Item
1. BUSINESS
This
Annual Report on Form 10-K (including the section regarding Management’s
Discussion and Analysis of Financial Condition and Results of Operations)
contains forward-looking statements regarding our business, financial condition,
results of operations and prospects. Words such as “expects,” “anticipates,”
“intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or
variations of such words are intended to identify forward-looking statements,
but are not deemed to represent an all-inclusive means of identifying
forward-looking statements as denoted in this Annual Report on Form 10-K.
Additionally, statements concerning future matters are forward-looking
statements.
Although
forward-looking statements in this Annual Report on Form 10-K reflect our
good faith judgment, such statements can only be based on facts and factors
currently known by us. Consequently, forward-looking statements are inherently
subject to risks and uncertainties and actual results and outcomes may differ
materially from the results and outcomes discussed in or anticipated by the
forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include, without limitation, those
specifically addressed in Item 1A—“Risks Factors” below, as well as those
discussed elsewhere in this Annual Report on Form 10-K. Readers are urged
not to place undue reliance on these forward-looking statements, which speak
only as of the date of this Annual Report on Form 10-K. We file reports
with the SEC. We make available on our website under “Investor Relations/SEC
Filings,” free of charge, our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports as soon as reasonably practicable after we electronically file
such materials with or furnish them to the SEC. Our website address
is
www.systechnologies.com
.
You can
also read and copy any materials we file with the SEC at the SEC’s Public
Reference Room at 100 F Street, NE, Washington, DC 20549. You can
obtain additional information about the operation of the Public Reference
Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains
an Internet site (
www.sec.gov
)
that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC, including
us.
We
undertake no obligation to revise or update any forward-looking statements
in
order to reflect any event or circumstance that may arise after the date
of this
Annual Report on Form 10-K. Readers are urged to carefully review and
consider the various disclosures made throughout the entirety of this Annual
Report, which attempt to advise interested parties of the risks and factors
that
may affect our business, financial condition, results of operations and
prospects.
Description
of the Business
General
SYS
and
its subsidiaries provide information connectivity solutions that capture,
analyze and present real-time information to customers in the Department
of
Defense (DoD), Department of Homeland Security (DHS), other government agencies
and commercial companies. Using interoperable communications software,
sensors, digital video broadcast and surveillance technologies, wireless
networks, network management, decision-support tools and Net-Centric
technologies, our technical experts enhance complex decision-making. Founded
in
1966, SYS is headquartered in San Diego and has principal offices in California
and Virginia. For additional information, visit
www.systechnologies.com.
Historically,
our revenues have been generated by providing information technology, systems
integration and program and financial management services under long term
contracts for the DoD and in particular the U.S. Navy. More recently, through
a
combination of acquisitions and internal growth initiatives, we have expanded
and leveraged our technical engineering services with complementary products
and
have broadened our customer base to include other government agencies and
commercial enterprises beyond the DoD.
These
expanded products and services capabilities, together with our longstanding
expertise in situational awareness and systems engineering, have enabled
us to
develop a set of information technology solutions to complement our services
offerings for the Information Technology (IT) services and Public Safety
and
Security (PSS) markets. Our customers in these markets such as federal, state
and local governments, public safety first-responders, large corporations,
schools and universities, all share a common need for decision support products
and services that enhance or enable connecting real-time data to decision
makers.
We
deliver our solutions through two reportable segments, the Defense Solutions
Group (DSG) and the Public Safety, Security and Industrial Systems Group
(PSSIG). The DSG focuses on engineering, technical and management services
to
Federal Government agencies. The PSSIG focuses on providing “right-time”
situation status and mission execution support solutions to government and
commercial customers.
We
also
provide solution lifecycle support with program, financial, test and logistical
services, including classroom and online training.
Relevant
Industry Terms
We
generally perform our services for Federal Government agencies pursuant to
both
contracts and task orders. A
contract
may
include specific work requirements for a particular job that is to be performed,
or may instead provide a framework that defines the scope and terms under
which
work may be performed in the future, in which case any
task
orders
that may
be issued from time to time under the contract set forth the specific work
assignments that are to be performed under the contract. In this document,
references to any contract include the task orders, if any, issued under
that
contract. Accordingly, information in this document regarding our revenue
under
government contracts includes revenue we receive under both contracts and
task
orders. We perform services as a
prime contractor
under
those contracts and task orders that are awarded to us directly by the Federal
Government. We also perform services for the Federal Government as a
subcontractor
to other
companies that are awarded prime contracts.
Some
of
our contracts are
multiple award contracts (MACs)
.
Multiple award contracts are vehicles pursuant to which the Federal Government
may purchase goods or services from several different pre-qualified contractors.
Such contracts include multiple award contracts (
MACs
),
blanket purchase agreements (BPAs), Government Services Administration (GSA)
Schedul
e
and
other
Indefinite Delivery/Indefinite Quantity (
ID/IQ
)
contracts.
MACs
are
task-order or delivery-order contracts for goods and services established
by one
agency for government-wide use.
BPAs
are a
simplified method of filling repetitive needs or services by establishing
“charge accounts” with qualified suppliers and eliminating the need for issuing
individual purchase, invoice and payment documents.
The
GSA Schedule
is
a
contracting vehicle sponsored by the General Services Administration that
is
available to all Federal Government agencies for procuring information
technology services and products pursuant to contracts (
GSA
Schedule Contracts
)
and
task orders (
GSA
Schedule Task Orders
)
awarded
thereunder. Finally,
ID/IQs
are
contracts for goods or services which do not specify a firm quantity and
that
provide for issuance of orders for the performance of tasks during the contract
period. Multiple award contracts typically have a
ceiling
,
which
is the maximum amount the government is authorized to spend under the contract
over the life of the contract. While the government is permitted to spend
up to
the ceiling amount, there is no guarantee that it will do so or that any
particular pre-qualified contractor will receive awards under the
vehicle.
Federal
Government contracts for our services include three types of pricing:
time-and-materials; cost-plus; and fixed-price.
Time-and-materials contracts
are
contracts under which we are reimbursed for labor at fixed hourly rates and
generally reimbursed separately for allowable materials, other direct costs
and
out-of-pocket expenses.
Cost-plus contracts
are
contracts under which we are reimbursed for costs that are determined to
be
allowable and allocable to the contract and receive a fee, which represents
our
profit.
Cost-plus fixed fee
contracts specify the contract fee in dollars.
Cost-plus incentive fee
and
cost-plus award fee
contracts provide for increases or decreases in the contract fee, within
specified limits, based upon actual results as compared to contractual targets
for factors such as cost, quality, schedule and performance.
Fixed-price contracts
are
contracts under which we perform specific tasks for a predetermined
price.
Industry
Overview /Market Opportunity
Our
services and products are designed to address the information connectivity
needs
of our target customers in the IT and PSS markets. All of these customers
have a
need for decision support solutions in order to respond quickly to an incident
and to share information with other agencies or organizations in a collaborative
effort.
DSG
Spending
by the U.S. Government on information technology and services supporting
the use
of information technology is increasing. The strategic priorities of the
DoD are
based in large part on the Quadrennial Defense Review, the first conducted
in an
era of global terrorism, which continues the shift in emphasis by identifying
key strategic priorities. These priorities are currently focused on mission
critical capabilities of our armed forces, and providing the support
infrastructure necessary to sustain these forces in a time of heightened
warfare
readiness and deployment.
The
Federal Government and the DoD in particular, is in the midst of a significant
transformation that is driven by the Federal Government’s need to address the
changing nature of global threats. A significant aspect of this transformation
is the use of Command, Control, Communications, Computing, Intelligence,
Surveillance and Reconnaissance (C4ISR), and information technology to increase
the Federal Government’s effectiveness and efficiency. The result is increased
Federal Government spending on information technology to upgrade networks
and
transform the Federal Government from separate, isolated organizations into
larger, enterprise level, network-centric organizations capable of sharing
information broadly and quickly. While the transformation initiative is driven
by the need to prepare for new world threats, adopting these IT transformation
initiatives will also improve efficiency and reduce infrastructure costs
across
all Federal Government agencies.
President
Bush’s fiscal year (FY) 2008 defense budget requests approximately $481 billion
in DoD discretionary budget authority, a 10.5% increase over FY 2007. The
government IT component of this budget is estimated to be approximately $70
billion, of which, approximately $55 billion represents the non-hardware
related
services market opportunity for government contractors. The 2008 budget supports
substantial investments in advanced technology to provide advantages over
our
enemies, particularly in remote sensing and high-performance computing. This
includes investments in communications improving connectivity between troops
and
their commanders well beyond the field of battle. C4ISR capabilities,
information communications and transformation are some of the key areas of
focus
for the DoD’s technology spending.
The
growth in the government information technology market is being driven by
a
number of factors, including an overall desire on the part of the Federal
Government to upgrade communication and information systems, the aging of
the
federal workforce, and an increase in the use of private sector outsourcing.
In
addition, market growth has been driven and will continue to be driven in
large
part by DoD information technology spending which has been increasing over
the
past two years at an even faster rate than the overall government information
technology market.
We
believe opportunities for growth can be found in the following areas:
•
C4ISR
•
Defense
IT
•
Knowledge management
•
Systems
integration
•
Training/simulation
SYS
has
historically targeted these areas for growth with engineering service solutions
and has begun to further supplement this growth with a combination of products
and services in order to offer complete solutions.
PSSIG
The
PSSIG
markets include: (i) the PSS market which includes the Federal Government
as
well as state and local municipalities, law enforcement, firefighters and
other
first responders as well as schools and universities and (ii) the commercial
markets which are generally comprised of non-government customers.
PSS
In
many
cases, these customers overlap and funding at the state and local levels
are
tied to funding at the federal levels often through the DHS. Further, there
may
be joint funding efforts between the state and local municipalities, school
districts and other constituents such as ports and transportation agencies
among
others.
Central
to the DHS budget are five themes: increasing overall preparedness and
strengthening the Federal Emergency Management Agency (FEMA); strengthening
border security and reforming immigration; enhancing transportation security
through more efficient and secure system controls; improving information
sharing; and strengthening the department’s organization in order to maximize
performance.
INPUT,
a
market research firm specializing in government business, forecasts that
the
state and local public safety interoperable communications marketplace will
grow
to $5.5 billion by 2012, including $3.4 billion from various federal funding
sources. Recently the National Telecommunications and Information Administration
issued the Public Safety Interoperable Communications (PSIC) grant program,
which will provide nearly $1 billion for agencies and jurisdictions to improve
public safety communications to get these systems closer to where first
responders need them to be.
While
a
significant objective for these initiatives is to achieve radio communications
interoperability, concurrent efforts are underway to develop similar data
based
interoperability solutions. Key areas of focus are multi-jurisdictional
information sharing and compliance with an emerging set of standards known
as
National Incident Management Systems (NIMS) and Incident Command Systems
(ICS).
In 2004, DHS released NIMS and designated the National Integration Center
(NIC)
Incident Management Systems Division as the lead federal entity to coordinate
NIMS compliance. Its primary function is to ensure that NIMS remains an
accurate and effective management tool through refining and adapting compliance
requirements to address ongoing preparedness needs.
We
believe that as a result of these initiatives opportunities exist to help
state
and local government agencies and jurisdictions incorporate data
interoperability into their public safety communications systems.
Finally,
schools and universities are another market segment that has a critical need
for
situational awareness solutions especially in light of national incidents
of
school shootings and other critical crisis incidents. Many school districts
have
already or are beginning to deploy video surveillance capabilities and we
believe the next phase of that effort will be integration and distribution
of
all the video data to those who are responsible within the school and local
communities charged with protecting the safety of the students and citizens.
Funding, for these efforts are often closely linked to the state and local
budgets, however, school districts themselves are allocating budget dollars
to
address these concerns.
Commercial
Enterprise
Video
The
enterprise video solutions business provides enterprise-class video product
solutions across numerous vertical markets, specifically; those categorized
as
the video surveillance and video distribution markets. Today, the convergence
of
broadcast networks and the Internet finds SYS well positioned in the markets
developing from this technology convergence.
Video
Surveillance
We
develop and sell software-based integrated digital video applications used
in
video surveillance, integrated security, and loss prevention solutions for
industrial and governmental applications. Our products are used by customers
in
market segments including point-of-sale (POS), central alarm monitoring,
and
homeland security.
The
emergence of Internet Protocol (IP) technology and intelligent video
capabilities is transforming video from a purely forensic tool to a real
time
source of actionable information, making video surveillance the fastest growing
segment of the $200 billion global security industry according to research
compiled by USBX Advisory Services, an investment bank with a group specializing
in government IT, Homeland Security and security systems. The physical security
sector is the global security industry’s largest sector, with revenues of
approximately $150 billion, or 75% of the total industry according to the
Lehman
Brothers Security Annual 2006. The physical security sector is broken down
into
two sub-sectors of services and products. The services sector includes, among
others, security systems integrators, alarm monitoring services, guard services,
and armored transit and cash services. The products sector includes, among
others, manufacturers of access control, alarm monitoring, video surveillance
and fire monitoring equipment.
According
to many security research industry groups, video surveillance is the fastest
growing segment with estimates ranging from 12-15% annually. Video surveillance
systems persistently gather information which is becoming increasingly valuable
with the advent of enhanced analytic capabilities and with the declining
costs
of IP-enabled systems.
Video
Distribution
In
the
video distribution market, we provide both products and end-to-end solutions
enabling the delivery of rich media services over a wide range of broadcast
and
enterprise digital networks.
Applications
for our products include the television broadcast industry for the delivery
of
broadcast content; satellite service providers for the delivery of IP based
video and data services; corporations for internal distributed learning and/or
financial information distribution; and the government, for use in data
broadcasting in emergency situations however, use of these broadcast solutions
to effect communications for homeland security purposes is just
emerging.
Trends
anticipated to drive increases in equipment sales for this market segment
are
based on: (i) recent FCC regulations mandating the use of digital formats
by
2009 and (ii) technology innovations such as: Internet Protocol Television
(IPTV) and expanded use of high definition programming. Finally, increased
bandwidth demands from high definition signals combined with the cost of
satellite transponder bandwidth, are pushing network operators to maximize
efficiency
Network
Security and Management
The
rise
of Net-centric applications and converged networks have driven increased
demand
for network management solutions for commercial enterprises, government
agencies, DOD and homeland security organizations. We provide network management
solutions including products and services that specialize in helping military,
government and commercial IT professionals assure the reliability, availability
and security of their mission critical network resources.
The
primary market for our network management solutions has been the U.S. Federal
Government and accordingly the same market drivers and industry data discussed
under DSG are equally applicable to the market for NSMG. Significant additional
market opportunities span the commercial markets as well. The research firm
Forrester anticipates an increase of 11% in 2007 over the $2.6 billion market
in
2006. This increase is essentially due to renewed interest from service
providers and enterprises in managing the network as part of the entire IT
service spectrum. Additionally, small and medium-size enterprises are interested
in network management as well. Key drivers and trends, include:
|
·
|
Application
performance management
|
|
·
|
Converged
voice, video and data networks
|
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·
|
Secure
network systems operations
|
Learning
and Performance Solutions
We
develop and provide classroom based and eLearning training and education
programs as well as Net-Centric Human Systems Integration (HIS) solutions
for
the DoD, other government agencies, universities and commercial
entities.
Rising
internet usage and declining telecommunication costs have helped fuel the
rising
demand for e-Learning solutions by both government and commercial organizations.
Many of these organizations are outsourcing entire training programs to outside
service providers. As organizations focus on their core competencies,
outsourcing of training programs to external service providers has gained
momentum. Outsourcing also enables organizations to minimize costs associated
with in-house design, development, and implementation of these
programs.
e-Learning
is poised to become an integral component of information dissemination. In
terms
of total time spent (in hours) on training, e-Learning has emerged as the
second
most employed method for imparting learning in organizations.
Solutions
Our
solutions include the following:
Systems
Engineering
We
have a
longstanding history of providing top quality systems engineering assistance
to
both government and industry customers. Using a diverse team of subject matter
experts, we apply a robust systems engineering approach that delivers the
proper
balance of total system performance and total ownership costs within a
family-of-systems, systems-of systems context. Our engineers have broad
experience in all aspects of systems engineering from requirements setting,
component design and testing to production. We achieve synergy by bringing
together our expertise in many disciplines to build solutions which connect
data
to decisions.
We
provide a variety of Test and Evaluation (T&E) core competencies geared to
the methodologies of the Department of Defense (DoD) C4ISR system
acquisition. We deliver an end-to-end solution providing T&E support
in program and administrative acquisition through the entire T&E
lifecycle.
Network
Security and Management
Our
solutions address the growing technological complexity, heightened security
awareness and operations infrastructure needs in an increasingly net-centric
world.
Our
NeuralStar
TM
product
is a network management platform that monitors networks in real-time, analyzes
performance metrics and captures, correlates and stores performance and alarm
events for network devices, applications and services. NeuralStar
TM
is a
network management platform that gives organizations the ability to manage
heterogeneous data, voice, video, wireless and satellite systems as a single
environment, also allowing them to take direct control by issuing commands
to
network elements and automating manually intensive processes.
Our
NSMG
solutions have been proven in some of the world's most intensive, high-security
military environments, including serving the core network management component
for the Department of Defense’s backbone network, known as the Global
Information Grid. SYS network management solutions serve mission-critical
roles
at the Ballistic Missile Defense Agency, the National Guard and the Defense
Advanced Research Projects Agency. Net-centered enterprises and service
providers, including Microsoft, BNSF, Broadwing and Cincinnati Bell, use
our
solutions to increase service quality, efficiency and profitability
Software
Engineering
Our
software engineering organization has a core expertise in a broad set of
application domains such as enterprise information management and visualization
computing problems utilizing state of the art tools to address a wide range
of
futuristic operational and technical requirements. The group has an established
reputation for technology transition. The software group’s predominant
customer-base includes military command and control, homeland security, public
safety, and related areas. Within the military domain, we have provided software
solutions for situation awareness, decision support, weather, anti-submarine
warfare, network management, and distance learning. Non military domains
include
enterprise video systems for surveillance and satellite broadcast, online
training systems, and first-responder incident management and emergency
response.
Public
Safety and Security
We
provide integrated solutions for data interoperability and real-time situational
awareness including collaboration, command and control, and accountability
for
safer emergency operations.
Our
initial product focus is in the areas of increasing overall preparedness
and
improving information sharing. We are addressing this through our Vigilys™
solution which can be used to more effectively manage incident response
operations and enable efficient sharing of time critical information between
responders in the field and supporting operations centers, and between
cooperating private, local, county, state, federal, and DoD
agencies.
Vigilys™
is a software based tactical operations system designed for public safety
agencies seeking to improve response capabilities and effectiveness. The
Vigilys™ solution delivers relevant and actionable real-time information to and
from the scene of an incident for improved decision-making, resource allocation
and response coordination. The Vigilys™ product suite consists of the Vigilys
Conductor, Vigilys Mobile and Vigilys Commander.
Enterprise
Video Solutions
Video
Surveillance
Our
Marathon product suite includes integrated video surveillance, security,
and
loss prevention solutions that enhance operational management, security &
safety and loss control. Our products are used by customers in market segments
including point-of-sale (POS), central alarm monitoring, and homeland security.
Our Marathon Digital Video Recorder (DVR) software utilizes patented
software-based video compression technology and state-of-the-art digital
recording which is designed to make video more practical by improving the
usability of video and data through scalable networked digital video
solutions.
Our
video
surveillance management systems provide: (i) security surveillance for safety
of
employees and customers; (ii) recording and observing in store operations
for
operational improvement, theft or accidents; (iii) POS software integrating
video clips with cash register transactions to reduce shrinkage and (iv)
the
ability to be remotely monitored by a remote central station
service.
Our
scalable PC network technology addresses the customer's operation as a whole,
providing efficiencies and cost savings through an integrated approach.
Video
Distribution
Our
video
distribution products represent the convergence of broadcast and Internet
technologies by providing head-end (transmission) equipment and edge device
(reception) equipment to provide the infrastructure for this key data and
video
powered distribution capability. Our products leverage our industry expertise
in
the video distribution market with specific concentration on the key convergence
technologies (MPEG-4 AVC/H.264, ATSC, DVB, IPv6, etc.) and an engineering
approach to building scalable and modular products that respond rapidly to
changes in the marketplace. We offer products, technologies and solutions
in the
following areas:
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IP-based
content distribution
|
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·
|
Set
top box IRD’s (integrated
receiver-decoders)
|
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ATSC
(American Television Standards Committee) digital
broadcasting
|
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·
|
DVB
(Digital Video Broadcast) satellite and terrestrial
broadcasting
|
Our
enterprise video solutions are distinguished by:
|
·
|
IP-centric
video delivery products for internet, satellite, and terrestrial
networks;
|
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·
|
Strong
reputation and presence in the satellite and broadcast video markets
and
the security industry;
|
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·
|
In-house
integration technology for rapidly integrating third-party systems
and
information sources.
|
Our
solutions address the customer's operation as a whole, providing efficiencies
and cost savings through an integrated approach based on
feature-rich:
|
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|
Scalable
network technology, including technology from SYS’s flag-ship network
management product, NeuralStar
TM
|
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·
|
Best-of-breed
SYS proprietary compression technology originally developed under
a grant
from the National Institute of Standards and Technology (NIST), as
well as
best-of-breed standards-based compression technologies (MPEG-4 H.264
AVC)
|
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·
|
Data
interoperability integration technology from the SYS Vigilys
TM
product suite
|
Learning
and Performance
Our
learning and performance solutions consist of a broad range of products and
services capabilities to deliver training solutions and web-enabled or satellite
based interactive distance learning (IDL) for customers in the DoD, other
government and commercial organizations.
Our
training solutions include services, product development, and tools addressing
a
breadth of related disciplines that include human performance factors, job
&
task analysis, competencies definition, skills & knowledge building via
multiple deliver mediums, tracking, assessment, evaluation, and trend
analysis.
Our
HSI
solutions focus on improving human performance and readiness through workload
analysis, process improvement, manpower optimization, human factors engineering,
and advanced training delivery methods/integrated learning environments.
This
area of work results in improved human performance, manpower optimization,
and a
higher state of readiness that reduce our customer’s total ownership
cost.
Our
IDL
solutions utilize our established strengths in digital, audio and video
broadcast products and expertise in our web-based learning management solutions
through which we have created a very robust, feature rich solution called
Global
Learning Solutions (GLS) which is targeted for the sizable interactive distance
learning market including university, government, defense, homeland security
and
company training and education programs.
GLS
is a
comprehensive learning management system with complete broadcast infrastructure
that enhances the distance learning experience. GLS incorporates a unique
blend
of content distribution products and web-based system architecture to provide
flexible content and delivery options that easily accommodate future expansion.
We customize solutions tailored to our clients’ needs and deliver them via the
Internet and/or by satellite. The system facilitates various types of live
and
on-demand learning including e-learning, instructor-led training, web and
audio
casts, live high-definition video, assessments/certifications, collaboration
tools and the flexibility to include third party courseware
integration.
Management
Support Services
Our
program management and logistics group provides solutions support and services
to meet the needs of our customers in business operations, program management,
financial management, engineering and maintenance services, enterprise solutions
development and implementation and, logistics support. Program management
includes all elements of operational and financial execution to meet required
objectives and results. Logistics support includes life-cycle supportability
and
in-service engineering services to support current and planned equipment,
in a
variety of platforms.
Business
Strategy
Our
business objectives are to diversify and grow our revenues, broaden our customer
base and improve operating margins. Our strategy to achieve these objectives
is
based on leveraging our core strengths in C4ISR,
information
technology, systems integration and program and financial management
while
adding complementary products and capabilities that will allow us to grow
our
markets in these areas as well as expand into other markets, including
commercial markets. We have affected this strategy through acquisitions and
through productizing capabilities and solutions developed through our
engineering services. We believe that this strategy will enable us to diversify
our revenue sources, compete for larger DoD programs and grow our operating
margins, especially through the inclusion of products. Three key aspects
of this
strategy are as follows:
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Timing.
The process of transforming from a pure service provider to providing
a
mix of high technology services and products is targeted to occur
in a
staged fashion. As growth rates in revenues from our engineering
and
program management services decrease or plateau, revenues from products
or
new customers need to be generated in a synchronized
fashion;
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Products.
As we acquire or develop new products our strategy is threefold;
(i) to
continue and grow the markets for which those products were initially
developed; (ii) to adapt those products for sale into our government
related businesses and (iii) to integrate these products such that
we can
pursue programs that require a broader mix of capabilities to deliver
a
complete solution;
|
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Acquisitions.
We have expanded our capabilities and broadened our markets by acquiring
companies that have products or niche service offerings. As we continue
to
execute on this strategy, we will build the existing infrastructure
to
accommodate these new organizations as they adapt to our systems
and
methodologies.
|
Growth
Strategy
We
have
grown our revenues (i) organically by establishing new business units with
experienced senior executives who have the ability to grow these business
units
and expand our customer base and (ii) through acquisitions of businesses
and
technologies that meet our primary objective of providing us with enhanced
capabilities in order to pursue a broader cross section of the DoD, DHS and
other government markets, which at the same time, may enable us to achieve
our
secondary objective of broadening our customer base.
Our
objective is to continue growing revenues organically and through acquisitions.
In order to assist in accomplishing this objective, we have continued to
increase our selling, general and administrative and research and development
expenditures to facilitate new business development and to build the necessary
infrastructure to support a larger organization. We are currently evaluating
potential targets. We anticipate that we will need to obtain additional
financing through the sale of equity or debt securities to fund any such
future
acquisitions. Our research and development activities are primarily oriented
towards further developing the products acquired from our acquisitions and
where
applicable, integrating those products into other solutions, with the intent
of
accelerating the development cycle and increasing sales.
We
anticipate that this strategy will allow us to bid on larger government
contracts and programs. We also expect to re-compete on our existing engineering
and management contracts. Our rate of revenue growth depends upon many factors,
including, among others, our success in bidding on new contracts and re-competes
of our existing contracts, the continuation of our existing programs, our
ability to develop and launch products, the funding levels for our contracts,
our ability to meet demand for our services or products and our ability to
grow
the businesses of our acquired companies.
Recent
Acquisitions and Technology Purchases
On
March 31, 2004, SYS acquired all of the outstanding stock of Polexis, a
privately held, San Diego-based provider of advanced data management software
in
support of enterprise operations and mission-critical decision-making.
On
December 16, 2004, SYS acquired all of the assets of Xsilogy, a privately
held,
San Diego-based provider of wireless sensor network technologies and
applications.
On
January 6, 2005, SYS acquired all of the outstanding stock of Antin, a
defense contractor that provided information technology, C4ISR, and technical
support services.
Effective
August 22, 2005, the Company acquired the assets of Web Technologies, LLC
(Web
Tech), a provider of e-learning and web application development for customers
in
the automotive, environmental, financial, technology, and hospitality
industries, as well as the U.S. government.
On
September 27, 2005, the Company entered into an agreement to purchase certain
technology and intellectual property rights related to the ForceViz technology
of Lomasoft Corporation.
On
November 7, 2005, SYS acquired all of the outstanding stock of Logic
Innovations, Inc. (Logic), a privately held, San Diego-based provider of
solutions that helped to ensure the fast and efficient delivery of digital
audio, video and data to the broadcasting, communications and consumer
electronics industries.
On
December 2, 2005, SYS acquired all of the assets and assumed certain specified
liabilities of cVideo, Inc., a San Diego-based provider of interactive video
and
information analysis products for business surveillance and security
applications.
On
April
2, 2006, SYS acquired Realty Based IT Services, Ltd. (RBIS), a provider of
Information Technology (IT) security engineering which developed, implemented
and maintained convergent security services that are delivered by personnel
with
high level U.S. government clearances.
On
October 17, 2006, SYS acquired all the outstanding common stock of Ai Metrix,
a
Reston, Virginia provider of innovative network management software solutions
delivered to government and commercial customers.
Productization
Strategy
By
taking
advantage of our experience in systems analysis, requirements definition
and
system operations, SYS is developing new solutions for both military command
and
control and commercial management decision support needs. This approach utilizes
information technology, artificial intelligence, logic and advanced
visualization techniques to develop knowledge management tools. The objective
is
to leverage both SYS and customer subject matter expertise to make more
effective decisions.
To
date
we have successfully developed two such solutions in the area of decision
support, namely; The Assessment Profiling System (TAPS) and Vigilys™, which
includes our flagship family of software products: Vigilys Commander, Vigilys
Conductor and Vigilys Responder Mobile.
TAPS
is
an advanced graphical visualization system coupled with a state space logic
engine to provide a web-based information service for real-time assessment
of
key metrics that contribute to decision making.
The
Vigilys™ applications can be used to more effectively manage incident response
operations and enable efficient sharing of time critical information between
responders in the field and supporting operations centers, and between
cooperating private, local, county, state, federal, and DoD
agencies.
Future
productization efforts include integrating other SYS products and services
where
we can bundle more of our capabilities to solve a customer need both in the
government and commercial markets. A few examples demonstrating this objective
are: (i) selling Vigilys™ together with our video surveillance products; (ii)
selling our IP encapsulators/multiplexers together with our e-learning and
learning management solutions; (iii) selling our network management software
together with our video related products and (iv) selling our e-learning
and
training solutions to provide customer support and to maintain the long term
interaction with our customers.
U.S.
Government Contracts
We
have
derived a majority of our revenues from contracts with government agencies,
the
vast majority of which are with the Federal Government, under which we act
as a
prime or subcontractor. During fiscal 2007, approximately 88% of our total
annual revenues were derived from contracts with government agencies and
12% was
derived from commercial customers. We intend to focus on retaining and trying
to
increase the percentage of our business as prime contractor because it provides
us with client relationships that generate higher levels of revenue and makes
us
less dependent on other prime contractors. Our mix of contracts in which
we acted as a prime contractor versus a subcontractor during fiscal 2007
and
2006 consisted of the following:
|
|
|
2007
|
|
2006
|
|
|
Prime
contractor
|
|
|
62
|
%
|
|
60
|
%
|
|
Subcontractor
|
|
|
38
|
%
|
|
40
|
%
|
|
Total
|
|
|
100
|
%
|
|
100
|
%
|
Our
costs
of revenues are affected by the mix of contract types (cost reimbursement,
fixed-price or time and materials) as well as the mix of prime contracts
versus
subcontracts. Further, with the recent inclusion of products, our cost of
revenues will be affected by the cost and availability of materials and
components, product mix and other fixed and variable costs. Significant portions
of our contracts are time and materials and cost reimbursement contracts.
Subject to contract limits, we are reimbursed for labor hours at negotiated
hourly billing rates and other direct expenses under time and materials
contracts and reimbursed for all actual allowable costs, plus a fee, or profit,
under cost reimbursement contracts. The financial risks under these contracts
are generally lower than those associated with other types of contracts such
as
fixed price contracts, however, the margins are also typically lower than
those
on fixed-price contracts. The U.S. Government also has awarded us fixed-price
contracts. Such contracts carry higher financial risks because we must deliver
the products, systems or contract services at a cost below the fixed contract
value in order to earn a profit.
Contract
backlog
We
define
backlog as the amount of revenues we expect to realize over the remaining
base
contract performance period and for signed contracts in existence as of the
measurement date. We do not include contract ceiling values under MAC or
ID/IQ
contracts in our backlog calculation. We also do not include in backlog
(i) the expected amount of revenues that would be realized if, and when, we
were successful in the re-compete of signed contracts in existence as of
the
measurement date or (ii) the expected amount of revenues that would be
realized from future unidentified growth on signed contracts and task orders
in
existence as of the measurement date.
We
define
funded backlog as the portion of our backlog for which funding currently
is
appropriated and obligated to us under a signed contract or task order by
the
purchasing agency, or otherwise authorized for payment to us by a customer
upon
completion of a specified portion of work, less the amount of revenue we
have
previously recognized under the contract. Our funded backlog does not include
the full potential value of our contracts, because Congress often appropriates
funds to be used by an agency for a particular program or contract on a yearly
or quarterly basis, even though the contract may call for performance over
a
number of years. As a result, contracts typically are only partially funded
at
any point during their term, and all or some of the work to be performed
under
the contracts may remain unfunded unless and until Congress makes subsequent
appropriations and the procuring agency allocates funding to the
contract.
As
of
June 30, 2007, the Company’s delivery order and contract tasking backlog totaled
approximately $47.7 million, of which $25.2 million was funded and $22.5
million
had been ordered, but not yet funded. As of June 30, 2006, the
Company’s delivery order and contract tasking backlog totaled approximately
$34.1 million, of which $23.4 million was funded and $10.7 million had been
ordered, but not yet funded.
All
of
our U.S. government contracts are subject to audit and various cost controls
and
include standard provisions for termination for the convenience of the U.S.
government. Multi-year U.S. government contracts and related orders are subject
to cancellation if funds for contract performance for any subsequent year
become
unavailable.
Much
of
the products business conducted by SYS to date consists primarily of component
assembly and integration where we contract with third parties to build product
specific components or we purchase standard off the shelf components both
of
which are delivered to our facilities where we complete the product assembly
and
quality assurance phases prior to shipping to our end customers. We are not
dependent on any one vendor as a source of the components nor are there any
rare
or hard to procure components in our product bill of materials.
SYS
is
engaged in multiple contracts as both a prime and subcontractor. Our customers
include (but are not limited to) the following:
|
Defense
|
Other
Government
|
Commercial
|
|
U.S.
Navy:
|
DHS
|
American
Honda Motor Co., Inc.
|
|
NAVSEA
|
Delaware
County, PA
|
Fox
Networks
|
|
SPAWAR
|
California
Office of
|
General
Electric Corporation
|
|
NAVAIR
|
Emergency
Services
|
HBO
|
|
ONR
|
California
Department of
|
IntelSat
|
|
Other
DoD Entities:
|
Transportation
|
Lehigh
University
|
|
DARPA
|
Orange
County Public Schools
|
Motorola
|
|
Missile
Defense Agency
|
|
PanAmSat
|
|
NASA
|
|
Pratt
& Whitney
|
|
DISA
|
|
Primemedia
|
|
Lockheed-Martin
|
|
Sempra
Energy
|
|
Northrop
Grumman
|
|
Southern
California Edison
|
|
L-3
Communications -Titan
|
|
United
Airlines
|
|
Cubic
Corporation
|
|
Volkswagen
of America
|
|
Boeing
|
|
|
Sales
and Marketing
DSG
SYS
markets its engineering services directly to governmental agencies through
its
headquarters and regional offices. Each office responds to the needs of
customers and looks for new business opportunities that match our technical
skills and competency. We often team, either as a prime or subcontractor,
with
other companies when bidding on government contracts. We use multiple
distribution channels to market our products and services including:
•
Our
website;
•
Direct
outbound sales efforts;
•
Competitive bidding; and
•
Strategic teaming arrangements and OEM’s.
We
have
supplemented this internal marketing approach through third party business
development efforts. These efforts are focused on longer term business
development activities that will position SYS to compete on larger and more
diverse programs that will be announced for competition over the next few
years.
A key to success in this strategy is to have the third party firm fully
conversant in the entire range of SYS product and services capabilities such
that SYS can be positioned to bid on and be a competitive vendor for these
services based programs.
PSSIG
To
date
much of our sales and marketing strategy has been oriented towards: (i) defining
the markets and the target customers within those markets; (ii) prioritizing
the
current products and services in terms of which have near term market
opportunities versus longer term opportunities; (iii) identifying strategic
business partners that are already serving those markets and customers so
that
SYS can form strategic relationships with those firms that would provide
access
to the customers without SYS having to develop its own channels; (iv) developing
sales and marketing collateral materials to promote and market these products
and services and (v) creating visibility for SYS’s solutions to prospective end
users and obtaining their feedback as we begin the process of launching and
rolling out products to the market.
To
this
end, SYS has made expenditures to build a sales and marketing organization
with
expertise in our targeted markets and to help develop and expand the selling
capabilities and strategies of our acquired businesses. A significant element
of
this strategy is to educate our sales and marketing personnel on all the
SYS
products and capabilities in order to broaden our reach and to capitalize
on
existing customer relationships.
A
significant area of emphasis for SYS in the near term is to work with state
and
local municipalities and agencies to develop grant or other funding vehicles
that will enable them to initiate pilot demonstrability projects where we
can
install the Vigilys incident management solution for use by their first
responder organizations and then seek additional funding for full deployment
and
roll-outs into multi-jurisdictional areas.
A
key
objective over the long term is to seek opportunities where we can bundle
more
of our capabilities to solve a customer need both in the government and
commercial markets. A few examples demonstrating this objective are: (i)
selling
Vigilys together with our video surveillance products; (ii) selling our IP
Encapsulators/multiplexers together with our e-learning and learning management
solutions; (iii) selling our network management software together with our
video
related products and (iv) selling our e-learning and training solutions to
provide customer support and to maintain the long term interaction with our
customers.
Research, Engineering and
Development Expenses
During
fiscal 2007 we have significantly increased our research, engineering and
development (R&D) activities associated with our newly developing product
lines. R&D expenses for the years ended June 30, 2007, 2006 and 2005 were
$4.0 million, $3.6 million, and $0.7 million, respectively.
During
the past year we have invested in both new product activities and sustaining
engineering activities. Areas of focus included further development of our
Vigilys
TM
software
based tactical operations system and expanded capabilities to our various
enterprise video solutions products.
COMPETITIVE
CONDITIONS
DSG
A
significant portion of our business is awarded through competitive procurements.
The engineering and management services industry consists of many companies
with
which SYS competes and who can provide the same or similar type of services.
Many of our competitors are larger and have greater financial resources than
we
do. We obtain much of our business on the basis of proposals to new and existing
customers. Competition usually centers on successful past performance, technical
capability, management, personnel experience and price.
SYS
has
many competitors who compete for the same customers. They are competent,
experienced and continuously working to take work and projects away from
SYS.
These competitors range in size from small businesses to multi-billion dollar
corporations. Much of our business is long term and continuous. We recognize
that the SYS niche areas are desirable to other professional service firms,
and
we continuously seek to improve within these niches.
Competition
is intense in DoD contracting. Typically, work is contracted to experienced
incumbents who have existing business relationships with the contracting
organization. Breaking into new markets is difficult and time consuming.
Though
competitors have a difficult time competing in those areas where we are
entrenched, we have also experienced difficulties breaking into new DoD markets,
where competitors are entrenched. In DoD contracting, there is a blurred
line
between competitors and partners. Often companies are in competition in bidding
for one contract, while they are cooperating team members in winning another.
Generally, we face competition from three categories of competitors:
Large
DoD Contractors.
Large
DoD
contractors, such as Lockheed-Martin, Northrop Grumman, L-3 Communications,
Raytheon and others, represent serious competition to SYS in areas of systems
engineering and in-service engineering. These and others compete in information
systems and communications. Large management consulting firms compete with
us
for management consulting, strategic planning and information technology
work.
These companies also team with smaller companies. Companies in this category
include Booz, Allen & Hamilton, Bearing Point and Accenture. These
large companies can rely upon considerable monetary and labor resources to
win
government contracts. They are broadly focused in the types of work they
will
seek to obtain and are often teamed with small businesses and minority-owned
businesses in subcontract arrangements.
Mid-Tier
Competitors
.
Mid-tier competitors include NCI, Inc., MTC Technologies, Kratos, and Dynamics
Reasearch Corp.
Small
Business DoD Contractors and Small Disadvantaged DoD
Contractors.
Small
business DoD contractors are generally more focused in their contracting
strategies. They have fewer resources unless teamed with larger competitors.
However, according to DoD policy, a certain portion of DoD work is set aside
for
small businesses, creating an environment of fierce competition among these
companies for the allocated work. The U.S. Government, according to policy,
also
sets aside certain contracts for companies owned by members of statutorily
identified disadvantaged groups. Because SYS does not qualify, it cannot
compete
in this arena, except as a subcontractor to qualified businesses. These
qualified small disadvantaged businesses, however, are free to compete for
all
government issued contracts.
We
believe that the principal competitive factors in our ability to win new
business include past performance, qualifications, domain and technology
expertise, the ability to replace contract vehicles, the ability to deliver
results within budget (time and cost), reputation, accountability, staffing
flexibility, and project management expertise. We believe our ability to
compete
also depends on a number of additional factors including the ability of our
customers to perform the services themselves, and competitive pricing for
similar services.
PSSIG
We
compete for both products and services based opportunities. On the services
side
many of the same competitors and competitive factors discussed under DSG
apply
equally to the PSSIG business. With regards to products the competitors are
generally industry or market specific, with some examples as
follows:
|
·
|
Network
Management (HP OpenView; Micromuse(IBM);EMC Smarts;
SolarWinds)
|
|
·
|
Video
Surveillance(Honeywell; Kalatel (G.E.);I3DVR;
ImageVault)
|
|
·
|
Digital/Audio
Broadcast (Tandberg; Thompson; Helius;
Wegener)
|
|
·
|
E-training/learning
solutions (General Physics; Learn.com)
|
In
addition to the competitors listed above, as newer technologies are developed,
many larger companies are forming strategic alliances to pursue market
opportunities as opposed to developing their own in-house proprietary solutions.
Intellectual
Property and Other Proprietary Rights
SYS
has
filed for a number of copyright protections on several of its products. In
addition, we have also registered a number of trademarks to protect our
intellectual property.
In
connection with the acquisition of the net assets of Xsilogy, SYS acquired
two
issued patents and numerous filed pending patents. The two issued patents
are in
the fields of flow sensors and sensing pressure. The patents pending are
in the
fields of sensors and sensor network architecture.
We
believe that our intellectual property is important to our success, and we
try
to protect it as described above and through the maintenance of trade secrets.
We feel that name brand recognition will make our products and services stand
out.
However,
the steps we take to protect our intellectual property may be inadequate.
Unauthorized parties may try to disclose, obtain or use our proprietary
information, which could harm our business. Others may claim that we have
violated their proprietary rights or infringed on their intellectual property.
Any such claims could subject us to significant liability for damages and
invalidate our proprietary rights. Any efforts to protect or defend our rights
could be time-consuming and costly. Other parties may also independently
develop
similar or competing technology.
Environmental
Laws
The
Company primarily provides services to government and industry. The
Company also builds products, primarily through integrating components developed
by third parties but does not manufacture any products at this time. Therefore,
environmental laws have not materially affected the Company.
Employees
On
June
30, 2007, we employed 404 full-time employees and 37 part-time employees.
None
of these employees are subject to a collective bargaining agreement, and
there
is no union representation within SYS. We believe our employee relations
are
good.
Code
of Ethics
We
have
adopted a code of business conduct and ethics for all employees, including
our
Finance department and those with financial oversight responsibility, including
our Chief Executive Officer and Chief Financial Officer, known as the Code
of
Ethics pursuant to Section 406 of the Sarbanes-Oxley Act of 2002. The Code
of
Ethics is available on our website at
www.systechnologies.com
under
Corporate Governance.
We
intend
to disclose any amendment to, and any waiver from, a provision of the Code
of
Ethics that applies to the Chief Executive Officer or Chief Financial Officer
or
any other executive officer and that relates to any element of the Code of
Ethics definition enumerated in Item 406(b) of Regulation S-K, on
Form 8-K, within five business days following the date of such amendment or
waiver.
Available
Information
Our
Internet address is
www.systechnologies.com
.
We make
available free of charge through our internet site all of our reports, including
10-K, 10-KSB, 10-Q, 10-QSB, 8-K and 14A, and any amendments to those reports
filed or furnished pursuant to the Securities Exchange Act of 1934, the
(Exchange Act), as soon as reasonably practicable after such material is
electronically filed with, or furnished to, the SEC.
Cautionary
Note Regarding Forward-Looking Statements
All
statements other than those of historical facts included in this Annual Report
on Form 10-K, including those related to our financial outlook, liquidity,
goals, business strategy, project plans and objectives of management for
future
operating results, are forward -looking statements with in the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Such forward-looking statements can be identified by
the
use of words such as "intends, anticipates, believes, estimates, projects,
forecasts, expects, plans and proposes." We believe that the expectations
reflected in these forward-looking statements are based on reasonable
assumptions. There are a number of risks and uncertainties that could cause
actual results to differ materially from such forward-looking statements.
These
include, among others, the cautionary statements contained in Item 1A "Risk
Factors" and Item 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained elsewhere in this Annual Report on Form
10-K.
Item
1A. RISK FACTORS
We
urge you to consider the following risk factors and all other information
contained in this Annual Report on Form 10-K for the fiscal year ended June
30,
2007, and other reports and filings made with the Securities and Exchange
Commission in evaluating our business and prospects. Risks and uncertainties,
in
addition to those we describe below, that are not presently known to us or
that
we currently believe are immaterial may also impair our business operations.
If
any of the following risks occur, our business and financial results could
be
harmed, and the price of our common stock could decline. You should also
refer to the other information contained in this Annual Report on Form 10-K,
including our consolidated financial statements and related
notes.
Risks
Related to Our Business
Federal
Government contracts generally contain provisions, and are subject to laws
and
regulations, that give the Federal Government rights and remedies not typically
found in commercial contracts, including provisions permitting the Federal
Government to:
ཉ
terminate our existing contracts;
ཉ
reduce
potential future income from our existing contracts;
ཉ
modify
some of the terms and conditions in our existing contracts;
ཉ
suspend
or permanently prohibit us from doing business with the Federal Government
or
with any specific government agency;
ཉ
impose
fines and penalties;
ཉ
subject
us to criminal prosecution;
ཉ
subject
the award of some contracts to protest or challenge by competitors, which
may require the contracting federal agency or department to suspend our
performance pending the outcome of the protest or challenge and which
may also require the government to solicit new proposals for the contract
or result in the termination, reduction or modification of the awarded
contract;
ཉ
suspend
work under existing multiple year contracts and related task orders if the
necessary funds are not appropriated by Congress;
ཉ
decline
to exercise an option to extend an existing multiple year contract;
and
ཉ
claim
rights in technologies and systems invented, developed or produced by
us.
The
Federal Government may terminate a contract with us either “for
convenience” (for instance, due to a change in its perceived needs or its desire
to consolidate work under another contract) or if we default by failing to
perform under the contract. If the Federal Government terminates a contract
with us for convenience, we generally would be entitled to recover only our
incurred or committed costs, settlement expenses and profit on the work
completed prior to termination. If the Federal Government terminates a contract
with us based upon our default, we generally would be denied any recovery
for
undelivered work, and instead may be liable for excess costs incurred by
the Federal Government in procuring undelivered items from an alternative
source
and other damages as authorized by law.
Our
Federal Government contracts typically have terms of base year and one or
more
option and award years. Many of the option periods cover more than half of
the
contract’s potential term. Federal governmental agencies generally have the
right not to exercise options to extend a contract. A decision to terminate
or
not to exercise options to extend our existing contracts could have a material
adverse effect on our business, prospects, financial condition and results
of
operations.
Certain
of our Federal Government contracts also contain “organizational conflict of
interest” clauses that could limit our ability to compete for certain related
follow-on contracts. For example, when we work on the design of a particular
solution, we may be precluded from competing for the contract to install
that
solution. While we actively monitor our contracts to avoid these conflicts,
we
cannot guarantee that we will be able to avoid all organizational conflict
of
interest issues.
If
we fail to establish and maintain important relationships with government
entities and agencies, our ability to successfully bid for new business may
be
adversely affected.
To
develop new business opportunities, we primarily rely on establishing and
maintaining relationships with various government entities and agencies.
We may
be unable to successfully maintain our relationships with government entities
and agencies, and any failure to do so could materially adversely affect
our
ability to compete successfully for new business.
Failure
to maintain strong relationships with other government contractors could
result
in a decline in our revenue.
In
our
federal business we often act as a subcontractor or in “teaming” arrangements in
which we and other contractors bid together on particular contracts or programs.
As a subcontractor or team member, we often lack control over fulfillment
of a
contract, and poor performance on the contract could tarnish our reputation,
even when we perform as required. We expect to continue to depend on
relationships with other contractors for a portion of our revenue in the
foreseeable future. Moreover, our revenue and operating results could be
materially adversely affected if any prime contractor or teammate chooses
to
offer a client services of the type that we provide or if any prime contractor
or teammate teams with other companies to independently provide those
services.
We
cannot guarantee that our contracts will result in actual
revenue.
There
can
be no assurance that our contracts will result in actual revenue in any
particular period, or at all, or that any contract will be profitable. The
actual receipt and timing of any revenue is subject to various contingencies,
many of which are beyond our control. The actual receipt of revenue on contracts
may never occur or may change because a program schedule could change, the
program could be canceled, a contract could be reduced, modified or terminated
early, or an option that we had assumed would be exercised not being exercised.
Further, while many of our Federal Government contracts require performance
over
a period of years, Congress often appropriates funds for these contracts
for
only one year at a time. Consequently, our contracts typically are only
partially funded at any point during their term, and all or some of the work
intended to be performed under the contracts will remain unfunded pending
subsequent Congressional appropriations and the obligation of additional
funds
to the contract by the procuring agency. Our estimates of contract value
are
based on our experience under such contracts and similar contracts. However,
there can be no assurances that all, or any, of such estimated contract value
will be recognized as revenue.
Loss
of our GSA contracts or MACs would impair our ability to attract new
business.
We
are a
prime contractor under several GSA Schedule contracts and MAC contracts.
We
believe that our ability to continue to provide services under these contracts
will continue to be important to our business because of the multiple
opportunities for new engagements each contract provides. If we were to lose
our
position as prime contractor on one or more of these contracts, we could
lose
substantial revenues and our operating results could suffer. GSA contracts
and
other MACs typically have a one or two-year initial term with multiple options
exercisable at the government client’s discretion to extend the contract for one
or more years. We cannot be assured that our government clients will continue
to
exercise the options remaining on our current contracts, nor can we be assured
that our future clients will exercise options on any contracts we may receive
in
the future.
If
we fail to attract and retain skilled employees or employees with the necessary
security clearances, we might not be able to perform under our contracts
or win
new business.
The
growth of our business and revenue depends in large part upon our ability
to
attract and retain sufficient numbers of highly qualified individuals who
have
advanced information technology and/or engineering skills. These employees
are
in great demand and are likely to remain a limited resource in the foreseeable
future. Further, obtaining and maintaining security clearances for employees
involves a lengthy process, and it is difficult to identify, recruit and
retain
employees who already hold security clearances. If we are unable to recruit
and
retain a sufficient number of these employees, our ability to maintain and
grow
our business could be limited. In a tight labor market, our direct labor
costs
could increase or we may be required to engage large numbers of subcontractor
personnel, which could cause our profit margins to suffer. In addition, some
of
our contracts contain provisions requiring us to staff an engagement with
personnel that the client considers key to our successful performance under
the
contract. In the event we are unable to provide these key personnel or
acceptable substitutions, the client may terminate the contract and we may
lose
revenue.
In
addition, certain Federal Government contracts require us, and some of our
employees, to maintain security clearances. If our employees lose or are
unable
to obtain security clearances, or if we are unable to hire employees with
the
appropriate security clearances, the client may terminate the contract or
decide
not to renew the contract upon its expiration. As a result, we may not derive
the revenue anticipated from the contract, which, if not replaced with revenue
from other contracts, could seriously harm our operating results.
Our
failure to maintain appropriate staffing levels could adversely affect our
business.
We
can
not be certain that we will be able to hire the requisite number of experienced
and skilled personnel when necessary in order to service a major contract,
particularly if the market for related personnel becomes competitive.
Conversely, if we maintain or increase our staffing levels in anticipation
of
one or more projects and the projects are delayed, reduced or terminated,
we may
underutilize the additional personnel, which would increase our general and
administrative expenses, reduce our earnings and possibly harm our results
of
operations. If we are unable to obtain major contracts or effectively complete
such contracts due to staffing deficiencies, our revenues may decline and
our
business may be harmed.
If
our subcontractors fail to perform their contractual obligations, our
performance and reputation as a prime contractor and our ability to obtain
future business could suffer.
As
a
prime contractor, we often rely significantly upon other companies as
subcontractors to perform work we are obligated to perform for our clients.
As
we secure more work we expect to require an increasing level of support from
subcontractors that provide complementary and supplementary services to our
offerings. Depending on labor market conditions, we may not be able to identify,
hire and retain sufficient numbers of qualified employees to perform the
task
orders we expect to win. In such cases, we will need to rely on subcontracts
with unrelated companies. Moreover, even in favorable labor market conditions,
we anticipate entering into more subcontracts in the future as we expand
our
work under our MACs. We are responsible for the work performed by our
subcontractors, even though in some cases we have limited involvement in
that
work.
If
one or
more of our subcontractors fail to satisfactorily perform the agreed-upon
services on a timely basis or violate Federal Government contracting policies,
laws or regulations, our ability to perform our obligations as a prime
contractor or meet our clients’ expectations may be compromised. In extreme
cases, performance or other deficiencies on the part of our subcontractors
could
result in a client terminating our contract for default. A termination for
default could expose us to liability, including liability for the agency’s costs
of reprocurement, could damage our reputation and could hurt our ability
to
compete for future contracts.
Our
employees may engage in misconduct or other improper activities, which could
cause us to lose contracts.
We
are
exposed to the risk that employee fraud or other misconduct could occur.
Misconduct by employees could include intentional failures to comply with
Federal Government procurement regulations, engaging in unauthorized activities
or falsifying time records. Employee misconduct could also involve the improper
use of our clients’ sensitive or classified information, which could result in
regulatory sanctions against us and serious harm to our reputation and could
result in a loss of contracts and a reduction in revenues. It is not always
possible to deter employee misconduct, and the precautions we take to prevent
and detect this activity may not be effective in controlling unknown or
unmanaged risks or losses, which could cause us to lose contracts or cause
a
reduction in revenues.
We
may not be successful in identifying acquisition candidates and if we undertake
acquisitions, they could increase our costs or liabilities and impair our
revenue and operating results.
One
of
our strategies is to pursue growth through acquisitions. We may not be able
to
identify suitable acquisition candidates at prices that we consider appropriate.
If we do identify an appropriate acquisition candidate, we may not be able
to
successfully negotiate the terms of the acquisition or finance the acquisition
on terms that are satisfactory to us. Negotiations of potential acquisitions
and
the integration of acquired business operations could disrupt our business
by diverting management attention from day-to-day operations. Acquisitions
of
businesses or other material operations may require additional debt or equity
financing, resulting in additional leverage or dilution of ownership. We
may
encounter increased competition for acquisitions, which may increase the
price
of our acquisitions.
We
have
completed several acquisitions of complementary businesses in recent years,
and
we continually evaluate opportunities to acquire new businesses as part of
our
ongoing strategy. We may continue to expand our operations through business
acquisition. Our integration of acquisitions requires significant management
time and financial resources. Any failure to properly integrate and manage
businesses we acquire could seriously harm our operating results. In addition,
acquired companies may not perform as well as we expect, and we may
fail to realize anticipated benefits. In connection with future acquisitions,
we
may issue common stock that would dilute our current stockholders’ ownership and
incur debt and other costs which may cause our quarterly operating results
to
vary significantly.
If
we are
unable to successfully integrate companies we may acquire in the future,
our
revenue and operating results could suffer. The integration of such businesses
into our operations may result in unforeseen operating difficulties (including
incompatible accounting and information management systems), may absorb
significant management attention and may require significant financial resources
that would otherwise be available for the ongoing development or expansion
of
our business. These difficulties of integration may require us to coordinate
geographically dispersed organizations, integrate personnel with disparate
business backgrounds and reconcile different corporate cultures. In certain
acquisitions, federal acquisition regulations may require us to enter into
government novation agreements, a potentially time-consuming process. In
addition, we may not be successful in achieving the anticipated synergies
from
these acquisitions, including our strategy of offering our services to clients
of acquired companies to increase our revenue. We may experience increased
attrition, including, but not limited to, key employees of the acquired
companies, during and following the integration of acquired companies that
could
reduce our future revenue.
In
addition, we may need to record write-downs from future impairments of
identified intangible assets and goodwill, which could reduce our future
reported earnings. Acquired companies may have liabilities or adverse operating
issues that we fail to discover through due diligence prior to the acquisition.
In particular, to the extent that prior owners of any acquired businesses
or
properties failed to comply with or otherwise violated applicable laws or
regulations, or failed to fulfill their contractual obligations to the Federal
Government or other clients, we, as the successor owner, may be financially
responsible for these violations and failures and may suffer reputational
harm
or otherwise be adversely affected. The discovery of any material liabilities
associated with our acquisitions could cause us to incur additional expenses
and
cause a reduction in our operating profits.
The
Small
Business Administration (SBA) has enacted new regulations which will require
small businesses to recertify their size standard within thirty days of any
sale
or merger. It is highly likely that any company we may acquire will have
small
business contracts. These new regulations may impact our ability to retain
all
of the contracts of an acquired business.
Our
cash flow and profitability could be reduced if expenditures are incurred
prior
to the receipt of a contract.
We
provide various professional services and sometimes procure equipment and
materials on behalf of our Federal Government customers under various
contractual arrangements. From time to time, in order to ensure that we satisfy
our customers’ delivery requirements and schedules, we may elect to commence
services or initiate procurement in advance of receiving final authorization
from the government customer or a prime contractor. In that event, if our
government or prime contractor customers’ requirements change we may not be able
to recover our costs. This could reduce anticipated earnings or result in
a
loss, negatively affecting our cash flow and profitability.
A
preference for minority-owned, small and small disadvantaged businesses could
impact our ability to be a prime contractor on certain governmental
procurements.
As
a
result of an SBA set-aside program, the Federal Government may decide to
restrict certain procurements to bidders that qualify as minority-owned,
small
or small disadvantaged businesses. As a result, we would not be eligible
to
perform as a prime contractor on those programs and would be restricted to
a
maximum of 49% of the work as a subcontractor on those programs. An increase
in
the amount of procurements under the SBA set-aside program may impact our
ability to bid on new procurements or restrict our ability to recompete on
incumbent work that is placed in the set-aside program.
We
derive a significant portion of our revenues from a limited number of
customers.
We
have
derived, and believe that we will continue to derive, a significant portion
of
our revenues from a limited number of customers. To the extent that any
significant customer uses less of our services or terminates its relationship
with us, our revenues could decline significantly. As a result, the loss
of any
significant customer could seriously harm our business. For the fiscal year
ended June 30, 2007, approximately 88% of our business was derived from
contracts with government agencies and 12% was derived from commercial
customers. None of our customers are obligated to purchase additional services
from us. As a result, the volume of work that we perform for a specific customer
is likely to vary from period to period, and a customer that is significant
in
one period may not use our services in a subsequent period.
Our
business is dependent upon our ability to keep pace with the latest
technological changes.
The
market for our services is characterized by rapid change and technological
improvements. Failure to respond in a timely and cost effective way to these
technological developments would result in serious harm to our business and
operating results. We have derived, and we expect to continue to derive,
a
substantial portion of our revenues from providing innovative engineering
services and technical solutions that are based upon today’s leading
technologies and that are capable of adapting to future technologies. As
a
result, our success will depend, in part, on our ability to develop and market
service offerings that respond in a timely manner to the technological advances
of our customers, evolving industry standards and changing client
preferences.
A
significant number of our customers are government agencies which are subject
to
unique political and budgetary constraints and have special contracting
requirements that may affect our ability to obtain other new government
customers.
A
significant number of our customers are government agencies, principally
DoD
agencies. These agencies often do not set their own budgets and therefore
have
little control over the amount of money they can spend. In addition, these
agencies experience political pressure that may dictate the manner in which
they
spend money. Due to political and budgetary processes and other scheduling
delays that frequently occur in the contract or bidding process, some government
agency orders may be canceled or substantially delayed, and the receipt of
revenues or payments may be substantially delayed.
In
addition, future sales to government agencies will depend on our ability
to meet
government contracting requirements, certain of which may be onerous or
impossible to meet, resulting in our inability to obtain particular contracts.
Common requirements in government contracts include bonding, provisions
permitting the purchasing agency to modify or terminate the contract at-will
and
without penalty and provisions permitting the agency to perform investigations
or audits of our business practices.
The
U.S. Government has a program that encourages and sometimes requires large
prime
contractors to use small businesses. The U.S. Government restricts the
competition on some contracts to qualifying small businesses. Some of our
contracts and subcontracts have been awarded based on our eligibility as
a small
business. The definition of a small business depends on the type of product
or
service being provided. The U.S. Government uses North American Industry
Classification System (NAICS) codes to classify the small business size
standards for all industries. One of our primary NAICS codes was for engineering
services, and beginning in fiscal year 2005, we no longer qualified as a
small
business using this code. However, we still qualify as a small business using
several other NAICS codes. In addition, the small business contracts currently
held by us do not terminate as a result of our no longer qualifying as a
small
business under any specific NAICS Code, and any option years on these contracts
are also not affected by a change in small business status. Nevertheless,
it is
possible that our future revenues may be adversely impacted by our recent
growth
and consequent failure to qualify as a small business under certain NAICS
codes.
Our
quarterly operating results may fluctuate significantly as a result of factors
outside of our control, which could cause the market price of our common
stock
to decline.
We
expect
our revenue and operating results to vary from quarter to quarter. As a result,
our operating results may fall below the expectations of securities analysts
and
investors, which could cause the price of our common stock to decline. Factors
that may affect our operating results include those listed in this “Risk
Factors” section and others such as:
ཉ
fluctuations in revenue recognized on contracts;
ཉ
variability in demand for our services and solutions;
ཉ
commencement, completion or termination of contracts during any particular
quarter;
ཉ
timing
of award or performance incentive fee notices;
ཉ
timing
of significant bid and proposal costs;
ཉ
variable purchasing patterns under the GSA Contracts, government wide
acquisition contracts (MACs), blanket purchase agreements and other Indefinite
Delivery/Indefinite Quantity (ID/IQ) contracts;
ཉ
strategic decisions by us or our competitors, such as acquisitions,
divestitures, spin-offs and joint ventures;
ཉ
strategic investments or changes in business strategy;
ཉ
changes
in the extent to which we use subcontractors or the timing of receipt of
invoices from subcontractors;
ཉ
seasonal fluctuations in our staff utilization rates;
ཉ
Federal
Government shutdowns or temporary facility closings;
ཉ
fluctuations in demand for outsourced network services or engineering
services;
ཉ
changes
in our effective tax rate including changes in our judgment as to the necessity
of the valuation allowance recorded against our deferred tax assets,
and
ཉ
the
length of sales cycles.
Reductions
in revenue in a particular quarter could lead to lower profitability in that
quarter because a relatively large amount of our expenses are fixed in the
short-term. We may incur significant operating expenses during the start-up
and
early stages of large contracts and may not be able to recognize corresponding
revenue in that same quarter. We may also incur additional expenses when
contracts expire, are terminated or are not renewed.
In
addition, contract awards of government agencies may be delayed or decreased
as
a result of failures of government budgets to gain congressional and
administration approval in a timely manner. The Federal Government’s fiscal year
ends September 30. If a federal budget for the next federal fiscal year has
not been approved by that date in each year, our clients may have to suspend
engagements that we are working on until a budget has been approved. Any
such
suspensions may reduce our revenue in our second or third fiscal quarter
of that
year. The Federal Government’s fiscal year end can also trigger increased
purchase requests from clients for equipment and materials. Any increased
purchase requests we receive as a result of the Federal Government’s fiscal year
end would serve to increase our first or second quarter revenue.
Our
inability to adequately retain or protect our employees, customer relationships
and proprietary technology could harm our ability to
compete.
Our
future success and ability to compete depends in part upon our employees
and
their customer relationships, as well as our proprietary technology and
trademarks, which we attempt to protect with a combination of patent, copyright,
trademark and trade secret claims, as well as with our confidentiality
procedures and employee contract provisions. These legal protections afford
only
limited protection and are time-consuming and expensive to obtain and/or
maintain. Further, despite our efforts, we may not prevent third parties
from
soliciting our employees or customers or infringing upon or misappropriating
our
intellectual property. Our employees, customer relationships and intellectual
property may not provide us with a competitive advantage adequate to prevent
competitors from entering the markets for our products and services.
Additionally, our competitors could independently develop non-infringing
technologies that are competitive with, and equivalent or superior to, our
technology. Monitoring infringement and/or misappropriation of intellectual
property can be difficult, and it is possible that we would not detect an
infringement or misappropriation of our proprietary rights. Even if we were
to
detect an infringement or misappropriation of our proprietary rights, litigation
to enforce these rights would be costly and would cause us to divert financial
and other resources from our normal business operations.
The
departure of certain key personnel could affect the financial condition of
SYS
due to the loss of their expertise and customer
relationships.
Certain
key employees are intimately involved in our business and have day-to-day
relationships with critical customers. Competition for highly skilled business,
product development, technical and other personnel is intense, and we may
not be
successful in recruiting new personnel or in retaining our existing personnel.
A
failure on our part to retain the services of these key personnel could have
a
material adverse effect on our operating results and financial condition.
We do
not maintain key man life insurance on any of our employees with the exception
of our CEO.
We
face intense competition from many competitors that have greater resources
than
we do, which could result in price reductions, reduced profitability or loss
of
market share.
We
operate in highly competitive markets and generally encounter intense
competition to win contracts from many other firms, including mid-tier federal
contractors with specialized capabilities and large defense and IT services
providers. Competition in our markets may increase as a result of a number
of
factors, such as the entrance of new or larger competitors, including those
formed through alliances or consolidation. These competitors may have greater
financial, technical, marketing and public relations resources, larger client
bases and greater brand or name recognition than we do. These competitors
could,
among other things:
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divert
sales from us by winning very large-scale government contracts, a
risk
that is enhanced by the recent trend in government procurement practices
to bundle services into larger contracts forcing us to charge lower
prices; or
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·
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adversely
affect our relationships with current clients, including our ability
to
continue to win competitively awarded engagements in which we are
the
incumbent.
|
If
we
lose business to our competitors or are forced to lower our prices, our revenue
and our operating profits could decline. In addition, we may face competition
from our subcontractors who, from time-to-time, seek to obtain prime contractor
status on contracts for which they currently serve as a subcontractor to
us. If
one or more of our current subcontractors are awarded prime contractor status
on
such contracts in the future, it could divert sales from us or could force
us to
charge lower prices, which could cause our margins to suffer.
Accuracy
of indirect billing rates is critical.
Our
provisional indirect billing rates are approved at least annually by the
Defense
Contract Management Agency (DCMA) after being reviewed by the Defense Contract
Audit Agency (DCAA). These rates can differ from our actual indirect
rates. We budget to have our actual indirect rates as close as possible to
our government approved indirect rates at fiscal year end. Throughout the
year, management assesses how these rates compare to forecasted rates for
the
year. If a variance is expected to exceed the amount to be billed,
provisions for such variance are recognized at that time.
For
interim reporting purposes, SYS applies overhead and selling, general and
administrative expenses as a percentage of direct contract costs based on
annual
budgeted indirect expense rates. To the extent actual expenses for an interim
period are greater than the budgeted rates, the variance is deferred if
management believes it is probable that the variance will be absorbed by
planned
contract activity. This probability assessment includes projecting whether
future indirect costs will be sufficiently less than the annual budgeted
rates
or can be absorbed by seeking increased billing rates applied on cost-plus-fee
contracts. At the end of each interim reporting period, management assesses
the
recoverability of any amount deferred to determine if any portion should
be
charged to expense. In assessing the recoverability of variances deferred,
management takes into consideration estimates of the amount of direct labor
and
other direct costs to be incurred in future interim periods, the feasibility
of
modifications for provisional billing rates, and the likelihood that an approved
increase in provisional billing rates can be passed along to a customer.
If
assumptions about the probability of recovering deferred variances change,
deferred amounts could be expensed and such expenses could have a material
adverse effect on the results of operations.
If
we are unable to obtain or maintain security clearances, we may not be able
to
perform certain work.
If
we
cannot obtain the necessary security clearances, we may not be able to perform
classified work for the government and our revenues may be adversely affected.
Certain government contracts require our facilities and some of our employees
to
maintain security clearances. If we lose or are unable to obtain security
clearances required for a particular contract, the client can terminate the
contract or decide not to renew it upon its expiration. As a result, to the
extent we cannot obtain the required security clearances for our employees
working on a contract, we may not derive the revenue anticipated from that
contract. Any such reduction in revenue, if not replaced with revenue from
other
contracts, could seriously harm our operating results.
Security
breaches in sensitive government systems could result in the loss of clients
and
negative publicity. Many of the systems we develop involve managing and
protecting information involved in national security and other sensitive
government functions. A security breach in one of these systems could cause
serious harm to our business, could result in negative publicity and could
prevent us from having further access to such critically sensitive systems
or
other similarly sensitive areas for other government clients.
There
are risks associated with our planned growth, such as a possible inability
to
manage our growth.
We
plan
to grow our revenues and profits by adding to our existing customer base
through
organic growth and by the acquisition of other government services and
government or commercial technology related companies. Over the past five
years
we have hired senior management personnel capable of establishing new business
units within SYS. Rapid expansion through internal growth has required
additional capital resources. We plan to continue this approach to building
our
business. There can be no assurances that such an approach will result in
profitability in the future.
We
may incur impairment charges in our reporting entities which could harm our
profitability.
In
accordance with Statement of Financial Accounting Standards, or SFAS,
No. 142, “Goodwill and Other Intangible Assets,” we periodically review the
carrying values of our goodwill to determine whether such carrying values
exceed
the fair market value. Our acquired companies are subject to annual review
for
goodwill impairment. If impairment testing indicates that the carrying value
of
a reporting unit exceeds its fair value, the goodwill of the reporting unit
is
deemed impaired. Accordingly, an impairment charge would be recognized for
that
reporting unit in the period identified, which could reduce our
profitability.
We
have
recorded significant non-cash charges in the past and will incur significant
non-cash charges in the future related to the amortization of acquired
technology and intangible assets from past acquisitions. We may also incur
non-cash charges in future periods related to impairments of long-lived assets.
During fiscal 2006, we recorded non-cash impairment charges of approximately
$1.3 million. To achieve profitability in the future, we must grow our revenue
sufficiently to cover our business expenses. Our failure to achieve
profitability in the future could cause our stock price to decline and may
lead
to additional impairment charges.
We
may be subject to additional income tax obligations arising from Internal
Revenue Service (IRS) examinations
The
Internal Revenue Service (IRS) is currently examining the Company’s federal
income tax return for the year ended June 30, 2004. The Company expects the
IRS
examination to be completed in fiscal 2008. The Company has reclassified
an
amount from deferred taxes to income taxes payable and accrued a provision
for
interest which it believes is adequate in relation to any potential adjustments.
These amounts may be adjusted when there is more information available or
an
event occurs that indicates a change is required. We believe any further
adjustment identified at the completion of the IRS examination will result
in a
further reclassification between current deferred taxes and income taxes
payable.
We
have very limited funds upon which to rely for adjusting to business variations
and for growing new businesses.
While
we
are likely to look for new funding to assist in the acquisition of businesses,
it is uncertain whether such funding will be available. Our substantial reliance
on our revolving line of credit facility with Comerica Bank - California
imposes
certain limitations on us, such as complying with financial covenants. If
we are
to grow and expand our operations, we will need to raise significant amounts
of
additional capital. We may not be successful in raising additional capital
on
reasonable terms. If we do raise additional capital, our existing shareholders
may incur substantial and immediate dilution. The net loss reported for the
fiscal years ended June 30, 2007 and 2006 may further impact our ability
to
raise capital.
As
of
June 30, 2007, there was $3.1million of convertible notes payable that mature
in
February 2009. The notes are convertible into SYS common stock at the rate
of
$3.60 per share. The Company may have to use its funds to pay these notes
when
they mature if the holders do not elect to convert notes into common
stock.
We
may violate financial covenants under our line of credit which could have
a
material adverse effect on our liquidity and financial condition.
SYS
must
maintain certain financial covenants, including tangible effective net worth,
current assets to current liabilities, minimum tangible net worth and the
ratio
of cash flow to the current portion of long-term debt. As of June 30, 2007
the
Company was in compliance with these covenants. We anticipate we will be
in
compliance with the modified covenants through the expiration date of the
credit
facility based on our operating budget for fiscal 2008. We intend to renew
or
replace the credit facility prior to its expiration date of December 31,
2008.
If we are not able to remain in compliance with the financial covenants,
the
lender may require the Company to pay the outstanding balance and cancel
the
credit facility which would have a material impact on our financial condition,
results of operations and cash flows.
We
are required to evaluate our internal control over financial reporting under
section 404 of the Sarbanes Oxley act of 2002, and any adverse results from
such
evaluation could result in a loss of investor confidence in our financial
reports and have an adverse effect on our stock
price.
Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, we will be required to
furnish
a report by our management on our internal control over financial reporting,
beginning with our Annual Report on Form 10-K for the fiscal year ending
June
30, 2008. Such a report will contain, among other matters, an assessment
of the
effectiveness of our internal control over financial reporting as of the
end of
our fiscal year. This assessment must include disclosure of any material
weaknesses in our internal control over financial reporting identified by
management.
The
Committee of Sponsoring Organizations of the Treadway Commission (COSO) provides
a framework for companies to assess and improve their internal control systems.
The Public Company Accounting Oversight Board's Auditing Standard No. 5
("Standard No.
5")
provides the professional standards and related performance guidance for
auditors to attest to, and report on, management's assessment of the
effectiveness of internal control over financial reporting under Section
404.
Management's assessment of internal controls over financial reporting requires
management to make subjective judgments and some of the judgments will be
in
areas that may be open to interpretation and therefore the report may be
uniquely difficult to prepare, and our auditors may not agree with management's
assessments. We are still performing the system and process documentation
and
evaluation needed to comply with Section 404, which is both costly and
challenging.
During
this process, if our management identifies one or more material weaknesses
in
our internal control over financial reporting, we will be unable to assert
such
internal control is effective. If we are unable to assert that our internal
control over financial reporting is effective as of June 30, 2008 (or if
our
auditors are unable to express an opinion on the effectiveness of our internal
controls), we could lose investor confidence in the accuracy and completeness
of
our financial reports, which would have an adverse effect on our stock
price.
We
cannot
be certain as to the timing of completion of our evaluation, testing and
any
required. If we are not able to complete our assessment under Section 404
in a
timely manner, we may be unable to conclude that our internal control over
financial reporting is effective as of June 30, 2008.
Risks
Related to the Market for Our Stock
There
are a large number of shares that are available for future sale, and the
sale of
these shares may depress the market price of our common
stock.
As
of
June 30, 2007, we had issued 19,231,949 shares of common stock. Up to 2,131,700
shares of common stock were issuable upon the exercise of employee stock
options
at prices ranging from $1.23 to $4.90 per share, 868,000 shares were issuable
upon the conversion of convertible notes at $3.60 per share, 313,401 shares
were
issuable upon the exercise of warrants at $2.50 per share, 50,000 shares
were
issuable upon the exercise of warrants at $3.85 per share, 110,000 shares
were
issuable upon the exercise of warrants at $4.00 per share, 20,000 shares
were
issuable upon the exercise of warrants at $2.44 per share and up to 3,475,613
shares were contingently issuable under earn-out provisions in various
acquisition transactions. Sales of shares issued upon any conversion of our
outstanding convertible notes or upon the exercise of outstanding options
and
warrants could adversely affect the market price of our common
stock.
There
is a limited market for our common stock which could impact your ability
to sell
your shares.
Our
common stock is traded on the American Stock Exchange. Trading in our common
stock has been sporadic, and at present, there is a limited market for the
stock. We cannot predict whether a stronger market will develop. Even if
such a
market does develop, it may not be sustained. There are no analysts currently
covering the Company.
Future
sales of our common stock by existing shareholders under Rule 144 could decrease
the trading price of our common stock.
As
of
June 30, 2007, a total of 8,253,755 shares of our outstanding common stock
were
“restricted securities” and could be sold in the public markets only in
compliance with Rule 144 adopted under the Securities Act of 1933 or other
applicable exemptions from registration. Rule 144 provides that a person
holding
restricted securities for a period of one year may thereafter sell, in brokerage
transactions, an amount not exceeding in any three-month period the greater
of
either (i) 1% of the issuer’s outstanding common stock or (ii) the
average weekly trading volume in the securities during a period of four calendar
weeks immediately preceding the sale. Persons who are not affiliated with
the
issuer and who have held their restricted securities for at least two years
are
not subject to the volume limitation. Possible or actual sales of our common
stock by present shareholders under Rule 144 could have a depressive effect
on
the price of our common stock.
Our
directors, executive officers and affiliated persons beneficially own a
significant amount of our stock, and their interests could conflict with
yours.
As
of
June 30, 2007, our directors, executive officers and
affiliated
persons beneficially own approximately 27% of our common stock, including
stock
options exercisable within 60 days of June 30, 2007. As a result, our executive
officers, directors and affiliated persons will have a significant ability
to:
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elect
or defeat the election of our directors;
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amend
or prevent amendment of our articles of incorporation or
bylaws;
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effect
or prevent a merger; sale of assets or other corporate transactions;
and
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control
the outcome of any other matters submitted to the shareholders for
vote.
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As
a
result of their ownership and positions, our directors, executive officers,
and
affiliated persons, collectively, are able to significantly influence all
matters requiring shareholder approval, including the election of directors
and
approval of significant corporate transactions. In addition, sales of
significant amounts of shares held by our directors and executive officers
and
affiliated persons, or the prospect of these sales, could adversely affect
the
market price of our common stock. Management’s stock ownership may discourage a
potential acquirer from making a tender offer or otherwise attempting to
obtain
control of us, which in turn could reduce our stock price or prevent our
shareholders from realizing a premium over our stock price.
Risks
Related to Our Industry
Our
revenue and operating profits could be adversely affected by significant
changes
in the contracting or fiscal policies of the Federal
Government.
We
depend
on continued Federal Government expenditures on intelligence, defense and
other
programs that we support. Accordingly, changes in Federal Government contracting
policies could directly affect our financial performance. In addition, a
change
in presidential administrations, congressional majorities or in other senior
Federal Government officials may negatively affect the rate at which the
Federal
Government purchases IT services. The overall U.S. defense budget declined
from
time-to-time in the late 1980s and the 1990s. While spending authorizations
for
intelligence and defense-related programs by the Federal Government have
increased in recent years, future levels of expenditures and authorizations
for
those programs may decrease, remain constant or shift to programs in areas
where
we do not currently provide services. Among the factors that could materially
adversely affect us are:
ཉ
budgetary constraints affecting Federal Government spending generally, or
specific departments or agencies in particular, and changes in fiscal policies
or available funding;
ཉ
changes
in Federal Government programs or requirements, including the increased use
of
small business providers;
ཉ
curtailment of the Federal Government’s use of professional services
providers;
ཉ
the
adoption of new laws or regulations;
ཉ
Federal
Governmental shutdowns (such as that which occurred during the Federal
Government’s 1996 fiscal year) and other potential delays in the government
appropriations process;
ཉ
delays
in the payment of our invoices by Federal Government payment offices due
to
problems with, or upgrades to, Federal Government information systems, or
for
other reasons;
ཉ
competition and consolidation in the IT industry;
ཉ
general
economic conditions; and
ཉ
a
reduction in spending or shift of expenditures from existing programs, and
a
failure of Congress to pass adequate supplemental appropriations to pay for
an
international conflict or related reconstruction efforts.
These
or
other factors could cause Federal Governmental agencies, or prime contractors
for which we are acting as a subcontractor, to reduce their purchases under
contracts, to exercise their right to terminate contracts or not to exercise
options to renew contracts, any of which could cause our revenue and operating
profits to decline.
Many
of our Federal Government clients spend their procurement budgets through
multiple award contracts under which we are required to compete for post-award
orders or for which we may not be eligible to compete and could limit our
ability to win new contracts and grow revenue.
Budgetary
pressures and reforms in the procurement process have caused many Federal
Government clients to increasingly purchase goods and services through ID/IQ
contracts, the GSA Schedule Contracts and other multiple award and/or MAC
vehicles. These contract vehicles have resulted in increased competition
and
pricing pressure, requiring us to make sustained post-award efforts to realize
revenue under the relevant contract vehicle. The Federal Government’s ability to
select multiple winners under multiple award schedule contracts, MACs, blanket
purchase agreements and other ID/IQ contracts, as well as its right to award
subsequent task orders among such multiple winners, means that there is no
assurance that these multiple award contracts will result in the actual orders
equal to the ceiling value, or result in any actual orders. We are only eligible
to compete for work (task orders and delivery orders) as a prime contractor
pursuant to MACs already awarded to us. Our failure to compete effectively
in
this procurement environment could reduce our revenue. If the Federal Government
elects to use a contract vehicle that we do not hold we will not be able
to
compete as a prime contractor.
Our
failure to comply with complex procurement laws and regulations could cause
us
to lose business and subject us to a variety of
penalties.
We
must
comply with and are affected by laws and regulations relating to the formation,
administration and performance of Federal Government contracts, which affect
how
we do business with our clients and may impose added costs on us. Among the
most
significant laws and regulations are:
ཉ
the
Federal Acquisition Regulations, and agency regulations supplemental to the
Federal Acquisition Regulations, which comprehensively regulate the formation,
administration and performance of Federal Government contracts;
ཉ
the
Truth in Negotiations Act, which requires certification and disclosure of
all
cost and pricing data in connection with contract negotiations;
ཉ
the
Cost Accounting Standards and Cost Principles, which impose accounting
requirements that govern our right to reimbursement under certain cost-based
Federal Government contracts; and
ཉ
laws,
regulations and executive orders restricting the use and dissemination of
information classified for national security purposes and the export of certain
products and technical data.
Moreover,
we are subject to industrial security regulations of the DoD and other federal
agencies that are designed to safeguard against foreigners’ access to classified
information. If we were to come under foreign ownership, control or influence,
our Federal Government clients could terminate or decide not to renew our
contracts, and our ability to obtain new contracts could be
impaired.
The
Federal Government may revise its procurement or other practices in a manner
adverse to us.
The
Federal Government may revise its procurement practices or adopt new contracting
rules and regulations, such as cost accounting standards. It could also
adopt new contracting methods relating to GSA contracts, MACs or other
government-wide contracts, or adopt new standards for contract awards intended
to achieve certain social or other policy objectives, such as establishing
new
set-aside programs for small or minority-owned businesses. In addition, the
Federal Government may face restrictions from new legislation or regulations,
as
well as pressure from government employees and their unions, on the nature
and
amount of services the Federal Government may obtain from private contractors.
These changes could impair our ability to obtain new contracts or contracts
under which we currently perform when those contracts are put up for
recompetition bids. Any new contracting methods could be costly or
administratively difficult for us to implement, and, as a result, could harm
our
operating results.
We
derive significant revenue from contracts awarded through a competitive
procurement process, which may require significant upfront bid and proposal
costs that could negatively affect our operating
results.
We
derive
significant revenue from Federal Government contracts that are awarded through
a
competitive procurement process. We expect that most of the Federal Government
business we seek in the foreseeable future will be awarded through competitive
processes. Competitive procurements impose substantial costs and present
a
number of risks, including:
ཉ
the
substantial cost and managerial time and effort that we spend to prepare
bids
and proposals for contracts that may not be awarded to us and could reduce
our
profitability; and
ཉ
the
expense and delay that we may face if our competitors protest or challenge
contract awards made to us pursuant to competitive procedures, and the risk
that
any such protest or challenge could result in the resubmission of offers,
or in
termination, reduction or modification of the awarded contract, which could
result in increased cost and reduced profitability.
In
addition, most Federal Government contract awards are subject to protest
by
competitors. If specified legal requirements are satisfied, these protests
require the Federal Government agency to suspend the contractor’s performance of
the newly awarded contract pending the outcome of the protest. These protests
could also result in a requirement to resubmit bids for the contract or in
the
termination, reduction or modification of the awarded contract.
Unfavorable
Federal Government audit results could subject us to a variety of penalties
and
sanctions, and could harm our reputation and relationships with our clients
and
impair our ability to win new contracts.
The
Federal Government, including the Defense Contract Audit Agency (DCAA), audits
and reviews our performance on contracts, pricing practices, cost structure
and
compliance with applicable laws, regulations and standards. The DCAA reviews
a
contractor’s internal control systems and policies, including the contractor’s
purchasing, property, estimating, compensation and management information
systems, and the contractor’s compliance with such policies. Any costs found to
be improperly allocated to a specific contract will not be reimbursed, while
such costs already reimbursed must be refunded. Adverse findings in a DCAA
audit
could materially affect our competitive position and result in a substantial
adjustment to our revenue and profit.
If
a
Federal Government audit uncovers improper or illegal activities, we may
be
subject to civil and criminal penalties and administrative sanctions, including
termination of contracts, forfeiture of profits, suspension of payments,
fines
and suspension or debarment from doing business with Federal Government
agencies. In addition, we could suffer serious harm to our reputation and
competitive position if allegations of impropriety were made against us,
whether
or not true. If our reputation or relationship with Federal Government agencies
were impaired, or if the Federal Government otherwise ceased doing business
with
us or significantly decreased the amount of business it does with us, our
revenue and operating profit would decline.
Item
1B. UNRESOLVED STAFF COMMENTS
Not
applicable.