reduce deferred income tax assets to an amount
expected to be realized in future periods. We determine our
valuation allowance pursuant to the provisions of FASB Statement of Financial
Accounting Standards No. 109, “Accounting for Income Taxes,”
which requires us to weigh all positive and negative evidence including past
operating results and forecasts of future taxable income. In
assessing the amount of the valuation allowance as of October 31, 2007 and
2008, we considered, in particular, our forecasted taxable income for the upcoming
fiscal year, current backlog of orders, including those recently received, and
other significant opportunities currently in our sales and marketing pipeline
with a high probability of generating revenues. Based upon this
review, we have continued to fully reserve for all deferred tax assets as of
October 31, 2008.
We
adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes — an interpretation of FASB Statement No.
109” (“FIN 48”), on November 1, 2007. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS
No. 109, “Accounting for Income Taxes”. It
prescribes that a company should use a more-likely-than-not recognition threshold
based on the technical merits of the tax position taken. Tax
positions that meet the more-likely-than-not recognition threshold should be
measured as the largest amount of the tax benefits, determined on a cumulative
probability basis, which is more likely than not to be realized upon effective
settlement in the financial statements. Our unrecognized tax
benefits at October 31, 2008 are approximately $61,000, which includes
approximately $49,000 of unrecognized tax benefits for windfall tax benefits
from stock options exercised that are not recognized under SFAS
123R. During the year ended October 31, 2008, we increased our
unrecognized tax benefits by approximately $100,000 due to windfall benefits
from stock options exercised and additional exposures identified during the
year. We reduced our unrecognized tax benefits by approximately
$654,000 by adjusting our NOL carryforwards
and making an automatic change in accounting method. Both of these
adjustments were made with the filing of our income tax return for the tax year
ended October 31, 2007. We have a valuation allowance against the
full amount of our net deferred tax assets and therefore the adoption of FIN 48
had no impact on our retained earnings. The amount of unrecognized
tax benefits that, if recognized, would impact the effective tax rate is $0.
11
We
conduct business in the
Inventory
Inventory
consists of materials and components used in the assembly of our products or
maintained to support maintenance and warranty obligations and are stated at
the lower of cost or market using actual costs on a first-in, first-out
basis. We maintain a perpetual inventory system and continuously
record the quantity on-hand and actual cost for each product, including
purchased components, subassemblies and finished goods. We maintain
the integrity of perpetual inventory records through periodic physical counts
of quantities on hand. Finished goods are reported as inventory
until the point of title transfer to the customer. Generally, title
transfer is documented in the terms of sale. When the terms of sale
do not specify, we assume title transfers when it completes physical transfer
of the products to the freight carrier unless other customer practices prevail.
We
periodically evaluate our inventory obsolescence to ensure inventory is
recorded at its net realizable value. Our policy is to assess the
valuation of all inventories, including manufacturing raw materials,
work-in-process, finished goods and spare parts in each reporting
period. Inherent in managements estimates of excess and obsolete
inventory are management’s forecasts related to our future manufacturing
schedules, customer demand, technological and/or market obsolescence and possible
alternative uses. If future customer demand or market conditions are
less favorable than our projections, additional inventory write-downs may be
required, and would be reflected in cost of sales in the period the revision is
made.
Warranty
Typically,
the sale of our specialized servers includes providing parts and service
warranties to customers as part of the overall price of the
systems. We offer warranties for our systems that typically cover a
period of one to three years that commences upon shipment of the system to the
customer. When appropriate, we record a reserve for estimated
warranty expenses to cost of sales for each system upon revenue
recognition. The amount recorded is based on an analysis of
historical activity. All actual parts and labor costs incurred in
subsequent periods are charged to the established reserves.
Actual
warranty expenses are incurred on a system-by-system basis, and may differ from
our original estimates. While we periodically monitor the
performance and cost of warranty activities, if actual costs incurred are
different than our estimates, we may recognize adjustments to the reserve in
the period in which those differences arise or are identified.
In
addition to standard warranties, we offer customer-paid extended warranty
services. Revenues for extended maintenance and warranty services
with a fixed payment amount are recognized on a straight-line basis over the
term of the contract.
Segment Reporting
FASB
Statement of Financial Accounting Standards No. 131, “Disclosures
about Segments of an Enterprise and Related Information” (“SFAS No. 131”), establishes standards for reporting
information about operating segments. Operating segments are defined
as components of an enterprise about which separate financial information is
available that is evaluated regularly by our chief operating decision maker, or
decision-making group, in deciding how to allocate resources and in assessing
performance. SFAS No. 131 also establishes
a quantitative threshold, whereby an enterprise should report separately
information about an operating segment if its reported revenue is 10 percent or
more of the combined revenue of all reported operating segments. We
are organized on the basis of products and services. Our chief
operating decision maker is our Chief Executive Officer. While the
Chief Executive Officer is apprised of a variety of financial metrics and
information, the Chief Executive Officer makes decisions regarding how to
allocate resources and assess performance based on a single operating unit.
12
Recently Issued
Accounting Pronouncements
In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, “Fair Value Measurements” (“SFAS
No. 157”). SFAS No. 157 provides a
common definition of fair value and establishes a framework to make the
measurement of fair value in
In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159, “The Fair Value Option for Financial Assets and Financial
Liabilities—Including an amendment of FASB
Statement No. 115” (“SFAS No.
159”). SFAS No. 159 provides a
choice to measure many financial instruments and certain other items at fair
value and requires disclosures about the election of the fair value
option. Unrealized gains and losses on items for which the fair
value option has been elected are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. Therefore, we are required to adopt SFAS No. 159 in the first quarter of 2009. We do
not believe the provisions of SFAS 159 will have
a material impact on our financial statements.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (Revised 2007) “Business Combinations” (“SFAS No. 141R”). SFAS
No. 141R, which replaces SFAS No. 141, requires that
the acquisition method of accounting (which SFAS No.
141 called the “purchase method”) be used for all business
combinations and for an acquirer to be identified for each business
combination. SFAS No. 141R also
establishes principles and requirements for how the acquirer recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest
in the acquiree; recognizes and measures the goodwill
acquired in the business combination or a gain from a bargain purchase; and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. SFAS No. 141R also requires
that acquisition-related costs be recognized separately from the business
combination. SFAS No. 141R will apply
prospectively to business combinations for which the acquisition date is after
fiscal years beginning on or after December 15, 2008. We have not
yet determined the impact that the implementation of SFAS
No. 141R will have on our financial statements.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, “Noncontrolling Interests in Consolidated
Financial Statements — an amendment of ARB No.
51” (“SFAS No. 160”). SFAS No. 160 requires all entities to report noncontrolling (minority) interests in subsidiaries as
equity in the consolidated financial statements. Its intention is to
eliminate the diversity in practice regarding the accounting for transactions
between an entity and noncontrolling
interests. This statement is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15,
2008. Earlier adoption is prohibited. We are in the
process of evaluating the effect, if any; the adoption of SFAS
No. 160 will have on our financial statements.
In
February 2008, the FASB issued Staff Position No. 157-2, “Effective Date
of FASB Statement No. 157” (“FSP
157-2”). FSP 157-2 deferred the
effective date of FAS 157 for all nonfinancial assets
and nonfinancial liabilities to fiscal years beginning after November 15,
2008. We are in the process of evaluating the effect, if any; the
adoption of FSP 157-2 will have on our financial
statements.
In
October 2008, the FASB issued Staff Position No. 157-3, “Determining the
Fair Value of a Financial Asset When the Market for that Asset is not Active” (“FSP
157-3”). FSP 157-3 provides guidance
for determining the fair value of a financial asset in an inactive
market. We are in the process of evaluating the effect, if any; the
adoption of FSP 157-3 will have on our financial
statements.
In
May 2008, the FASB issued Staff Position No. APB 14-1, “Accounting for
Convertible Debt Instruments that May be Settled in Cash Upon
Conversion” (“APB 14-1”). APB 14-1 requires that the
liability and equity components of convertible debt instruments that may be
settled in cash upon conversion (including partial cash settlement) be
separately accounted for in a manner that reflects an issuer’s
nonconvertible debt borrowing rate. The resulting debt discount is
amortized over the period the convertible debt is expected to be outstanding as
additional non-cash interest expense. APB 14-1 is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Retrospective
application to all periods presented is required except for instruments that
were not outstanding during any of the periods that will be presented in the
annual financial statements for the period of adoption but were outstanding
during an earlier period. We are in the process of evaluating the
effect, if any; the adoption of APB 14-1 will have on our financial statements.
13
Fiscal Year Ended October
31, 2008 Compared to Fiscal Year Ended October 31, 2007
Net Revenue Discussion:
The
following table summarizes our net revenue for the fiscal years ended October
31, 2007 and 2008 in dollars and as a percentage of net revenues.
|
|
|
Fiscal Year Ended October 31, |
|
|||||||||||||||||||||
|
|
|
2007 |
|
|
2008 |
|
|
Increase (decrease) |
|
|||||||||||||||
|
|
|
|
|
|
% of Net |
|
|
|
|
|
% of Net |
|
|
|
|
|
|
|
||||||
|
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Percentage |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Products |
|
$ |
21,421,129 |
|
|
|
91.87 |
% |
|
$ |
16,333,600 |
|
|
|
85.88 |
% |
|
$ |
(5,087,529 |
) |
|
|
(23.75 |
)% |
|
Services |
|
|
1,894,551 |
|
|
|
8.13 |
% |
|
|
2,685,296 |
|
|
|
14.12 |
% |
|
|
790,745 |
|
|
|
41.74 |
% |
|
Total net revenues |
|
$ |
23,315,680 |
|
|
|
100.00 |
% |
|
$ |
19,018,896 |
|
|
|
100.00 |
% |
|
$ |
(4,296,784 |
) |
|
|
(18.43 |
)% |
The
decrease in product revenue is primarily attributable to a decrease in our
integrator business as a result of certain program delays and a reduction in
purchases from our ISV customers. The current economic downturn has
prolonged the award of the integrator programs, as well as affected the amount
purchased by our ISV customers. We plan for revenue to grow as we continue
to focus our resources on our chosen markets and our end user solution line of
products.
The
increase in service revenue is the result of to new client acquisitions as a
result of the Company expanding its service offerings. We expect
service revenue to continue to grow in the future.
|
Gross Profit Discussion: |
The
following table summarizes our gross profit for the fiscal years ended October
31, 2007 and 2008 in dollars, as a percentage of gross profit and as a
percentage of net revenues.
|
|
|
Fiscal Year Ended October 31, |
|
|||||||||||||||||||||
|
|
|
2007 |
|
|
2008 |
|
|
Increase (decrease) |
|
|||||||||||||||
|
|
|
|
|
|
% of Gross |
|
|
|
|
|
% of Gross |
|
|
|
|
|
|
|
||||||
|
|
|
Dollars |
|
|
Profit |
|
|
Dollars |
|
|
Profit |
|
|
Dollars |
|
|
Percentage |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Products |
|
$ |
4,356,274 |
|
|
|
88.09 |
% |
|
$ |
2,569,499 |
|
|
|
83.02 |
% |
|
$ |
(1,786,775 |
) |
|
|
(41.02 |
)% |
|
Products – GP% |
|
|
20.34 |
% |
|
|
|
|
|
|
15.73 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Services |
|
|
588,947 |
|
|
|
11.91 |
% |
|
|
525,543 |
|
|
|
16.98 |
% |
|
|
(63,404 |
) |
|
|
(10.77 |
)% |
|
Services – GP% |
|
|
31.09 |
% |
|
|
|
|
|
|
19.57 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross profit |
|
$ |
4,945,221 |
|
|
|
100.00 |
% |
|
$ |
3,095,042 |
|
|
|
100.00 |
% |
|
$ |
(1,850,179 |
) |
|
|
(37.41 |
)% |
|
Total – GP% |
|
|
21.21 |
% |
|
|
|
|
|
|
16.27 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
The
decrease in product gross margin percentage is largely attributable to
maintaining our production facility at normal capacity in anticipation of
receiving the delayed integrator contracts. We expect gross profit
as a percentage of net revenues to continue to fluctuate from quarter to
quarter as product lines expand, new products are brought to market, start up
costs are incurred and new discounts, incentives and rebates become available.
The
decrease in services gross profit percentage is attributable to our incurring
costs associated with obtaining new clients. We have been successful
in expanding our customer base during fiscal year 2008 as compared to fiscal
year 2007, which contributed to an increase in services revenue. We
will continue to incur lower initial margins as we expand into new markets and
increase our service offerings. We anticipate gross profit for
services to fluctuate in future quarters as we continue to realign and grow the
services division.
14
Operating Expense
Discussion:
The
following table summarizes our operating expenses for the fiscal years ended
October 31, 2007 and 2008 in dollars and as a percentage of net revenues.
|
|
|
Fiscal Year Ended October 31, |
|
|||||||||||||||||||||
|
|
|
2007 |
|
|
2008 |
|
|
Increase (decrease) |
|
|||||||||||||||
|
|
|
|
|
|
% of Net |
|
|
|
|
|
% of Net |
|
|
|
|
|
|
|
||||||
|
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Percentage |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Selling and marketing |
|
$ |
1,614,817 |
|
|
|
6.93 |
% |
|
$ |
1,259,416 |
|
|
|
6.62 |
% |
|
$ |
(355,401 |
) |
|
|
(22.01 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative |
|
|
4,315,254 |
|
|
|
18.51 |
% |
|
|
3,901,499 |
|
|
|
20.51 |
% |
|
|
(413,755 |
) |
|
|
(9.59 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and product development |
|
|
661,550 |
|
|
|
2.84 |
% |
|
|
702,231 |
|
|
|
3.69 |
% |
|
|
40,681 |
|
|
|
6.15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance and restructuring costs |
|
|
317,548 |
|
|
|
1.36 |
% |
|
|
- |
|
|
|
- |
|
|
|
(317,548 |
) |
|
|
(100.00 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
$ |
6,909,169 |
|
|
|
29.63 |
% |
|
$ |
5,863,146 |
|
|
|
30.83 |
% |
|
$ |
(1,046,023 |
) |
|
|
(15.14 |
)% |
The
decrease in selling and marketing expenses is the result of aligning expenses
to our current and future business models during fiscal year
2008. During fiscal year 2008, marketing activities, specifically in
the area of marketing campaigns and tradeshows, and expense associated with
selling and marketing personnel decreased as a result of our cost cutting
efforts. Selling and marketing expenses have been kept in line with
projected revenue. We will continue to evaluate our costs relative to
our revenues and gross margins.
General
and administrative expenses decreased as a result of cost cutting efforts
incurred during fiscal year 2008 as compared to fiscal year
2007. The cost reductions continue to include curtailing expenses
related to non-revenue generating activities, terminating non-essential
employees, and instituting across the board departmental expense
reductions. Our cost reductions were offset by approximately
$202,000 of fees incurred related to us implementing FIN 48 for the fiscal year
2008. Although we continue to manage our costs relative to our
revenues and gross margins, additional resources may be required in order to
invest in our federal integrator, ISV, and SteelWorks®
Research
and development expenses have remained consistent as the Company continues to
make investments in its SteelWorks® mobile products as well as bringing new
products to market. We continue to make investments in research and
product development to maintain and enhance current products. We
believe that research and product development expenses will fluctuate from
quarter to quarter as new products are being developed and introduced into the
marketplace.
The
decrease in severance and restructuring charges for the twelve months ended
October 31, 2008 compared to the twelve months ended October 31, 2007 is the
result of incurring approximately $318,000 of non recurring costs associated
with the employment resignation agreement entered into with our previous CEO
during fiscal year 2007.
Other Income (Expense)
Discussion:
The
following table summarizes our other income (expense) for the fiscal years
ended October 31, 2007 and 2008 in dollars and as a percentage of net revenues.
|
|
|
Fiscal Year Ended October 31, |
|
|||||||||||||||||||||
|
|
|
2007 |
|
|
2008 |
|
|
Increase (decrease) |
|
|||||||||||||||
|
|
|
|
|
|
% of Net |
|
|
|
|
|
% of Net |
|
|
|
|
|
|
|
||||||
|
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Percentage |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Interest income net |
|
$ |
19,353 |
|
|
|
0.08 |
% |
|
$ |
8,542 |
|
|
|
0.04 |
% |
|
$ |
(10,811 |
) |
|
|
(55.86 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income, net |
|
$ |
19,353 |
|
|
|
0.08 |
% |
|
$ |
8,542 |
|
|
|
0.04 |
% |
|
$ |
(10,811 |
) |
|
|
(55.86 |
)% |
15
The
decrease in net interest expense for fiscal year 2008 is due to lower interest
income attributable to lower cash balances and interest rates earned over the
twelve months ended October 31, 2008 compared to the same period in fiscal year
2007.
Net (Loss) Discussion:
The
following table summarizes our net (loss) for the fiscal years ended October
31, 2007 and 2008 in dollars and as a percentage of net revenues.
|
|
|
Fiscal Year Ended October 31, |
|
|||||||||||||||||||||
|
|
|
2007 |
|
|
2008 |
|
|
Increase (decrease) |
|
|||||||||||||||
|
|
|
|
|
|
% of Net |
|
|
|
|
|
% of Net |
|
|
|
|
|
|
|
||||||
|
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Revenues |
|
|
Dollars |
|
|
Percentage |
|
||||||
|
Net (loss) |
|
$ |
(1,944,595 |
) |
|
|
8.34 |
% |
|
$ |
(2,759,562 |
) |
|
|
14.51 |
% |
|
$ |
814,967 |
|
|
|
41.91 |
% |
The
increase in net loss for the twelve months ended October 31, 2008 as compared
to the same period in fiscal 2007 is the result of lower revenues and
corresponding gross margin dollars. We have instituted a
conservative revenue and cost of goods sold plan to minimize our net loss in
fiscal year 2009. This plan also includes company-wide personnel
terminations and the elimination of all non-essential costs to reduce our
operating expenses for the upcoming year.
Liquidity and Capital
Resources
We
have experienced recurring losses from operations and negative cash
flows. For the fiscal year ended October 31, 2008, we incurred a net
loss of $2,759,562 and an accumulated deficit of $44,868,564 as of that
date. The report from our independent registered public accounting
firm on our audited financial statements at October 31, 2008 contains an
explanatory paragraph regarding doubt as to our ability to continue as a going
concern as a result of our net loss from operations. Despite our
history of revenues, there is no assurance that we will be able to maintain or
increase our revenues in fiscal 2009 or that we will be successful in reaching
profitability or generate positive cash flows from our
operations. We are considering all strategic options to improve our
liquidity and provide us with working capital to fund our continuing business
operations including equity offerings, asset sales and debt financing as
alternatives to improve our cash needs however, there can be no assurance that
we will be successful in negotiating financing terms. If adequate
funds are not available or are not available on acceptable terms, we will
likely not be able to take advantage of unanticipated opportunities, develop or
enhance services or products, respond to competitive pressures, or continue as
a going concern.
Our
consolidated financial statements for the fiscal year ended October 31, 2008 do
not give effect to any adjustments to recorded amounts and their
classifications, which would be necessary should we be unable to continue as a
going concern and therefore, be required to realize our assets and discharge
our liabilities in other than the normal course of business and at amounts
different from those reflected in the consolidated financial statements.
As
of October 31, 2008, we had cash and cash equivalents of approximately $750,000
and working capital of approximately $1.7 million. We do not have
any working capital commitments nor do we not presently have any external
sources of working capital. Historically, our revenues have not been
sufficient to fund our operations and we have relied on capital provided
through the sale of equity securities. Our working capital needs in
future periods depend primarily on the rate at which we can increase our
revenues while controlling our expenses and decreasing the use of cash from
operations. Additional capital may be needed to fund acquisitions of
additional companies or assets, although we are not a party to any pending
agreements at this time and, accordingly, cannot estimate the amount of capital
which may be necessary, if any, for acquisitions. We believe cash on
hand together with cash generated from operations will provide sufficient
financial resources to finance our current operations through the end of fiscal
2009 although we can provide no assurance we will be able to do so.
In
fiscal 2008, we used approximately $1.7 million in cash flow from operating
activities. Our primary use of cash was to finance operating losses
and reduce our accounts payable balance by approximately $1.1
million. The collection of accounts receivable generated $1.1
million of cash.
In
fiscal year 2008, we invested approximately $425,000 in property and
equipment. We have monetized certain of these leased assets to
customers in fiscal year 2009.
16
Our
financing activities consisted of the exercise of options associated with our
stock option and warrant exercises which generated approximately $245,000 in
cash. In addition, we reduced our notes payable balance by
approximately $13,000.
On
March 6, 2008, we renewed our bank line of credit that allows us to borrow an
amount to the lesser of our collateralized cash on hand or $3.5
million. The line of credit bears interest at the LIBOR Market Index
rate plus 1.25%. The line of credit is secured by all of our assets
and expires on March 31, 2009. There can be no assurance that we
will be able to renew this line of credit. There were no outstanding
borrowings on the line of credit at October 31, 2007 and October 31, 2008.
We
have short-term (less than one year) obligations under our operating lease and
employment agreement commitments of approximately $1,786,000 and $1,144,000
respectively, for fiscal year 2008.
From
time to time, we may pursue strategic acquisitions or mergers, which may
require significant additional capital. In such event, we may seek
additional financing of debt and/or equity. However, there can be no
assurance that we will be successful in negotiating financing on terms
agreeable to us or at all.
Off-Balance Sheet
Arrangements
Contractual Obligations
and Commercial Commitments
We
have significant contractual obligations for fiscal year 2008 and beyond for
our operating leases. Our total obligation for our headquarters and
operations facilities, expiring in August 2009 and August 2014 respectively, is
approximately $44,000 a month. We currently have plans to
consolidate our facilities into one leased location upon expiration of our
lease in August 2009 reducing rent expense by approximately $20,000 a
month. We do not have any purchase obligations, capital lease
obligations or any material commitments for capital expenditures. We
have not engaged in off-balance sheet financing, commodity contract trading or
significant related party transactions.
Impact of Inflation
We
do not believe that inflation has had a material effect on our financial
position or results of operations during the past three
years. However, we cannot predict the future effects of inflation.
ITEM 7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
Financial
Statements of SteelCloud, Inc.
|
|
|
Page |
|
Report of Independent Registered Public Accounting Firm |
|
F-1 |
|
Consolidated Balance Sheets |
|
F-2 |
|
Consolidated Statements of Operations |
|
F-3 |
|
Consolidated Statements of Stockholders' Equity |
|
F-4 |
|
Consolidated Statements of Cash Flows |
|
F-5 |
|
Notes to the Consolidated Financial Statements |
|
F-6 |
|
Schedule II – Valuation and Qualifying Accounts |
|
22 |
|
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES |
There
were no changes in and disagreements with accountants on accounting and
financial issues during the fiscal year ended October 31, 2008.
17
ITEM 9A(T). CONTROLS
AND PROCEDURES
We
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(f)
under the Securities Exchange Act of 1934, as amended) (the “Disclosure
Controls”) as of the end of the period covered by this Annual
Report. The Disclosure Controls evaluation was done under the
supervision and with the participation of management, including our Principal
Executive Officer (“PEO”) and Principal
Accounting Officer (the “PAO” and
together with the PEO, the “Certifying
Officers”)..
Attached as exhibits to this Annual Report are
certifications of the Certifying Officers, which are required in accordance
with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”). This
“Controls and Procedures” section includes the information
concerning the controls evaluation referred to in the certifications and it
should be read in conjunction with the certifications for a more complete
understanding of the topics presented.
Disclosure Controls and
Procedures
We
maintain Disclosure Controls and procedures that are designed to ensure that
the information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized, authorized and reported on a timely basis, and
that such information is accumulated and communicated to our management,
including our Certifying Officers, as appropriate, to allow timely decisions
regarding required disclosure.
Under
the supervision and with the participation of our management, including our
Certifying Officers, we evaluated the effectiveness of the design and operation
of our Disclosure Controls as of October 31, 2008. Based upon that
evaluation, our Certifying Officers concluded that, as of the date of such
evaluation, our Disclosure Controls were effective in timely alerting them to
information relating to us that is required to be included in our reports filed
under the Exchange Act.
Limitations on the
Effectiveness of Controls
We
maintain a system of internal control over financial reporting to provide
reasonable assurance that assets are safeguarded and that transactions are
executed in accordance with management’s authorization and recorded
properly to permit the preparation of financial statements in accordance with
Management’s Annual
Report on Internal Control Over Financial Reporting
Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting is
defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a
process designed by, or under the supervision of, our principal executive and
principal financial officers and effected by our board of directors, management
and other personnel, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those polices and procedures that:
18
|
|
• |
|
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; |
|
|
• |
|
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and |
|
|
• |
|
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Management
assessed the effectiveness of our internal control over financial reporting as
of October 31, 2008. In making the assessment, management used
the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
in “Internal Control—Integrated Framework.” Based
on this assessment, management believes that, as of October 31, 2008, our
internal control over financial reporting was effective based on those
criteria.
Management’s
assessment of the effectiveness of our internal control over financial
reporting as of October 31, 2008 has not been audited by an independent
registered certified public accounting firm.
This
Annual Report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation
by our registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this Annual Report.
Changes in Internal Control
Over Financial Reporting
There
were no changes in our internal control over financial reporting during our
fiscal quarter ended October 31, 2008 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Not
applicable.
19
The
Notice and Proxy Statement for the 2008 Annual Meeting of Stockholders to be
filed pursuant to Regulation 14A under the Exchange Act, which is
incorporated by reference in this Annual Report on Form 10-K pursuant to
General Instruction G (3) of Form 10-K, will provide the information
required under Part III, including Item 10 (Directors, Executive Officers
and Corporate Governance), Item 11 (Executive Compensation), Item 12 (Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters), Item 13 (Certain Relationships and Related Transactions and Director
Independence) and Item 14 (Principle Accounting Fees and Services), which will
be filed within 120 days after the end of the fiscal year covered by this
Annual Report on Form 10-K.
PART IV
ITEM 15. EXHIBITS,
FINANCIAL STATEMENTS SCHEDULES
|
(a) 1. |
Index to Financial Statements |
|
|
|
Page |
|
|
||
|
|
||
|
|
||
|
|
||
|
|
||
|
|
|
(a) 2. |
Index to Financial Statement Schedules |
Schedules, other than those
listed above, have been omitted since they are not applicable or the
information is included elsewhere herein.
|
(a) 3. |
The exhibits which are filed with this report or which are incorporated by reference are set forth in the exhibit index hereto. |
|
Exhibit Number |
|
Description |
|
3.1 |
|
Articles of Incorporation of the Company, dated February 25, 1998, and effective as of February 26, 1998. (Filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1, Amendment No. 1, dated April 23, 1998 (File No. 333-47631) and hereby incorporated by reference). |
|
3.2 |
|
By-laws of the Company, effective as of March 5, 1998. (Filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File No. 333-47631) and hereby incorporated by reference). |
|
4.1 |
|
Specimen common stock certificate for the Company. (Filed as Exhibit 4.1 to the Company's S-8 dated July 15, 2002 (File No. 333-47631) and hereby incorporated by reference). |
|
10.1 |
|
Employment Agreement by and between Dunn and Thomas P. Dunne (Filed as Exhibit 99.2 to Dunn's Registration Statement on Form SB-2, Amendment 2, dated April 4, 1997 (File No. 000-24015) and hereby incorporated by reference). |
|
10.2 |
|
1997 Amended Stock Option Plan. (Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File No. 333-92406) and hereby incorporated by reference). |
|
10.3 |
|
Agreement, dated May 5, 1997, by and between International Data Products, Corp. and the U.S. Air Force, the Desktop V Contract. (Filed as Exhibit 10.13 to the Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File No. 333-47631) and hereby incorporated by reference). |
|
10.4 |
|
Employee Stock Purchase Plan. (Filed as Exhibit 10.22 to the Company’s 10-K, dated February 16, 1999 (File No. 000-24015) and hereby incorporated by reference). |
|
10.5 |
|
Employment Agreement by and between SteelCloud, Inc. and Kevin Murphy, dated June 8, 2004. (Filed as Exhibit 10.32 to the Company’s 10-K, dated January 26, 2005 (File No. 000-24015) and hereby incorporated by reference). |
20
|
10.6 |
|
Employment Agreement by and between SteelCloud, Inc. and Brian Hajost, dated June 8, 2004. (Filed as Exhibit 10.33 to the Company’s 10-K, dated January 26, 2005 (File No. 000-24015) and hereby incorporated by reference). |
|
10.7
|
|
Sublease by and between SteelCloud and NEC America Inc., dated September 28, 2004. (Filed as Exhibit 10.35 to the Company’s 10-K, dated January 26, 2005 and hereby incorporated by reference). |
|
10.8 |
|
Revised Rent Commencement Date Agreement, dated March 16, 2005 between OTR and the Company (Filed as Exhibit 10.36 to the Company’s 10-K, dated January 30, 2006 (File No. 000-24015) and hereby incorporated by reference). |
|
10.9
|
|
Standard Industrial Gross Lease, dated November 4, 2004 between OTR and the Company and Lease Amendment #1, dated March 28, 2005 (Filed as Exhibit 10.37 to the Company’s 10-K, dated January 30, 2006 (File No. 000-24015) and hereby incorporated by reference). |
|
10.10 |
|
Loan Agreement, dated January 22, 2004, by and between Steelcloud, Inc. and Wachovia Bank, National Association and Promissory Note issued by SteelCloud, Inc. on March 21, 2005 to Wachovia Bank, National Association (Filed as Exhibit 10.36 to the Company’s 10-K, dated January 30, 2006 (File No. 000-24015) and hereby incorporated by reference). |
|
10.11 |
|
Employment Agreement by and between SteelCloud, Inc. and Clifton W. Sink (Filed as Exhibit 10.1 to the Company’s 8-K, dated June 8, 2006 (File No. 000-24015) and hereby incorporated by reference). |
|
10.12 |
|
Separation Agreement by and between SteelCloud, Inc. and Thomas P. Dunne (Filed as Exhibit 10.1 to the Company’s 8-K, dated June 19, 2006 (File No. 000-24015) and hereby incorporated by reference). |
|
10.13 |
|
Employment Agreement by and between SteelCloud, Inc. and Robert Richmond (Filed as Exhibit 10.1 to the Company’s 8-K, dated September 21, 2006 (File No. 000-24015) and hereby incorporated by reference). |
|
10.14 |
|
Amendment, dated April 19, 2006, to Employment Agreement by and between SteelCloud, Inc. and Brian Hajost, dated June 8, 2004, originally filed as Exhibit 10.33 to the Company’s 10-K, dated January 26, 2005 (Filed as Exhibit 10.42 to the Company’s 10-K, dated January 23, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
10.15 |
|
Employment Agreement as Executive Director by and between SteelCloud, Inc. and Robert E. Frick (Filed as Exhibit 10.1 to the Company’s 8-K, dated August 31, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
10.16 |
|
Employment Agreement as President and Chief Executive Officer by and between SteelCloud, Inc. and Robert E. Frick (Filed as Exhibit 10.2 to the Company’s 8-K, dated August 31, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
10.17 |
|
Employment Resignation Agreement and Release by and between SteelCloud, Inc. and Clifton W. Sink (Filed as Exhibit 10.2 to the Company’s 8-K, dated August 31, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
10.18 |
|
Amendment, dated October 31, 2007, to Employment Agreement by and between SteelCloud, Inc. and Kevin Murphy, dated June 8, 2004, originally filed as Exhibit 10.32 to the Company’s 10-K, dated January 26, 2005. (Filed as Exhibit 10.1 to the Company’s 8-K, dated November 1, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
10.19 |
|
Amended 2002 Employee Stock Option Plan (Filed as Exhibit 4.1 to the Company’s S-8, dated June 25, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
10.20 |
|
Amended Employee Stock Purchase Plan (Filed as Exhibit 4.3 to the Company’s S-8, dated June 25, 2007 (File No. 000-24015) and hereby incorporated by reference). |
|
*10.21 |
|
Form of Restricted Stock Agreement. |
|
*10.22 |
|
Amended 2007 Stock Option and Restricted Stock Plan. |
|
*10.23 |
|
SteelCloud MEA Joint Venture Agreement dated October 2008. |
|
*21.1 |
|
List of Subsidiaries. |
|
*23.1 |
|
Consent of Grant Thornton LLP, Independent Registered Public Accounting Firm. |
|
*31.1 |
|
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
*31.2 |
|
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
*32.1 |
|
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002. |
|
*32.2
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002. |
|
* |
Filed herewith |
21
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
STEELCLOUD, INC.
|
|
|
|
|
|
Additions |
|
|
|
|
|
|
|
||||||||
|
Classification |
|
Balance at |
|
|
Charged to |
|
|
Charged to |
|
|
Deductions |
|
|
Balance at End of Year |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Allowance for doubtful accounts: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Year ended October 31, 2007 |
|
$ |
73,000 |
|
|
$ |
4,000 |
|
|
$ |
- |
|
|
$ |
37,000 |
(1) |
|
$ |
40,000 |
|
|
Year ended October 31, 2008 |
|
$ |
40,000 |
|
|
$ |
9,500 |
|
|
$ |
- |
|
|
$ |
13,500 |
(1) |
|
$ |
36,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warranty reserve: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended October 31, 2007 |
|
$ |
144,000 |
|
|
$ |
292,000 |
|
|
$ |
- |
|
|
$ |
254,000 |
(2) |
|
$ |
182,000 |
|
|
Year ended October 31, 2008 |
|
$ |
182,000 |
|
|
$ |
126,000 |
|
|
$ |
- |
|
|
$ |
148,000 |
(2) |
|
$ |
160,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax valuation allowance: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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